A World-Class Bargain Copper Play
04/03/2012 11:00 am EST
As the markets roil in the midst of election years in a number of key countries, industrial metals stocks are taking it on the chin, which is good news for bargain hunters, writes Yiannis Mostrous of Global Investment Strategist.
Politics continue to play a huge role in the metals market around the world, influencing production and investment plans. Consequently, the risk of investing in commodity stocks has increased, which in turn has improved valuations as share prices decline.
This dynamic has generated attractive entry points for top material stocks, but risks remain. Investors should allocate funds gradually.
Freeport McMoRan (FCX), our favorite copper play, is a case in point. FCX is the world’s largest publicly traded copper and molybdenum producer. For every 10-cent change in the price of copper, the miner’s EBITDA (earnings before interest, taxes, depreciation, and amortization) rises or falls by approximately $400 million.
The firm’s major assets include the Grasberg mine in Indonesia; the Cerro Verde, El Abra, and Candelaria copper mines in South America; the Tenke Fungurume copper/cobalt mine in the Democratic Republic of Congo; and the Henderson molybdenum mine in Colorado.
The company has traditionally traded at a discount to some of its less robust peers, because of its big exposure to Indonesia. The Grasberg mine boasts the world’s largest recoverable reserves of copper, and the mine is one of the world’s biggest gold producers.
Grasberg suspended operations at the end of February, because of labor strife. Two weeks ago, operations restarted but full production won’t be reached until sometime in the second quarter. Consequently, the company has revised down its production numbers for the current quarter to 795 million pounds of copper and 300,000 ounces of gold, from the previous figure of 875 million pounds of copper and 425,000 ounces of gold.
The salient political issue for the company relates to its operations in Indonesia. A new law, signed by President Susilo Bambang Yudhoyono on February 21, changes the rules on foreign ownership of mines.
Under the new rules, Southeast Asia’s largest economy will require foreign companies to sell down stakes in mines and increase domestic ownership to at least 51% by the 10th year of production.
Freeport announced that it was confident the Indonesian government would honor all existing contracts and that it has voluntarily agreed to divest some of its stake. The consensus here is that FCX will be one of the least affected companies, and more importantly, the effect won’t be as severe as some investors fear.
FCX has shown commitment to Indonesia throughout the years. For instance, it has retained 25% of Gresik smelting, the only copper smelter currently in Indonesia, and one which the company built. FCX has indicated to the government that it would supply additional concentrates, subject to market terms, if additional smelter capacity were developed in the country.
That said, the likely scenario is for FCX to divest the 9.36% stake in PT Freeport Indonesia held through its wholly-owned subsidiary PT Indocopper Investama. The transaction would be close to fair market value, minimizing the impact to the company.
Copper remains one of our favorite metals this year. The supply/demand imbalance in the copper market is expected to persist for at least another year, as current production remains insufficient to cover demand despite slowing global economic growth. With copper already in tight supply, further disruptions to copper production could push copper prices higher.
Meanwhile, it appears that the Chinese economy will avoid a “hard landing.” Although Chinese policymakers have dampened the country’s rapid growth and cooled its overheated real estate market, the Middle Kingdom remains on track to deliver gross domestic product (GDP) growth at close to 8% this year.
China’s preliminary import numbers for February indicate that iron ore imports were up 34% yoy to 64.98 million tons; copper up 125% yoy to 485,000 tons; and steel imports grew by 19% yoy to 1.22 million tons.
Freeport McMoRan is one of the best-run companies in the mining industry and remains a buy up to $50.