With the stock trading irrationally 40.8% below its 52-week high, Freeport (FCX) has plenty of room to expand its respective 8.5x and 6.6x past and earnings multiples. Based on my calculation of the firm's price target, intrinsic value, and the fundamentals, I see strong returns for Freeport with minimal risk despite what the gold critics say. Barrick (ABX) and Goldcorp (GG) are similarly undervalued.
Source: Internal research. Note: Freeport's EPS over the past decade.
First, take a look at how solid Freeport has been in generating earnings. The bears would have you believe that 2008 weakness was not an isolated and singular event; but, in reality, the fundamentals have been generally consistent in the long-term. It's the long-term that matters for value investors, since anything can happen between individual quarters.
If you take a logarithmic regression of EPS over the last decade (excluding the 2008 outlier), you extrapolate 2016 EPS to be $7.49. In order to make any meaning out of this figure, an exit multiple calculation should be taken that is appreciative of peer levels and the past. As it stands, Freeport's 8.5x multiple is unusually low given that it is 61% of the sector's and contrasts to 11.1x just 26 weeks ago. Assuming a multiple of 13x and my 2016 EPS figure, the future value of the stock is $97.43. Discounting backwards by 10% yields a price target of $60.50 -- that's a staggering 76.6% margin of safety. The market seems to be factoring in an egregious discount rate close to 25%.
But the story gets even better. Freeport is a free cash flow machine even assuming slow growth that is around 700 basis points annually below what is expected for the S&P 500. In my DCF model, I assume a 4.1% growth rate over the next 6 years and 2% into perpetuity, consistent operating metrics (i.e. no improvement), and a 10% discount rate. Based on these assumptions, I find the intrinsic value to be north of $66 for 73.3% upside. This is significant value at an attractive price.
Ditto for Barrick and Goldcorp. The former, for example, has a PE multiple that is 41% of its sector's and is currently rated a 7 out of 10 on MSN Money's StockScouter Report. Performance hasn't been great of late, but it hasn't been either with more successes than misses over the last five quarters. 24.3% growth is expected in FY2013 -- an expectation that is appreciative of Barrick's fundamentals.
Interestingly, Barrick's recently ousted CEO brought in more profit per dollar of his pay than any gold peer in Canada or the United States in 2011. Not only is management better than what the market appreciates, but the company is also committed to growth. Acquisitions will help the firm spread out costs as it increases scale and thus boost margins.
While I expect less appreciation from Goldcorp, I still find the basic materials producer meaningfully undervalued. In particular, I think the firm has an impressive growth story working in its favor. The Cerro Negro project is elevated 600m above sea level and ideal for mining with 4.26 Moz of gold & growing. Drill programs at Marianas and San Marco has further boosted the potential for greater ore shoots. Execution risks at Penasquito may deter investors, but management's strength in not caving to labor interests are a long-term value driver.