Freeport-McMoRan Copper & Gold (FCX) is among the leading basic material producers around the world. Established in 1987, the Phoenix, Arizona-headquartered company has grown into a diversified mining giant. Freeport-McMoRan has interests in several mines spread around the world. As of January 2012, the company reported copper reserves of about 119.7 billion pounds. Its proven and probable reserves of gold amount to almost 24 million ounces. The company has operations in North America, South America, as well as Democratic Republic of Congo. Besides copper and gold, Freeport-McMoRan also has substantial reserves of silver and cobalt.
The demand for processed copper in emerging markets is also on the rise. However, while the demand for copper is strong, the oversupply concerns in the copper market have negatively affected the investor sentiment. Freeport-McMoRan was able to boost its earnings by about 5% in this year, but the stock lost about 17% since January.
As of the time of writing, Freeport-McMoRan stock was trading at $35.67 with a 52-week range of $28.85 - $48.96. It has a market cap of $33.9 billion. Trailing twelve month P/E ratio is 10.7, and forward P/E ratio is 7.9. P/B, P/S, and P/CF ratios stand at 2.0, 1.8, and 7.5, respectively. Operating margin is 35.2% and net profit margin is 17.2%. The company has only minor debt issues. Debt/equity ratio of 0.2 is well below the market average. Freeport-McMoRan pays okay dividends. Trailing yield is 3.16%. The forward yield is likely to be higher, as the company increased the quarterly dividends to 31.25 cents this year.
Freeport-McMoRan has a 3-star rating from Morningstar. Out of four analysts covering the company, 3 have buy, and 1 has hold rating. Wall Street has diverse opinion about the company's future. Average five-year annualized growth forecast estimate is 5%. Given the company's past growth rate of 7.5%, this is a pretty achievable target.
What is the fair value of Freeport-McMoRan given the forecast estimates? We can estimate Freeport-McMoRan's fair value using discounted earnings plus equity model as follows.
Discounted Earnings Plus Equity Model
This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5 + Disposal Value
V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r
While this formula might look scary for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my growth estimates. You can set these parameters as you wish, according to your own diligence.
Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate. In order to smooth the results, I will also take the average of ttm EPS along with the mean EPS estimate for the next year.
E0 = EPS = ($3.32 + $4.84) / 2 = $4.08
Wall Street holds diversified opinions on the company's future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 5%. Book value per share is $17.47. The rest is as follows:
Fair Value Estimator
Fair Value Range
I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for Freeport-McMoRan is between $49 and $67 per share. At a price of $35, Freeport-McMoRan is trading at a significant discount. The stock has at least 40% upside potential to reach its fair value.
While there are several companies in the copper business, Southern Copper (SCCO) is probably the closest competitor of Freeport-McMoRan. Both stocks did not perform well in this year. However, Freeport-McMoRan's annual return is deep in the red territory compared with Southern Copper. The stock disappointed its shareholders with a return -17%. When we look at the monthly performance, with a positive return of 6.5%, FCX performed better than Southern Copper, which returned only 2.5%.
Freeport McMoRan has a cheaper valuation, as its stock is trading at a relatively lower P/E ratio. FCX also has a relatively lower debt/equity ratio. However, its yield is much lower. Current yield is 3.16%. With a trailing yield of 5.13%, Southern Copper offers a much better dividend income. That is probably the reason why Freeport-McMoRan is priced with a relatively higher discount. Based on an EPS growth estimate of 8.7%, Southern Copper has a fair value range of $36 - $42. At a price of $32, it is also a cheap one based on my fair value estimates.
Freeport-McMoRan has been a nifty dividend payer. While the dividends are erratic, the company managed to boost dividends by 100% in the last 5 years. The recent increase moved the quarterly dividend to 31.25 cents from 25 cents. I expect the company to keep increasing its dividends as the global economic recovery keeps its pace.
Based on the historical valuation metrics, Freeport-McMoRan is trading at a discount. The trailing P/E ratio of 10.7 and P/B ratio of 2.0 are significantly lower than the 5-year average P/E ratio of 12.1, and P/B ratio of 3.9. Compared with the market's forward P/E ratio of 13.8, FCX is significantly undervalued. The stock looks like a deep bargain as it is trading with low valuation multiples.
Based on my FED+ valuation, SCCO is substantially undervalued. The stock has at least 40% upside potential to reach its fair valuation range. Analysts also agree with me. In agreement to what my model suggests, their target price of $49 suggests 40% upside potential. Note that, the stock is highly cyclical. Similar to other commodity producers, Freeport-McMoRan's future growth is determined by its primary commodity output. If copper prices collapse due to lower demand, then its stock might also suffer.