Freeport-McMoRan Is Overvalued

Freeport-McMoRan (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.

Comments

[Camden:]

I'm curious why you think copper prices will fall. I heard yesterday that the analyst at Lehman thinks it's going over $6 in 2009. Do you have a rationale for your prediction?

2008 Apr 24 09:51 AM

[slim1216:]

if only your earning estimates and assumptions of current prices for copper were correct I might be worried. I won't argue you might see a pullback. It is already $10 down from the blowout earnings high. The stock has run, but nothing unusual. It barely made a 52 week high with copper prices at all time highs and the company is executing. The stock is undervalued.

2008 Apr 24 10:02 AM

[Greg Feirman1:]

Right, so my entire call is predicated on a fall in copper prices. And my call for a fall in copper prices is purely a macro call: copper prices are a good barometer for worldwide economic growth. See, for example, this wonderful article by Dan Gross:

www.slate.com/id/21300...#

As the growth slows down worldwide, I expect the edge to come off the price of copper which, it should be noted, is trading at multi year highs.

If I'm right, Freeport will selloff massively as it is essentially a huge call option on copper prices.

2008 Apr 24 12:07 PM

[Stephen Ros...:]

FCX guided to a robust 2nd half as Grasberg ore grade improves. They all but promised greater gold and copper output, something that they have been lacking the last 2 quarters. This is the time to get on board, not jump ship.

2008 Apr 24 01:16 PM

[pondee:]

Your bear case is based upon a drop in copper prices. Could you please state you reasons for believing such a drop will occur?

2008 Apr 24 05:45 PM

[jeff a:]

I'm long in fcx and while I think short term it will take some hits, global growth is multi-year and at some point the US has to do some serious infrastructure rebuilding.

2008 Apr 25 05:51 AM

[auminer:]

FCX is undervalued here simply on copper valuations. Copper supply/demand has never been tighter, and with China's rampant growth along with a growing need for India to build an infrastructure, there are no signs of copper demand slowing. Throw in high gold prices, the Climax molybdenum mine restart and you've got a recipe for continued growth. We might take some short-term licks since most, like you, feil to truly grasp the situation. But the stock will continue to vastly outperform the market, along with a possible deus ex machina from RTP, BHP, RIO, or Chalco.

2008 Apr 25 09:29 AM

[redrum:]

Wow, that certainly is one contrarian view you got going there. You have a strike in Chile, from what I read a three day world supply and you think copper prices will fall. If your short is to find a few bucks, yeah, that can happen, but if you looking for a big down side move, then I think you are in for some pain.

2008 Apr 26 04:33 PM

[iman:]

China? India? slow down? we'll see...

2008 Apr 28 09:19 AM