Friday, October 17, 2008


There is no doubt that investors' fears of a slowing global economy are valid, as frozen credit markets and a crumbling demand have taken their toll. This reduced demand has resulted in a sharp drop in commodity prices, which in turn has hurt commodity stocks across the board. Although many of these stocks deserve to be trading at current levels, there are others that have valuations that are all too compelling to overlook. Among these is Freeport McMoran (FCX) which is the focus of this article.

Freeport McMoran is one of the largest producers of copper and gold in the world. One of the main reasons for the stock's recent decline is the company's heavy reliance on copper prices. Being an industrial metal, copper prices fluctuate based on prospects for global growth and continued industrialization of emerging economies.

With a clear indication that global growth is slowing, traders have brought copper prices down almost 50% in the last 4 months from over $4.00/lb in July to 2.12/lb yesterday. I am not going to suggest that copper prices will re-test their July highs anytime soon. In fact, it is entirely likely that we may see a stalling of copper prices at these levels, until we get a better indication of what effect a prolonged recession might have. After all, copper production this year has increased quite dramatically compared to actual consumption which has stayed steady.

However, when looking from an individual company perspective, FCX appears extremely cheap. The company has a trailing P/E of 3.90 and a forward P/E of 3.28. This is a steep discount from the stock's historical levels as it had maintained a P/E in range of 7 to 13 over the past three years. The company has been growing cash flow year over year, as it is expected to return a cash flow per share of 14.38 in 2008, a 10% increase from 2007. The company has a ton of cash on the balance sheet, which sat at $1.6 billion at last check, indicating cash per share of $4.30.

When comparing Freeport to the rest of the copper industry, the company is best-of-breed and continues to be among the most inexpensive. The average P/E for the copper industry is around 9.00, which indicates that FCX is trading at a relative discount of approximately 60%. When taking a closer look by comparing FCX to one of its largest competitors, Southern Copper (PCU), we notice that FCX is still cheaper by traditional metrics. PCU has a forward P/E of 5.00, which is a 40% premium over FCX. Further, Southern Copper is actually projected to have negative revenue growth for 2008, while Freeport is projected to grow revenues by 28%. So not only is FCX the best-of-breed company within the industry, but it trades at one of the cheapest valuations in the group.

In addition to falling copper prices, FCX has experienced some operational hurdles, as there have been recent workers strikes that have hindered production and shipments. This includes strikes at their Cerro Verde mining location in Peru as well as a strike at the Chilean mining port of Antofagasta, where a third of the world's copper supply runs through. If you combine this with crumbling stock markets in emerging countries, lowered industry outlooks, and other negative news from mining giants Rio Tinto (RTP) and Companhia Vale Do Rio Doce (RIO), it is pretty safe to say that Freeport has been the victim of a great deal of headline risk.

All things considered, it appears all of this bad news has been priced into FCX given that the stock has slid 76% from an all time high of $125 just 4 months ago. Down here near $30, the risk/reward is very compelling by virtually all valuation metrics. Freeport reports earnings on October 20, which will give some clarity on how the company is weathering falling copper prices. Investors will likely focus on what the company has to say about the direction of copper prices in 2009, as well as updates on how the company is adjusting their capital structure to accommodate this recessionary environment.

Disclosure: Long FCX

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