Freeport-McMoRan Copper & Gold Inc. (FCX) is considered as a macro bet on commodities, global GDP, and Chinese economic growth. Its stock has traditionally illustrated volatile patterns. This year, general macro concerns (like the euro debt crisis) and the risk of change in Indonesian mining laws impacted its share price negatively. In addition, the foreclosure of its operations during February and March, along with sluggish import demand from China, contributed further to the decline in the share price. However, conditions should improve as the demand from China is expected to increase, the Indonesian government is expected to honor articles in the existing Contract of Work (COW), and monetary easing policies are expected to recover the economy. All of these positive trends -- coupled with attractive potential growth opportunities, a high dividend yield, and cheap valuations -- enable us to recommend a long position in Freeport-McMoRan stock.
Industry Introduction
Copper is an industrial metal and is used, on its own or as part of alloys, for a multitude of purposes. Its major markets are building wiring, plumbing, automotive applications, and telecommunications.
According to the Copper Development Association, copper's supply will remain higher in the future because:
- The availability of major domestic deposits makes the U.S. self-sufficient in copper. Despite continuous mining, the U.S. reserve base has stayed relatively constant in previous years.
- For metals, the recycling of scrap is more energy efficient compared to mining from ores. Given the fact that copper's recycling rate is higher than any other engineering metal, it is a prime choice for recycling.
Company Description
Freeport is the world's largest publicly traded copper producer. It is also the world's largest producer of molybdenum and a significant established producer. Its upcoming projects include underground development at Grasberg, expansion at Tenke Fungurume, concentrator expansion at Cerro Verde, and mill expansion at Morenci. These developments portray Freeport's efforts to sustain its comparative advantage in the long term.
Stock Price Drivers
- Macroeconomic Conditions
Copper prices are largely dependent on the general macroeconomic environment, and so exhibit volatile trends. Since Freeport is the world's largest publicly traded copper producer, the movement in copper prices directly impacts its share price.
Copper prices have generally increased on speculation that a recovery in the Chinese economy and more measures by the U.S. Federal Reserve will strengthen demand for commodities. However, its prices suffered a slight dip two days ago as Greek election relief fades, but again jumped more than 1% yesterday on Fed stimulus hopes.
In the future, copper prices are further expected to rise due to low inventories and steady demand from China and India. Especially in China, a number of infrastructure projects have been approved, but its impact on copper prices is expected to be felt in the second half of this year.
- Imports From China
Copper imports by China, the world's largest copper consumer, have increased by 52% from January to May. However, in May, its imports dropped due to unfavorable prices and high stockpiles. Similarly, in June, the demand from China remained sluggish, but conditions are expected to improve in the second half of 2012.
- Labor Strikes and Work Interruptions
Freeport stopped production at the Grasberg mine in Indonesia, which has the world's largest copper reserves, in February and March for about two weeks. This came as a result of violence after a three-month strike at the mine over pay issues, which adversely impacted global copper supply and increased copper prices.
As a result of these work interruptions and the related temporary suspension of operations, copper production In Indonesia was affected during Q1 2012. As a result, Freeport's share price underperformed relative to S&P 500 Index from March onward. However, the operations have started to improve at the Grasberg mine recently. Still, whenever there is a threat of strike by Indonesian workers for whatever reason, Freeport's share price is affected adversely.
- Potential Changes to Mining Laws in Indonesia
The Indonesian government is considering a heavy tax of 25% on mining exports this year. However, Freeport is confident that the government will honor articles in the existing Contract of Work, according to which no changes could be made to the COW without Freeport's consent. In addition, the share price has dropped considerable since March onward to reflect the uncertainties associated with this event.
Valuation
Freeport's dividend yield of 3.7% is way above the industry average of 1.8%. Its price-to-earnings ratio of 8.6 times trails the industry average of 18.5 times. Its stock price has dropped this year, a YTD decline of almost 13%, reflecting its mine's foreclosure, sluggish Chinese demand, the worsening euro debt crisis, and risk of a high tax rate by the Indonesian government. However, there have been some recent improvements regarding the aforementioned factors, which is a healthy signal for Freeport's shareholders.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
