Freeport-McMoRan: Contrarian Value

02/05/2015 8:00 am EST


Adrian Day

Chairman and CEO, Adrian Day Asset Management

This recommendation has had a tough few months, as first oil—representing a third of its earnings—then copper—which accounts for 70% of its revenue—collapsed, explains Adrian Day, editor of The Global Analyst.

Freeport-McMoRan (FCX) is the world’s largest publicly traded copper producer with long-life reserves and lots of reserve and production upside (from current resources, mine-site development, and brown-fields and green-fields exploration). 

The company has a history of capital discipline and return-driven investments, with strong cash flows. Approximately half of its earnings come from North America, offsetting political risk in Congo and Indonesia.

In 2013, the company had record production of all four minerals and last year likely saw production increases. Though the decline in commodity prices will hurt, Freeport is a low-cost producer, with copper at a net cost of $1.50 a pound and oil $20 a barrel. 

Copper is back in surplus after months of deficit and the sentiment has changed due to China’s economy slowing. These are real factors, but the price decline is overdone and will be relatively short lived. 

The oil output is mostly hedged. These prices have driven tremendous free cash flow over the years, which enabled the company to boost its dividend, pay special dividends, undertake a significant buy-back program, and rapidly pay down the debt it assumed to buy Phelps Dodge. 

It is wanting to do the same with the debt taken on to acquire McMoRan Oil & Gas and Plains Exploration at the end of 2012. In reality, the debt profile is reasonable for a capital intensive company and cash flow will enable the company to pay its debt down comfortably. 

The stock is now inexpensive, trading at a single-digit p/e, less than book, and yielding 6.75%. We would buy Freeport under $19. 

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