Is Freeport-McMoRan Copper & Gold (FCX) a "diamond in the rough" investment right now? Curt Woodworth, an analyst with Nomura, has taken the position that the company is a good buy. Even though gold prices continue to deflate and the stock is in a well-defined bearish pattern he thinks it's a good long-term buy. This is how he justifies his position:
"Freeport is entering a significant growth phase within both mining and oil/gas segments, which should result in meaningful EBITDA growth and deleveraging potential over the 2013-2016 time horizons under most commodity scenarios, in our view."
According to Mr. Woodworth, he believes the company is going to enter into a nice growth phase over the next three years, which should result in a good EBITDA. If you are unfamiliar with this acronym it means; (Earnings before Interest, Taxes, Depreciation and Amortization).
In short, EBITDA is used to determine the cash flow that is available to pay off the debts that have accrued on items against "worth" in the future like machines, and other equipment found in the company. It is a popular formula that many companies use to determine the true net worth of a company. So Mr. Woodworth believes the company is going to grow in value from both mining and its oil/gas segments over the next three years.
As an investor, if you are considering looking into a mining stock, a company such as FCX would be on your radar. The company may have an advantage - or what I would call a "differentiating factor" - over other mining companies that would be considered peers. Its advantage lies in the fact that is involved in mining and oil/gas plus having the potential for growth in both fields.
Look at some of these forecasts:
- FCX has the potential to grow copper volumes by 37% from 2012 to 2015. This will be during a time when oil/gas is expected to remain stable and self-sufficient.
- The oil/gas business has the potential to grow ~55% from 2015-2020.
If one takes these forecasts in stride, the results come out to seven years of EBITDA growth that averages out to 10%-15% per year. This growth forecast puts FCX at the forefront of its peers. This is the reason Mr. Woodworth takes the position he does on the company.
The position appears sound and logical provided we don't have any commodity price crashes.
Mining is a Risky Business
The more balanced approach of having both mining and oil/gas also gives the company better protection and also offers the investor a more balanced approach to growth. Mining can be a very high-risk venture considering the potential disasters that can take place and thus affect the value of the company overnight.
Freeport had a recent example of that in its Grasberg copper mine in Indonesia. A tragic accident that cost lives of dozens of miners resulted in the government shutting down the mine. While it investigated what happened, no metal was being extracted and many employees that were not receiving paychecks rioted, which in turn led the government to ease up on restrictions while it was still doing its investigation. FCX was allowed to restart operations on the open pit mining but not its underground facilities. This just goes to show how fragile a mining operation can be.
The FCX purchase of oil and gas drillers Plains Exploration and McMoRan Exploration brings more balance to the company when something tragic like this occurs. I live in Colorado, and I remember the Bingham Canyon copper mine in Utah, which recently had a collapse. The mine is owned by Rio Tinto (RIO) and may not be open again for another year. Starting a mine again is very expensive and the company's diversification into oil/gas would help it through difficult times that visit these types of operations unannounced.
Gas & Oil
It has turned itself into a "Diversified Resource Company." The revenue it can generate from the oil/gas company it purchased is 90% oil and liquids, while the natural gas will not do much in today's environment.
I know not everybody is happy with the $19 billion purchase/investment, but time will tell if the company made a good move. I know the company had a plan to grow its copper business through 2015 and large-scale copper operations are not discovered very easily anymore. The possibility of low interest rates could have made the purchase of the oil/gas business a valuable and strategic move.
The oil/gas business is not without risk. Even though the company has production hedges in place, natural gas prices and oil are subject to extreme highs and lows. But it looks like a good cash flow business.
Not everyone was pleased with the value of the transaction. In its report from an investor's perspective, Peter Ward, an analyst for Jefferies states:
We have studied the arguments in favor of this transaction for months; we find none of them persuasive.
But at the same time the company gave FCX a "buy" rating.
The jury is still out on Freeport-McMoRan Copper & Gold's transition from a mining operation to a "Diversified Resource Company." A lot of its future success will depend upon commodity prices but the diversification looks like it will strengthen the company and grow its EBITDA value over the next 5 to 7 years. Investors should delve deeper into this company and consider it as a possible investment.