Freeport, Vale, Barrick All Undervalued 'Buys'

Includes: ABX, FCX, VALE
by: Takeover Analyst

As the Fed commits America to low interest rates for at least the near-term, basic materials will continue to hedge against greater economic uncertainty. Within the basic materials sector, investors can back a variety of different industries: copper, gold, molybdenum, silver, potash, iron ore, steel, and phosphate, among others. Where diversification is advised, investors are encouraged to "keep it simple" - many stocks, like Freeport (FCX) already offer diversification across a variety of precious metals.

Gold has been one of the main ways to protect investments from economic "tail risks", or unlikely, but devastating, potential macro events. In my view, investors should consider backing some producers because they are undervalued in the sense that future growth has not been factored into the stock price. Put differently, I recommend betting on volume increases, not metal price changes--the latter of which is inherently challenging to forecast. Three basic materials that I recommend going long are Freeport, Barrick Gold (ABX), and Vale (VALE). Here's why:


Freeport is currently rated a "strong buy" according to data from While many view the basic materials firm as almost a true copper play (it contributes roughly a 10th of international mining output through copper), Freeport is actually a join bet on gold from the Indonesia Grasberg project, which several months back resolved a value destructive strike. Grasberg is currently experiencing low ore grades, and gold volumes has fallen from 2.54M oz in 2009 to 1M oz in 2012. But the good news is that volumes are expected to pick up in 2015, and I believe investors will be rewarded for patience.

All told, I believe that too much risk is being factored into the stock price. Yes, copper prices have been volatile, but Chinese inelastic demand growth will sustain elevated levels. The market is still thinking about the 2008 market response when copper fell 60% in just a few months, but investors should focus on the future and see growing demand from both emerging and developing economies. Indonesian resource nationalism is not likely given Freeport's role in supporting the broader community and political system.

The stock offers a very generous dividend yield of 3.8%. Analysts also expect EPS growth of only 5.7% in the near-term versus a record of 7.6% over the past 5 years. This means 2016 EPS of around $5.83, which, at just a 13x multiple, translates to a future stock value of $75.79. Discounting backwards by 10% yields a present value of $47.06, which is at a more than 40% premium to the current market value. The target price on the stock is even higher at $51.


Then there is Barrick and Vale. The gold producer is currently preferred over the iron ore producer on the Street, but both are still "buys" that trade at low multiples. Value currently trades at a respective 5.2x and 5.3x past and forward earnings versus corresponding figures of 7.7x and 6.3x for Barrick. Analysts forecast Vale's, the iron ore firm, EPS declining 2.5% annually over the next 5 years versus a record of 26.3% over the past 5. Consensus 2014 EPS of $3.35 implies a future stock value of $43.55 at a 13x multiple. Discounting backwards by 10% yields a present value of $27.04 - a roughly 40% premium to the current market value on top of a 3% dividend yield.

A few weeks back, Vale received an environmental license for its Carajas Serra Sul project, which removed a major headwind. This will help the company grow iron ore capacity by an expecting 30%, improve product quality, and drive value creation. Investors will now be focused on the growth story and low iron ore quality from other mines can be "mixed" with higher quality at Carajas to increase operating life.


Barrick is one of the more popular gold producers, and it is currently near its 52-week low and down in the double-digits for the year. The firm had quite a bit of managerial turnover of late with a new CFO and CEO being brought in. It is the largest pure gold producer in the world and operates in North America, South America, Australia Pacific, and Africa. Sovereign debt crisis will keep gold prices elegant and, fortunately, the company's margins from North American operating have sharply increased from 30% four years ago to 67% last year.

Since Barrick's bottom-line is dependent on the spot market price of gold while extracting at a lower cost, it could also outperform gold ETFs. With an extensive geographical footprint, a proven reserve base of 140M oz of gold, and a record in being one of the most efficient producers at a cash cost of $460 per ounce, Barrick is well positioned to outperform peers.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.

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