Freeport-McMoRan Is Overvalued

Apr.24.08 | About: Freeport-McMoRan Inc. (FCX)

Freeport-McMoRan (NYSE:FCX), the largest publicly traded copper company, reported 1st quarter earnings Wednesday morning, before the open. The numbers were good: revenues up 24%, operating income up 62% and net income up 81%. That’s no surprise as copper prices are sky high, and their average realized price per pound was $3.69 (FCX Earnings Release (pdf file)).

However, at this point in time, I think this stock is overvalued. At $118, Freeport has a market cap of $53 billion. It earned about $3.5 billion over the last four quarters, and forecasts $3.5 billion free cash flow for 2008, which gives it a multiple around 15.

That’s already a decent multiple for a cyclical commodities business, but it also depends on commodity prices remaining sky high. Its 2008 forecast assumes $3.75 copper and $900 gold. Every $0.20 per pound change in the price of copper impacts operating cash flow by $450 million.

So, for example, a $0.60 drop in the price of copper would reduce operating cash flow by $1.35 billion. All of a sudden that 15 forward multiple becomes 25, and the stock is really expensive. Of course, if commodity prices go up the valuation is really cheaper. But I think there’s a very thin margin of error here and if copper prices come down, Freeport will get hammered.

Longer term, with 41 million proven and probable ounce of gold and 93 billion pounds of copper reserves, I believe Freeport is in excellent shape. The demand for raw materials is in a long-term bull market with the industrialization of the rest of the world, such as China, India, Russia and Brazil. These reserves are probably worth $200 billion - almost four times Freeport’s enterprise value (market cap + net debt).

But over the shorter term, I think we’ll see pressure on copper prices, and therefore on Freeport shares. If you look at the chart, it is also facing big resistance at $120 (FCX 3 Year Chart (pdf file)).

The stock has had a great run, but I can’t help thinking it has to come to an end.

Disclosure: Top Gun is short Freeport-McMoran shares.