We wrote an article on Freeport-McMoRan Copper & Gold (FCX) back in July and discussed many reasons why we believe FCX presents a strong investment opportunity and even though the news of the company diversifying into the energy sector came as a surprise, it was time for investors to move on. Since we last wrote on FCX in July the stock is up by 15% and by 22% in the last three months. FCX has been in the news again recently particularly in relation to its Grasberg mine, the world's second biggest copper mine, in Indonesia. We reiterate our view that FCX still represents a very compelling long-term investment opportunity among copper miners and broadly within the U.S. metals and mining sector.
The largest publicly traded copper company in the world has significant growth potential and is undervalued compared to its copper peers. The concerns related to labor contract renewal uncertainty, Grasberg ramp-up execution risk, and ongoing Grasberg contract review are all overstated and are adding to the valuation gap.
Agreement With Indonesian Union Workers
There has been a lot of uncertainty surrounding the contract with Indonesian union workers over wages and pensions and a possibility of a strike if an agreement wasn't reached. However, Reuters reported earlier this month that an agreement would probably be signed by mid-October.
"We can say that in principle we have reached an agreement on pay talks with Freeport management including on wages and pensions," Juli Parorrongan, spokesman for the workers' unions, told Reuters. "The final agreement has not yet been reached because there are still several points to be discussed further." Freeport Indonesia CEO Rozik Soetjipto said talks were still ongoing over minor issues but he's 95% sure there won't be a strike.
Deleveraging and Copper Prices
Investors have also been concerned about the company's ability to de-lever following the acquisitions of PXP and MMR; however, the company's deleveraging goals look very achievable. According to a GS report published last month, the copper miner could reach its $12 billion total debt goal before year-end 2016. According to the investment management firm, FCX could have $12.4 billion in cash against $21 billion in current debt, which should be sufficient to reduce total debt to below $12 billion. The reduction in capital expenditure, asset sales, and higher volume particularly from Grasberg also provide the Phoenix, Arizona-based company opportunities to speed up its debt reduction goals.
There are also concerns about the copper pricing as the copper concentrate market is moving further into surplus but the company could offset the price weakness by higher volumes. FCX could offset a 5% decline in spot metal prices with a 6% increase in overall production or by a 25% increase in energy volumes. On the other hand, a rebound in commodity prices could provide an upside for FCX share prices.
Attractive Valuation And Dividend Yield
Finally FCX's attractive valuations and forward annual dividend yield of 3.7% also make a strong case for investment in this mining giant. The company is trading at a discount to its copper mining peers, industry average, and S&P 500. FCX has a current P/E ratio of 9.1 compared to the industry average of 13.3 and 17.0 of S&P 500. FCX has forward P/E of 11.3, compared to 15.2 of the S&P 500.
The company has price-to-book ratio of 1.7 compared to the industry average of 2.3 and FCX's own 5-year average of 3.7. It has price-to-sales ratio of 1.8 compared to the historical average of 1.9 and industry average of 2.3. Finally, FCX has a price-to-cash flow ratio of 8.8 compared to the industry average of 12.3.
In comparison Southern Copper (SCCO) has a current price-to-earnings ratio of 14.2 and a forward P/E of 16.3. SCCO has price-to-book ratio of 4.4, price-to-sales ratio of 3.7, and finally price-to-cash flow ratio of 12.7.
As stated earlier the concerns related to labor contract renewal uncertainty, Grasberg ramp-up execution risk, and ongoing Grasberg contract review are overstated and are all adding to the valuation gap. A situation like 2011, when the current Grasberg contract was being renewed and unions went on a three-month strike, is unlikely because of the wage adjustment framework put in place during the previous agreement.
We reiterate our buy rating on FCX. Freeport appears cheaper at current metal prices and is trading at a discount compared to its copper mining peers. The company is near signing a new agreement with union workers in Indonesia. The Grasberg ramp-up execution risk is also overstated. The management's guidance on Grasberg looks conservative and a full ramp-up before mid-2014 is possible. Finally better-than-expected volumes, lower political risk, and a rebound in commodity prices can provide further upside to FCX's share price.