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Freeport-McMoRan (NYSE:FCX) is among the leading basic material producers around the world. Established in 1987, the Phoenix, Arizona-headquartered company has grown into a diversified mining giant. Freeport-McMoRan has interests in several mines spread around the world. As of the last quarter, the company reported recoverable and probable reserves of 120 billion pounds of copper, 34 million ounce of gold, 3.4 billion pounds of molybdenum, and 330 million ounces of silver. However, the oversupply concerns in the copper market have negatively affected the investor sentiment. While FCX was able to boost its earnings by 4.5% in this year, the stock lost almost 25% in the last 12 months.

As of the time of writing, Freeport-McMoRan stock was trading at $38.56 with a 52-week range of $28.85 - $58.75. It has a market cap of $36.8 billion. Trailing twelve month P/E ratio is 8.08, and forward P/E ratio is 7.3. P/B, P/S, and P/CF ratios stand at 2.4, 1.8, and 5.6, respectively. Operating margin is 43.4% and net profit margin is 27.5%. The company has a clean balance sheet with low debt. Debt/equity ratio is 0.23. Freeport-McMoRan is an okay dividend payer. Based on an annual dividend of $1.5, trailing yield is 3.8%.

Freeport-McMoRan has a 3-star rating from Morningstar. Out of 7 analysts covering the company, 6 have buy, and 1 has hold rating. Wall Street has diverse opinion about the company's future. Average five-year annualized growth forecast estimate is 5%. Given the company's past growth rate of 7.5%, this is an attainable target.

What is the fair value of Freeport-McMoRan given the forecast estimates? We can estimate Freeport-McMoRan's fair value using discounted earnings plus equity model as follows.

Discounted Earnings Plus Equity Model

This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:

V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5 + Disposal Value

V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]

The earnings after the last period act as a perpetuity that creates regular earnings:

Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r

While this formula might look scary for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my growth estimates. You can set these parameters as you wish, according to your own diligence.

Valuation

Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate. In order to smooth the results, I will also take the average of ttm EPS along with the mean EPS estimate for the next year.

E0 = EPS = ($4.77 + $5.39) / 2 = $5.08

Wall Street holds diversified opinions on the company's future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 5%. Book value per share is $16.50. The rest is as follows:

Fair Value Estimator

V (t=0)

E0

$5.08

V (t=1)

E0 (1+g)/(1+r)

$4.81

V (t=2)

E0((1+g)/(1+r))2

$4.55

V (t=3)

E0((1+g)/(1+r))3

$4.30

V (t=4)

E0((1+g)/(1+r))4

$4.07

V (t=5)

E0((1+g)/(1+r))5

$3.85

Disposal Value

E0(1+g)5/[r(1+r)5]

$34.98

Book Value

BV

$16.50

Fair Value Range

Lower Boundary

$62

Upper Boundary

$78

Minimum Potential

60%

Maximum Potential

103%

I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for Freeport-McMoRan is between $62 and $78 per share. At a price of $38.4, Freeport-McMoRan is trading at a significant discount. The stock has at least 60% upside potential to reach its fair value.

Peer Performance

While there are several companies in the copper business, Southern Copper (NYSE:SCCO) is probably the closest competititor of Freeport-McMoRan. Southern Copper returned 6.16% in this year, but similar to FCX, the stock's annual return is in the red territory. Southern Copper has a richer valuation, as its stock is trading at double digit P/E ratios. However, with a yield of 6.43%, it offers a much better dividend income. That is probably the reason why Southern Copper is priced with a relatively lower discount.

Based on an EPS growth estimate of 8.7%, Southern Copper has a fair value range of $38 - $43. It is also cheap, but Freeport-McMoRan is trading at a deeper discount compared to Southern Copper.

Technicals(Click to Expand)

From a technical perspective, Freeport-McMoRan has recently broken a narrow-triangle formation. At the current valuation, it is trading near the middle of its 52-week range. The stock started the new year with strong bullish momentum, but it could not stay above $42, and retreated. The relative strength index of 34 suggests that the stock is trading near the oversold territory. Those, who trade on technical indicators, should look for the stock's behavior around $42, as this price is a strong local resistance point.

Summary

Based on the historical valuation metrics, Freeport-McMoRan is trading at a discount. The trailing P/E ratio of 8.1 and P/B ratio of 2.3 are significantly lower than the 5-year average P/E ratio of 12.1, and P/B ratio of 3.9. Compared to the market's forward P/E ratio of 13.4, FCX is significantly undervalued. The stock looks like a deep bargain as it is trading with a forward P/E of 7.3.

Based on my FED+ valuation, FCX is undervalued by almost 40%. The stock has at least 60% upside potential to reach its fair valuation range. Analysts also agree with me. While not as bullish as the model suggests, their target price of $55.77 suggest almost 50% upside potential. Note that, similar to other commodity producers, Freeport-McMoRan's future growth is determined by its primary commodity output. If copper prices collapse, then FCX might also suffer.

Source: Freeport-McMoRan: 60% Upside Potential