Freeport-McMoRan could be one of the higher risk equity plays going forward in 2012 even though the fundamentals of the company look outstanding. The market may seem to be pricing in too much downside in this stock but perhaps the pricing is just a hint of the possibility of economic shocks, mine strikes, global strife and high volatility that drives participants out of the market.
Freeport-McMoRan suffers from what I like to call a double edge sword syndrome, which basically means in good times it slices apart competitors via outperformance and during declines it essentially cuts off your head quite easily. This is because the company is a global equity play (would not be considered blue chip due to high volatility in my opinion) while also being viewed as a play on copper and gold prices.
I am not going to delve into all of the negative impacts of the company and how it will impact the stock, as I am actually somewhat bullish on the company over the long term. The reason I won’t delve into the negative impacts of the company is because the events are going to be hard to predict and possibly carry a low probability of occurrence for some of them. It is better to be aware of them occurring and in broad measures of how it could impact the stock price.
Given a number of negative events occurring the stock of Freeport could easily see below $25 per share in 2012. Making any purchases of the stock in the upper $30’s a very badly timed investment that could take years to overcome.
However, if no major negative events occur then a low point could be established in the low $30’s and highs could be in the low $50’s. Fundamentally the company appears to be a rockstar and could be on pace for $4 in earnings in 2012 (could be higher if copper and gold prices increase and costs do not dramatically increase). This would put a P/E of 9.50 on the shares at $38 per share. Throw in a $1 in dividends per share an investor would receive during the 2012 fiscal year and it could be looked at as a value play if the negative scenarios do not manifest themselves.
Currently while I feel a little bullish about the company I do not want to take on a cost average in the $38 range, not given the risks that are currently out there. Possible avenues of taking a bullish stance in the company are many. Two I highlight below are plans I am either in or plan on implementing in a quick time frame.
The first bullish trade I see that offers a lot of potential is a $38-$33 1:2 put ratio trade out in January 2013. The $38 had an ask of $7.50 while the $33’s had a bid of $5.05. Net credit on the trade would be $2.60. An investor entering into this trade would not be assigned the stock long until $33 but would have $7.60 in profits ($2.60 net credit + $5.00 profit in put spread) or a cost average in Freeport-McMoRan $25.40.
The one benefit to this trade is there are a number of components in it that offer the ability to trade and move the strikes around to adjust risk throughout the year depending on what the stock price is doing. Throughout 2012 I plan on writing and updating on how to trade around this exact position.
Given the $2.60 net credit received which is over $1.60 over the annual dividend of the company, I would be looking at pairing the put spread with a call spread.
The $39-44 call spread in January 2013 would cost $2.10 net debit and yield a net profit of $2.90. This in my view carries a bit more risk as if the stock declines into the first quarter of the new year the position could be revamped at the same net debit cost but have lower strike prices on the calls (increases the probability of it being fully in the money). It may be more prudent to wait and see when to add a call spread position.
Implementing the put ratio trade and the call spread immediately offers a decent bullish view on potential profits for Freeport-McMoRan while not forcing the investor to own shares at a cost average in the $38 per share area. Given the risk and reward of the trade it may be slightly more optimal to enter into the trades at different times in my opinion.
Overall I view Freeport-McMoRan as a long-term buy that warrants some type of a bullish position that either gets you a lower cost average basis or limited risk at current prices than being outright long the stock at $38.32.
Disclosure: I am long FCX.
Additional disclosure: Not currently in any strikes mentioned in the article.