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Magic Formula Stock of the Week: Freeport McMoran (FCX)

September 12, 2011 | About:
Andrew Paul

Paul Andrews

Freeport McMoran (FCX) is the largest copper and gold producer in the world. This is a business that requires massive amounts of initial investments and has huge ongoing fixed costs. However, with commodity prices (and gold prices in particular) soaring over the past two years as central banks continue to print money, Freeport has leveraged the rise in prices into massive profit gains. And the rise in commodity prices seemingly has no end in sight, which should lead to continued increases in Freeport’s profits. As a matter of fact, in 2010, a year where Freeport set a new record for profits, the average price they sold copper at was $3.42 and ounce and their average gold price was $1,225 an ounce. Given that today’s prices are over $4.10 and $1,850, respectively, there’s reason to believe Freeport should realize huge gains in profits just by holding costs and production steady.

So with all of those secular tailwinds, how is this company trading for less than 8x trailing earnings and less than 7x forward earnings?

Honestly, I don’t know. But it’s gotten so cheap that it’s landed the stock on the magic formula list, and at these prices it certainly looks attractive. As a matter of fact, it has many of the qualities we look for in GuruFocus’ own Microcap Magic Formula Newsletter: sustainable competitive advantages (huge capital costs and government connections needed to enter business), secular tail winds (rising commodity prices and demand from emerging markets), incredibly cheap valuation metrics (trading for about 7x earnings), and a great balance sheet (cash balance exceeds debt).


So just how cheap is Freeport?

To put it simply, incredibly cheap. You’d have to have an incredibly bearish outlook for the world economy and metals prices to justify today’s prices.

Freeport’s market cap today is $40 billion, which means they trade for a P/E of barely over 7x. We could look at a different way and see that Freeport trades for EV/EBITDA of just 3.4x and EV/EBIT of just 3.8x.

These are incredibly cheap ratios. Out-of-this-world cheap. Warren Buffet has said before that he likes to buy the stock of world class companies when they trade for under times 7x EV/EBIT. Freeport currently trades for almost half that buy price, and with trailing returns on equity approaching 50% despite minimal leverage, Freeport seems to qualify as one of those great companies.

Competitive Advantage

So how does Freeport earn such great returns on capital?

They’ve got two key competitive advantages.

First, the mining business is not exactly easy to break into. It requires huge upfront costs and tons of political connections to get the necessary permits to start the work. Plus, the established players have huge advantages in terms of the knowledge they’ve accrued mining over the years.

Second, there are a limited number of mines in the world. The established players already own the most promising ones, and new ones aren’t exactly popping up every year. In other words, Freeport owns a bunch of rare assets, and as demand for the output of those rare assets rises, they can enjoy premium pricing and above normal profits.

Rating: 3.7/5 (23 votes)


James L Roberts
James L Roberts - 2 years ago
Nice Work. We own the stock in our Fortune's Most Admired Companies Portfolio.

Jim Roberts
Ranjitsudan premium member - 2 years ago
Are they low cost producer of copper and gold? How much does it cost them to mine copper and gold?

Mining business is very sensitive to commodity price, currencies, cost blow out on projects etc so not easy to value the intrinsic value of the business. The valuation of business can change quickly; just too many moving parts!!

Stock price performance is highly sensitive to commodity price so if company is trading at these multiple; market is anticipating commodity price to correct and go down significantly in future. Be careful as commodity price can correct by 50% in no time. Therefore, investing in low cost producer is important, it will provide margin of safety to significant commodity price correction.
Ranjitsudan premium member - 2 years ago
I forgot to add: these multiple are available cross the board for all major miners so FCX is not the only one trading at these multiples. Compare it with more diversified miner like BHP, RIO - they all trading at these multiples. This suggest commodities price will go down in next year or two and market is pricing this in stock price.

Tkervin - 2 years ago
"..........._ And the rise in commodity prices seemingly has no end in sight, which should lead to continued increases in Freeport’s profits............."

Very dangerous thinking in my view.
Tkervin - 2 years ago
Some of the things you need to understand before you invest in copper producers are nicely outlined in this video. It is simply not enough to look at current valuation. Not if you value margin of safety.
Crude Oil Trader
Crude Oil Trader - 2 years ago
We hold FCX in our long term fund and have always looked at it as a play on China. If we have a "real" real estate bubble in China we will no doubt get killed on FCX.
Ranjitsudan premium member - 2 years ago
I would suggest reader to have a look at BHP if they wanna play commodities and China. It has very diversified portfolio of commodities (iron ore,base metal, precious metal, alumina, coal etc) with considerable exposure to oil. It's a low cost producer of commodities as well. It gives investor considerable margin-for-safety if bought at right price (currently trading at single digit multiple!)

Diversification across different commodities, low cost producer, very strong balance sheet (no net debt) gives BHP distinct advantage over number of other commodities players. Over the years commodities price has fluctuated dramatically but BHP earning has been considerably stable due to diversification.
Crude Oil Trader
Crude Oil Trader - 2 years ago
Indeed Ranjitsudan, we also hold BHP. Thanks for your reply.

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