Shares of copper and gold miner Freeport-McMoRan, Inc. (FCX +2.14%) rocketed 36% higher in December. That's a massive gain in a short period of time, and shows just how quickly this miner could turn investors into millionaires. But it's also evidence of risk if you take the time to look past the headline numbers. And then there are some company-specific issues that you'll want to know about before you jump aboard. In the end, Freeport-McMoRan could be a millionaire maker stock, but I don't think it's worth the risk for most investors. Here's why.
About that huge advance
Freeport-McMoRan investors were treated to a stock price advance at the end of 2017 that was nothing short of incredible. However, the stock would have been up in the mid-single digits last year if it weren't for that December price gain. In other words, almost all of the 44% gain in the year that just ended came in a single 31-day period.
Image source: Getty Images
So it's important to understand what happened. There was no dramatic ore discovery or some key technological advance in mining. The rally was driven by a swift increase in copper prices that led investors to push related mining stocks higher. The impetus for this advance was the expectation that copper demand out of China would remain robust even as the giant nation moved to reduce its own copper production.
The risk here is that China changes its mind, or that investors overreacted to the positive news. Commodities are notoriously volatile, with often swift and dramatic price moves in both directions. Yes, Freeport could end up making investors a lot of money, but it could lose investors a lot of money too. So unless you have a constructive view of commodities, specifically copper, you should tread cautiously here.
Some more bad news
But that's just a look at Freeport's broad commodity exposure; I could say the same about almost every miner. There's a couple of other risks investors need to know about when looking at Freeport specifically.
For example, Freeport made an ill-timed $20 billion bet on the oil and gas business in 2013. When oil prices fell in mid-2014 the investment quickly turned into a material drag on performance. The miner has since extracted itself from the energy space, but it's still dealing with this mistake.
The big concern for me is on the balance sheet. Before the pair of 2013 oil acquisitions, Freeport's long-term debt stood at roughly $3.5 billion. That figure rose to more than $20 billion in a single year, a massive increase. Now, having largely exited the oil space, long-term debt stands at around $12.5 billion. In other words, investors are still paying for that mistake with nothing to show for it. Interest expense ate up 30% of the company's operating income through the first nine months of 2017.
Freeport's largest assets, which shows just how important the Grasberg mine is to the company. Image source: Freeport-McMoRan, Inc.
You'll also want to consider that Freeport is currently in tense negotiations with Indonesia over its ownership of the giant Grasberg mine. This single asset holds roughly 30% of Freeports copper reserves and all of its gold reserves. To simplify a complex issue, Indonesia wants to get more financial benefit from Grasberg, which basically means that Freeport will get less. There's a broad framework for a solution, but nothing concrete just yet. I'm certain something will get worked out, but the outcome for Freeport is still unclear.
The answer is yes, but...
Freeport-McMoRan could easily turn an investor into a millionaire. The December advance shows that it could happen quickly, too. But there are huge risks that come along with that potential, most notably that often volatile commodity prices go both up and down. But there's also a material debt overhang at Freeport, the result of an ill-timed investment, and ongoing troubles at a key mine. Most investors would be better off avoiding the risks here for now.
