3 Cheap Resource Companies With A P/E Of Less Than 12

Includes: AA, BP, COP, CVX, FCX, HAL, XOM
by: Global Value Investor

The following three resource companies operate at the heart of the global supply chain producing essential commodities that are without substitute for gobal growth. Each of these commodities is heavily demanded by developed and emerging markets alike and are primary inputs for the construction industry.

The first undervalued company is Alcoa (AA). The company is heavily concentrating on the production of aluminium and has a market capitalization of only $9 billion. About Alcoa, I like the focus on the aluminium value chain from exploring to transporting, marketing and selling.

Despite being cheap on an absolute level with a P/E of 11, the company pays investors a 1.43% dividend yield. In addition, EPS has increased over 112% compared to last year as the company profits from increased global construction activity. I rate Alcoa a BUY with a price target of $18 based on a premium multiple of 18 considering its strong position in the aluminium market.

The stock pattern is interesting as well: The shares currently trade at $8.42 fluctuating around its support level at $8.50. If Alcoa can resist breaking lower, the company has immediate upside potential to its upper bound of the trend canal at $9.80.

Exxon Mobil (XOM) is a US listed, S&P 500 company engaging in the exploration and production of oil and natural gas. The company also produced related petroleum products and operates the entire value chain from production to transportation and sale of those products. Exxon competes with Conoco Philips (COP), BP (BP) and Chevron (NYSE:CVX). The company operates globally with operations in the United States, Canada/South America, Europe, Africa, Asia, and Australia which allows for a very geographically diversified resource base.

Given that crude oil and natural gas are essential commodities for the technology, automobile and construction industry, I find the long-term supply/demand picture very interesting and favorable for Exxon. I also consider the crude oil explorers more attractive than their servicers, such as Halliburton (HAL) for example, because commodity margins are higher.

In addition to being well positioned to deliver on the global need for energy, the company can translate its manufacturing footprint into tangible economic success: The profit margin stands at 9% and the return on equity at a remarkable 26%. Exxon produced about $58 billion in operating cash flow, which is more than enough to fund capex and pay investors a 2.7% dividend. Despite being very profitable on an operating basis, Exxon trades at only 11x forward earnings.

I have a 2013 earnings estimate of $9 per share on the stock. Applying a multiple of 15x forward earnings, the company is materially undervalued with an intrinsic value of $135 justifying 60% upside potential.

The technical pattern illustrates that Exxon is currently trying to break its 52 week high at $87.94. If Exxon can break through its resistance range of between $86-87, the stock could have immediate momentum to reach even higher.

Another hopelessly undervalued resource company is Freeport-McMoRan (FCX). The company has a market capitalization of $31 billion and is significantly smaller than the usual S&P 500 resource company. Freeport engages in the exploration of copper, gold, silver, cobalt, molybdenum and other minerals. The company has a heavy focus on copper and its profitability is subject to changes in the underlying copper price. Freeport's share price seems to be highly correlated with the copper future prices.

I do acknowledge the relevance of copper futures for the general profitability of FCX, but disagree with the extent to which investors punish the stock for having a focus on copper. Temporary setbacks in the copper price might affect margins in the short-term, the long-term perspective remains untouched from this volatility:

Copper is a core commodity needed for the transportation, construction and technology industry. As such, there is no substitute so far that could replace the vital function that copper plays in many products. Considering a generally finit supply of copper and increasing demand, particularly from emerging markets, the supply/demand picture is quite favorable for FCX and its profitability going forward. Hence, investors should focus more on the bigger picture and stop worrying about short-term margin impacts from price fluctuations are input costs, such as labor expenses.

Freeport trades at only $33.23 and has a dirt cheap P/E of 6.74. Investors have been hit hard since the stock lost about 40% from its 52 week high of $56.78. Given a strong underlying profitability with a net profit margin of 25% and a return on book value of 26%, the stock is massively undervalued at 7x forward earnings.

Analysts estimate a 2013 average EPS of close to $5.00 on the stock. Applying a (conservative) multiple of 15x forward earnings the intrinsic value stands at $75 giving the stock about 127% upside potential.

Disclosure: I am long FCX.