Investors looking for outperformance in the stock market need to have an edge. One way is to find stocks that are trading down for a well understood reason. Another way is to find stocks that are closely tied to macro-economic conditions, where the cycles of demand and production are fairly predictable. Or, they can simply look for companies that have a competitive advantage over their rivals. All of these characteristics apply to the copper and gold miner Freeport-McMoRan (FCX).
Freeport-McMoRan is an Arizona-based company with mining operations in North and South America, Indonesia and Africa. With more than 31,000 employees world-wide and a market cap of almost $36 billion, Freeport is no small operation. With only a 25 year history as a publicly traded company, they have grown to become one of the largest and best run mining operators in the business.
In addition to copper and gold, Freeport-McMoRan also explores for and mines silver, cobalt, molybdenum and other industrial metals. Given the global demand for these materials from growing economies like China, India and Russia, the company finds itself in a very comfortable position within this highly cyclical industry. Freeport-McMoRan competes with Newmont Mining (NEM) in the production of copper and gold, but has a superior P/E multiple to that company. It also competes with pure-play gold miner Barrick Gold (ABX), but with much better diversification. Another Arizona-based miner, Southern Copper (NYSE:SCCO) has similar metrics, but without near the number of active mines and proven reserves.
With the entire segment trading near 52-week lows, this is an attractive cohort. The fundamentals for mining and exploration companies are directly correlated to the price of the commodities that they produce. As such, there are periods where the stock price may not accurately reflect the value of the companies. Trading in a range between $30 and $57 for the past year, Freeport-McMoRan is currently trading near the bottom of its range at around $37 per share.
Freeport-McMoRan is primarily a copper mining company, with that metal comprising 73% of total reserves. Gold makes up only 5% of reserves, although it contributes more than 10% of the company's overall revenue. Silver, molybdenum and cobalt reserves make up the remaining 22% of what the company mines.
The best way to value a mining and exploration company is to examine the total proven and probable reserves in the mines which the company owns and/or leases. Freeport-McMoRan currently has 120 billion pounds of copper, 34 million ounces of gold, nearly 4 billion pounds of molybdenum, 330 million ounces of silver and 86 million pounds of cobalt proven. The result, if applied to shares issued, equates to $116 per share in total reserves.
With the stock currently trading at around $38 per share, you can begin to see the value proposition. A word of caution about the stock - it tends to have wild price swings, with a beta of around 2.5. But with such a cushion of assets why is the stock so volatile, reacting to global headlines with massive fluctuations in price? In a word - analysts.
When the Indonesian government announced on March 5th, 2012 that all foreign mining companies had 10 years to divest themselves of a controlling interest in any operations within the country, the stock fell by nearly 11%. Analysts immediately lowered their price targets and earnings estimates. This reaction may have been predictable, given the scale of Freeport-McMoRan's operations in Indonesia, but it was completely wrong. If the company slowly scales out of some of its Indonesian interests, it is highly likely to replace most of those lost reserves through new finds. Also, the Indonesian government has agreed to compensate companies for their ownership rights.
In addition, analysts have also over-reacted to recent drops in the price of gold on the world markets. While gold has been climbing steadily for the past 4 years, reaching a peak of nearly $1,900 an ounce in August of 2011, a recent pullback has caused the analyst community to drastically cut estimates for gold miners. I believe this is also wrong. While it's true that no one can predict the future gold prices, companies like Freeport are very conservative with their valuations on in-ground reserves.
The declines in both gold and copper prices will have a short-term impact on earnings for Freeport-McMoRan, but do not affect the overall demand for these materials. While growth in China may not continue in the double digits, almost everyone agrees it will be near 9% for the next five to ten years. This expansion will require the raw materials that Freeport-McMoRan produces, and will ultimately cause the prices to continue rising.
Catalysts and Momentum
Since the setbacks that the company has experienced are short-term problems, it is worth looking beyond them to catalysts that are expected to move the stock. Aside from the macro-economic influences that I have already mentioned, there are some company-specific events that will contribute to stock appreciation.
Freeport-McMoRan plans to re-open a molybdenum mine in Lake County, Colorado, that has been shut down since 1995. The Climax mine is one of the world's largest sources of molybdenum, and will produce up to 30 million pounds per year for the company. Adding to the value of this new mine is the fact that China has placed restrictions on the export of molybdenum from that country, causing prices to rise globally.
In addition, mining operations at the company's Grasberg mine in Indonesia had been affected by striking workers late last year. The hit to the bottom line from lost production was a significant 60% decline in profits in the last quarter. Since then, the strike has been halted and unionized workers are back on the job. The results should show up in the coming quarter, with an equivalent increase in profits as was lost in the previous quarter.
Finally, the company's dividend yield of 3.3% is attractive to individual investors, as well as institutional holders. With US Treasuries expected to remain at historic low levels, any return above 3% is an attractive reason to own a stock. Also, Freeport-McMoRan has increased its operating free cash flow to around $6.6 billion, making the relatively high yield look very secure.
But setting assets and catalysts aside, a simple look at the fundamentals of this well-run company will tell you all you need to know. Operator of some of the largest and best producing mines in the world; a conservative and shareholder-friendly management team; a strong track-record of returning capital to investors; and the list goes on. This is a company and a stock that is poised to benefit from improving macro conditions and global trends that are not likely to end for a decade or more. In other words, this is one to stick with.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.