The best time for value investing is when the sentiments are down for a stock or industry and the company has strong fundamentals. From this perspective, Freeport-McMoRan Copper & Gold (FCX) is an excellent value investing stock. This article looks at the reasons for depressed valuations and the reasons to be bullish on Freeport-McMoRan for the long-term.
Depressed Stock And Valuations
Over the last two years, Freeport-McMoRan stock has trended higher by just 7.9%. The upside is minimal considering the fact that the broader markets are in a multi-year rally. With no significant stock movement over the last two years, the stock is currently trading at an EV/EBITDA valuation of 6.8. This is certainly cheap as compared to some peers in the industry. Sesa Sterlite (SSLT) is trading at an EV/EBITDA valuation of 8.2 and Southern Copper (SCCO) is currently trading at an EV/EBITDA valuation of 9.7.
There are two reasons for the depressed valuation – First, Freeport-McMoRan has been negatively impacted by significant slowdown in global GDP growth and in particular, China’s GDP growth. Second, Freeport-McMoRan built up high leverage in the recent past and high debt is a challenge the company has to deal with in relatively depressed times.
However, for the reasons discussed below, I believe that Freeport-McMoRan is likely to bounce back soon and investors can consider buying this value pick.
The De-leveraging Plan
Freeport-McMoRan plans to reduce the total debt to $12 billion by 2016 from December 2013 levels of $20.7 billion.
As a first step towards debt reduction, Freeport-McMoRan sold Eagle Ford shale interest to Encana for $3.1 billion. Further, the company acquired deepwater interests for $1.4 billion.
On a consolidated basis, both the transactions resulted in a net cash inflow of $1.3 billion for the company and Freeport-McMoRan intends to use this cash to repay the debt. In the foreseeable future, there is likely to be more asset sales in order to reduce leverage.
Therefore Freeport-McMoRan is working towards debt reduction aggressively and the markets should react positively to the debt reduction initiatives.
The Growth Plan
With the global economy on a recovery path, Freeport-McMoRan is gradually getting aggressive with its growth plans. This is likely to translate into higher revenue and meaningful stock upside over the next few years.
Freeport-McMoRan has increased its capital expenditure to $5.3 billion in 2013 from $1.6 billion in 2009. This is a clear indication of the point that the company expects higher demand in the foreseeable future and is ramping up capacity accordingly. Even for 2014 and 2015, the company expects further ramp-up in capital expenditure to $7.1 billion and $7.3 billion respectively.
Considering the current capital expenditure plans, Freeport-McMoRan expects copper sales (billion lbs) to increase to 5.7 in 2016 from 4.1 in 2013. During the same period, Freeport-McMoRan expects the oil & gas sales to increase to 78mmboe from 38mmboe.
Therefore, the next few years will be growth along with debt reduction for the company and both these factors should combine to create shareholder value. High capital expenditure will translate into high cash flow growth for the company over the next few years.
Change in EBITDA Mix
For 2014, Freeport-McMoRan expects 68% EBITDA contribution from the mining sector and 32% EBITDA contribution from the oil & gas sector. However, as mentioned above, the company intends to ramp-up oil & gas production to 78mmboe from 38mmboe currently.
As the production increases, the oil & gas sector will have a higher contribution to the EBITDA than the 2014 expected levels. This is important as the oil & gas sector has a higher EBITDA margin than the mining sector. Therefore, Freeport-McMoRan’s EBITDA margin will be significantly higher in 2016. This is another reason to be bullish on the natural resources giant.
Besides the positives factors in terms of debt reduction and higher expected growth in the foreseeable future, Freeport-McMoRan also offers an annual dividend of $1.25 per share. At a current stock price of $34.9, this translates into a good dividend yield of 3.7%.
I do believe that the dividend per share will trend higher over the next few years and this is another strong reason to own Freeport-McMoRan. The company’s operating cash flow has increased from $4.4 billion in 2009 to $6.1 billion in 2013 and this supports my case for higher dividends as the company’s growth becomes more robust over the next 2-3 years.
Considering all these factors, Freeport-McMoRan is an excellent stock to buy and hold. The stock is a potential long-term value creator.