The first law of
is the lone rule when it comes to
prices and commodity stocks. Surplus creates price drops and
shortages spur price increases.
For copper miners, one side of the equation is about to sharply
change. Though demand remains weaker than normal in the face of a
, supply is tightening.
The coming shift from oversupply of copper to undersupply
helps explain why
rallied more than $1 on Thursday, July 19, even as the company
reported second-quarter results that were far below year-ago
results. Investors are appropriately looking ahead, focusing on
what this company's quarterly results could look like a year from
For a recap of why I think this stock is quite undervalued,
As I wrote back in April, "the supply and demand picture enables
this company to generate decent profits when the global economy is
under pressure and copper demand cools, and really solid profits
when demand is at a more normal state."
In the second quarter, Freeport-McMoran earned $0.80 a share,
roughly half of what the company earned a year ago.
the current profits, and Freeport would make around $3 a share this
year, meaning shares trade for a reasonable 11-12 times depressed
figure is after one-time charges, so Freeport actually topped the
consensus if you back that out).
Yet looked at in the context of a more typical results, this is
one cheap stock. For example, shares trade for just seven times
2011 EPS of $4.84. And here's the key takeaway: That's what
Freeport-McMoran is likely to earn in 2013. The projected
rebound (from an expected $3.50 in EPS in 2012) is mostly a
function of forecasts for copper prices. It's not that demand for
copper is likely to suddenly surge -- the global economy won't
likely look that healthy unto 2014 or 2015. Instead, you have to
focus on the supply side of the equation.
Simply put, many copper producers around the world are
struggling to meet production quotas because current mined ore has
a lower concentration of copper than we've seen in the past.
Notably, that's not the case for Freeport 's mines, which remain
among the most productive in the world. Yet in the coming quarters,
Freeport-McMoran is voluntarily reducing output by about 5% anyway,
in a bid to support firmer prices.
You can already see the effects of falling output. The world had
been awash in copper at the start of the year, with supply
exceeding demand by more than 100,000 tons. But that figure has
fallen below 20,000 tons, according to a Bloomberg survey. More to
the point, it increasingly appears as if there will be greater
demand than supply in 2013 as supply keeps falling. And this comes
at a time of weak global economic activity. You can only imagine
what the supply and demand imbalance will look like when the global
My take: In coming months,
prices for copper will strengthen as the copper shortage starts to
take shape, bringing a fresh wave of buying interest to
Freeport-McMoran. Right now, copper futures are flat into 2014, at
around $3.50 a pound, but this defies the reality that is emerging
for the economics of copper.
As I've noted before in columns about gold and silver miners,
rising labor and extraction costs are now a fact of life.
Freeport-McMoran must now spend roughly $1.50 for every pound of
copper it mines -- up 50% in the past year. This trend has
likely peaked and mining costs should stay flat in the periods
ahead. Notably, Freeport-McMoran is still solidly profitable with
copper selling at $3.50, though it's profit spread would rise 25%
(from $2 a pound to $2.50) if copper prices move up to $4, as I
Risks to Consider:
The European economic crisis has not disappeared. There is
still a small chance that we return to the scary investor
environment that we saw back in 2008 and early 2009, which would
quickly push this stock down into the $20s.
Action to Take -->
Shares of Freeport-McMoran have fallen from $55 to $35 during the
past year. A year ago, investors were focusing on what could go
right for the copper mining sector. In effect, the glass was half
full. Paradoxically, that's the wrong time to own a mining stock.
Instead, you should be focusing when these stocks are deeply out of
Shares of Freeport rallied nicely on news of production cuts and
the looming transition from oversupply to undersupply of copper.
Yet shares remain sharply undervalued in the context of rebounding
earnings and the value of the company's global network of mining
assets. Investors who buy into the stock before the crow catches on
will be better positioned to make huge gains.
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC owns
shares of FCX in one or more if its "real money" portfolios.
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