The industry dynamics for base metals have been weak as of late, and investors are unsure on when they will bottom. Copper remains the best commodity to invest in amongst base metals, as its low supply and tight inventory has been bullish for the metal. In addition, we expect copper demand to improve as a result of positive data from construction, automotive, and housing sectors. We recommend investing in Freeport-McMoRan Copper & Gold Inc. (FCX) to play rising copper prices due to its high dividend yield, cheap valuations, and balance sheet strength.
Copper Prices Update
Unlike other base metals, copper prices have remained at fairly stable levels over the past two months, despite weak demand coming as a result of a macroeconomic meltdown. The most important reason for this apparent steadiness is a reduction in copper supply, as copper miners have failed to increase production. In addition, the inventory situation is also tighter for copper, relative to other metals, which has also strengthened copper prices.
According to Bloomberg, copper traders are the most bullish since October last year on growing expectations that central banks will take more steps to bolster economic growth. Copper stockpiles in warehouses have dropped to their lowest levels in almost four years, which makes us bullish on copper prices. Yesterday, the European Central Bank (ECB) announced that it is going to launch a bond-buying scheme to decrease the borrowing costs of European countries, which are struggling from one of the worst debt crisis. Consequently, 3-month copper on the London Metal Exchange (LME) hit a 7-week high of $7,788.5 per metric ton. On a YTD basis, copper has seen an upsurge of 2.4%, relative to a slump of 21% last year.
China remains an important player in copper markets, as it is the top copper consumer. With the recent optimistic data from its biggest trading partner (Europe), we expect China's growth to pick up, which will be beneficial for those raw materials whose main end market is China, like copper.
According to Credit Suisse metals analyst Ivan Szpakowski, "Copper has rallied pretty well, so the risk is that we could see a sell-off. September is usually one of the stronger months of the year, ahead of the October holidays (in China) so there's a seasonality effect. October will be even worse this year because you have the mid-Autumn festival and the national day holiday back-to-back, which is not always the case."
We remain bullish on copper as of now, and our favorite player is Freeport-McMoRan Copper & Gold Inc. is a macro bet on commodities in addition to being a pure play on copper.
FCX's recent quarter's earnings saw a 48% YoY decline, but once adjusted for one-time items, its per-share earnings of 80c beat expectations of 75c. The main reason for this dip was tight conditions in copper markets amidst weak demand due to the macroeconomic condition. However, the current market dynamics indicate an appropriate time to take a long position in copper, especially in FCX.
As we indicated in our previous report, the following points make us bullish on FCX:
- Balance sheet strength - Consolidated cash is $4.5 billion (debt of $3.5 billion).
- Grasberg productivity increasing - After a strike last year and a temporary shutdown at the start of this year, one of the largest copper mines is back to production.
- Increase in copper production - Copper production is expected to increase by 25% in the upcoming three years, as FCX is expanding its Brownfield projects.
Furthermore, the recent trends in housing and automotive markets have been positive, indicating a possible recovery of copper demand, which is currently facing the impact of macroeconomic contraction. The August Seasonally-Adjusted Annual Rate (SAAR) of auto sales has shown a 19.9% YoY increase to reach 14.52 million vehicles. Likewise, the housing sector continues its rebounding phase, as all three S&P Case-Shiller Home Price Indices increased simultaneously after almost 2 years, and new-home and existing-home sales have also shown upward movements. Coupled with that is a good rebounding trend shown by the Architecture Billings Index (ABI), a leading indicator of U.S. construction activity, although it still indicates a declining demand for design services.
The following table shows that FCX is a cheapest stock relative to its main competitors, Newmont Mining Corp (NEM) and Southern Copper Corp (SCCO), as its forward P/E of 7.5x and EV/EBITDA of 4.9x are the lowest of the lot. In addition, the stock is offering the highest dividend yield of 3.5%, which makes it our favorite among copper players.
Forward P/E (1 year)
Share price performance (%)