There's an old saying onWall Street that investors should look
for upside and the
for downside protection. But for mining and energy stocks, this
axiom has been spun on its head. Income-statement metrics are
forcing many of these stocks down, but their balance sheets point
to the way to vigorous upside (while that downside protection also
remains in place).
You can find no greater example of this than copper and gold miner
Freeport McMoran (NYSE:
. Copper prices have fallen from around $4.50 a pound in early 2011
to a recent $3.60, dampening the company's
prospects. Adding insult, the company is temporarily seeing reduced
output at a key Indonesian mine on the heels of work stoppages.
Lastly, concerns continue to fester that China's insatiable
appetite for copper is set to slow down. Add it up, and you have a
pretty dismal stock chart...
To be sure, this stock may look attractive at less than eight times
trailing profits and less than four times trailing
, but Freeport McMoran's
earnings per share (
is expected to slump about 15% this year to about $4.15 a share.
And investors simply shun stocks that are posting falling profits.
But such an environment is precisely where you find value. Freeport
McMoran is becoming a deep-value stock if you measure the company's
stock against the unlocked value in its various copper and gold
mines. Let me explain...
As mining engineers will tell you, it's highly unlikely that we'll
soon hear about a brand new mining opportunity anywhere in the
world. Any region that contains vast stores of copper, gold or
other minerals has already been identified and exploited. So
Freeport should benefit in the years to come from finite industry
supply and stable to rising demand. Simply based on current
dynamics, Goldman Sachs says Freeport McMoran's mines are worth $50
a share. That's more than 25% above current levels.
Values across the board
You can apply this same logic to many other mining firms. Take
gold-mining stocks as an example. They've been steadily falling in
value, even as the value of gold has remained fairly steady. As I
in this article
, a number of gold-mining stocks now trade well below analysts'
price targets. These stocks actually trade above
net asset value
), but that's only because the calculation involves historical
purchase prices of mines and not the value of untapped gold that is
waiting to be harvested. On that basis, analysts see solid
potential upside for this beaten-down group.
The oil and gas conundrum
Trying to find verifiable bargains in the energy sector is a bit
trickier. Natural gas prices have been plunging and production is
becoming uneconomical for many players. Yet many of these same
firms also have significant exposure to crude oil, which has seen
more robust pricing. In light of the uncertainty regarding gas
pricing right now, it only pays to look at oil-focused companies
(which have a greater reliance on oil production than gas
production) in the context of their underlying NAV.
What's a good baseline assumption for oil prices when calculating
NAVs? Well, conveniently enough, investing firm Jefferies Group has
just issued an updated oil price forecast and updated NAV
assumptions for many of the oil companies that the firm follows.
For the past few years, Jefferies had assumed that Brent Crude Oil
(which reflects the
in Europe) would settle in at $85 a barrel in 2013. This figure has
now been bumped to $100. Their targets for West Texas Intermediate
), which is the basis for U.S. pricing and is often at hefty
discount to Brent Crude, is now higher: Jefferies sees WTI at $90 a
barrel in 2013 and $95 a barrel by 2014 or 2015.
Key positive and negative factors behind this updated view:
• Chinese oil imports will likely slow, because domestic natural
gas production is rising at a 20% annual pace and substituting oil
at some power plants.
• OPEC is showing more discipline, and will "defend" oil by cutting
output if Brent falls below $100.
• Rising production costs are making certain energy fields
economically unfeasible when oil falls much below $100 a barrel,
creating a supply cut trigger.
With higher targets for oil prices in the coming years, the
analysts at Jefferies have also been kind enough to reconsider
their previous target prices, so the following oil stocks now have
solid upside, according to the firm.
My personal favorite NAV play remains
Marathon Oil (NYSE:
, which is a member of my
$100,000 Real-Money Portfolio
. The company has a range of assets in the United States and
abroad. Merrill Lynch pegs the NAV for Marathon Oil at $56 a share,
nearly double the current price.
have weakened recently on slipping energy prices, but coming
quarters should start to show the results of the company's large
capital spending program, which should steadily boost output of oil
and gas over the next few years.
Risks to Consider:
China is still a driving force in the commodities markets, and
although recent economic data suggest that
is doing OK, a
would bring down demand and
Action to Take -->
These companies have spent considerable sums acquiring and
developing their assets. On occasion, investors tend to overlook
the value of these investments and sell off stocks based on
trends. These are the times when asset-focused investors tend to
come in and scoop up bargains. Any of the stocks I mention here are
good candidates to consider buying based on that premise.
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-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC owns
shares of MRO in one or more if its "real money" portfolios.
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