- Amidst a slowdown in China, Freeport-McMoRan has underperformed in the last two years.
- Freeport-McMoRan capital expenditure cycle is picking-up and it indicates stronger growth in the future.
- Significant investment in next 3 years in oil & gas assets will boost the EBITDA margin.
- Resumption of exports from Indonesia is another stock upside factor.
Amidst a slowdown in the Chinese economy, Freeport-McMoRan (NYSE:FCX) has struggled in the last two years. If investors look at the two year stock price chart, the company's stock is trading at almost the same level it was trading two years before.
This is big underperformance at a time when equity markets in the United States have surged. This article discusses why the underperformance might end and why Freeport-McMoRan is a good stock to consider.
Freeport-McMoRan Is Undervalued
From an investment point of view, this is the first factor to consider. Freeport-McMoRan is undervalued as compared to peers and this presents a good buying opportunity. Readers might argue that the company might remain undervalued if growth remains weak. I will discuss in the sections to come why Freeport-McMoRan is likely to grow at a stronger pace going forward.
Freeport-McMoRan is currently trading at an EV/EBITDA of 6.2, a price to sales of 1.7 and a forward PE of 13.0. The valuation is attractive as compared to Southern Copper (NYSE:SCCO), which is trading at an EV/EBITDA of 10.4, a price to sales of 4.6 and a forward PE of 15.1.
Undervaluation is understandable as the stock price has been stagnant for the last two years. I believe this is a great opportunity for long-term investors to buy a stock that also offers a dividend yield of 3.6%.
Turnaround In Capital Expenditure
A turnaround in capital expenditure is a good indicator of what the company expects going forward in terms of demand. Freeport-McMoRan's capital expenditure cycle explains this point very clearly.
In 2009 and 2010, the company's capital expenditure was $1.6 billion and $1.4 billion respectively. In 2011 and 2012, the company's capital expenditure increased to $2.5 billion and $3.5 billion respectively. In 2013, the company's capital expenditure surged to $5.3 billion.
This factor is important as the capital expenditure will translate into future growth and cash flow. A relatively low capital expenditure in 2009-2011 resulted in a not so exciting time for the company and stock. The capital expenditure started to pick up in 2012 and increased significantly in 2013. These investments will translate into higher growth in the next few years.
More than just the past capital expenditure, the coming capital expenditure will dictate the stock upside. In 2014, the company expects to incur a capital expenditure of $7.1 billion followed by a capital expenditure of $7.3 billion and $6.6 billion in 2015 and 2016 respectively.
These numbers clearly show that Freeport-McMoRan is more bullish on the future and the company is increasing its investments to meet the demand. There is a second interesting factor behind the increase in capital expenditure and I will discuss it in the next section of my analysis.
Growth From Oil & Gas Assets
Investment in oil & gas assets has been another great move by Freeport-McMoRan and this will result in more shareholder value creation over the long term. There are two reasons to be bullish on the company's investment in oil & gas assets - First, oil & gas prices will remain firm on high geo-political tensions and this is positive for all oil & gas companies. Second, Freeport-McMoRan's EBITDA margin will increase significantly as more revenue contribution comes from oil & gas business.
For 2014, the company expects 32% of the EBITDA to come from oil & gas and 68% from mining. This will change meaningfully in the future. The company has a growing production profile in established basins with proved and probable reserves of 861mmboe as of December 2013.
Of the $21 billion capital expenditure planned for 2014-16, $10.5 billion is allocated towards the oil & gas sector. With these investments, the company plans to increase oil & gas production from 38mmboe in 2013 to 78mmboe in 2016. Growth in the oil & gas sector is therefore something to watch out in the future for Freeport-McMoRan.
For 2013, the company's cash operating margin from the copper segment was 54.8% and the cash operating margin from the oil & gas segment was 77.7%. This is an indication of the kind of boost the oil & gas business growth can provide to the EBITDA margin of the company.
Resumption Of Exports From Indonesia
On July 25, 2014, Freeport-McMoRan announced the resumption of exports from Indonesia and this is another positive factor for stock upside in the near to medium-term. Freeport-McMoRan has entered into an agreement with the government under which the government has agreed to negotiate and amend the contract of work over the next six months.
Freeport-McMoRan has significant investment plans in the region, which will benefit the government of Indonesia in terms of taxes and I expect that the issue will be completely resolved over the next six months. Grasberg minerals district in Indonesia is one of the world's largest copper and gold deposits and this asset should continue to be one of the key growth drivers for the company.
The resumption of exports, turnaround in investment cycle and big investment in the oil & gas sector are some of the significant growth drivers for Freeport-McMoRan. Over the next 2-3 years, all these growth drivers will result in robust revenue and EBITDA growth for the company.
I also expect that the company's dividend payout will also increase as operating cash flows increase. Freeport-McMoRan is also keen on reducing its debt and the company is working towards this. This will be an added positive. In May 2014, Freeport-McMoRan sold Eagle Ford Shale interest to Encana for $3.1 billion. Of this, $1.4 billion was used for acquisition of deep-water GOM interest and $1.3 billion was used to repay debt. This shows that the company is committed to de-leveraging and this is just another positive factor.
In conclusion, Freeport-McMoRan is a good stock to consider at these levels for investors with a long-term investment horizon. The company has created significant shareholder value in the past and will continue to do so in the future.