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