At the conclusion of a week that saw the price of precious metals strengthen, the real question for Freeport-McMoRan (FCX) is how the Chinese economy will impact its stock. The firming of commodities prices is a bullish sign for Freeport, although there is not always a direct correlation between the price of precious metals and the more industrial-focused copper price; the price of copper is still down on the year but rose marginally last week and appears firm. Given that 78% of the company's revenue is derived from copper, the pricing power of this metal will have a significant impact on the price of the stock.
In terms of the China issue, there are really two questions that need to be considered by potential investors: what is the likely economic future of China over both the near and longer-term, and what impact will this result have on the company? The importance of the first question is inextricably linked to the answer to the second, meaning that if the importance of China has been overplayed as a driver for the performance of this stock, that very fact can be seen as creating a buying opportunity since there is no doubt that the Chinese slowdown has already weighed on the stock.
The Road Ahead for China
It is nothing new for investors to consider the situation in China and conclude that there are a few possible options moving forward: a continued slowdown, a full recession or even and catastrophic crash. The last of these options seems very improbable, but between the other two, much has been written arguing that a hard landing is more probable that a soft one. The case for a soft landing is based on the Keynesian idea that government spending is the silver bullet in fighting economic issues. Specifically, the International Monetary Fund (IMF) recently stated its view that China had indeed achieved a soft landing in the short-term, but needed more deep-reaching reforms to maintain this position. The report acknowledged that the challenges faced by the Chinese economy were increasing, but cited effective government intervention as a means to lessening the negative impact of the slowdown.
The argument for a hard landing is very straightforward, and takes a more critical view of China's overall position in the global economy. Firstly, export growth in the economy has decreased to an anemic 1%, restricting a key economic stimulus for the country as a whole. On an industry by industry basis, the picture is also bleak. China's top retail appliance manufacturer warned that profits are likely to fall by as much as 30%, while a major telecom equipment manufacturer warned that profits could fall by as much as 80%. The combined argument is that profits are under fire, leading to dramatic deleveraging, and that the potential safety net of government spending is spearheaded by officials known to be possessed by corruption and ulterior motives. While this may be an overly jaundiced view, it is held by many and that alone can become a driving factor.
The Impact on Freeport
As with China, the answer to the impact of China on Freeport has been mixed. On the one hand, there is little question that there has been a falloff in global demand as China has slowed. As industrial production in China decreases, the need for copper is decreased and the price of the commodity is likely to fall. The cautious argument is that until the situation with the Chinese economy is more clearly defined and understood, an investment in any company with significant exposure is problematic. In addition to Freeport, this includes Cliffs Natural Resources (CLF), Molex (MOLX) and Rio Tinto (RIO). Additionally, while less directly exposed to China, Southern Copper (SCCO) and Newmont Mining (NEM) will be affected by any developments in this market segment.
On the other end of this argument is the belief that other emerging markets will continue to grow sufficiently to mitigate reduced demand from China and keep the price of copper strong. Other infrastructure developments are also likely to have an impact. Freeport's Chief Executive Officer, Richard Adkerson, said in the company's recent earnings report that a lake of supply caused by "mine disruptions, falling grades at existing mines, and delays of constructing new mines," should be bullish factors for the price of copper. Essentially, the counter to the reduced demand argument is that there is likely to be a corresponding reduction in supply. This decrease in supply is believed to be sufficiently sizable to more than counteract the fall in demand, thus driving prices higher.
Generally speaking, Freeport is one of the more attractive companies in its space. It offers an aggressive dividend yield of 3.7% and is exceptionally well-run. On the other hand, the company has significant exposure to China and has experienced a healthy amount of price appreciation over the last few weeks: the stock has risen from a per share price of $31.43 on July 25 to recent prices around $35. If the stock is able to break $39, there is a technical argument that a breakout to much higher levels is possible, but until then, the stock has more downside than upside. With the looming headwind of China never out of the minds of investors, waiting for things to play out a bit more is prudent.