Copper miner Freeport-McMoRan (FCX -0.16%), data center REIT Equinix (EQIX 2.21%), and package delivery giant UPS (UPS 0.98%) are three vastly different stocks, but they are all well worth holding for long-term investors. Let's take a closer look at all three, focusing on the favorable megatrends that each company has exposure to.
Freeport-McMoRan, the old economy, the new economy
Copper might not immediately spring to mind as a "new economy" industry, but investors shouldn't overlook the importance of the metal to the old and new economy alike. Copper is traditionally seen as a way to play cyclical growth due to its broad-based use across the economy.
In addition, China's role in driving demand caused a near tripling of the price for copper products through the 2000s. However, in the decade that followed, the price of copper moderated as China's growth rate slowed and leading players like Freeport-McMoRan, Antofagasta, and Southern Copper dialed back capital spending on growth projects.
The critical question now is whether there is anything that will cause a marginal shift in demand for copper over the long term. The answer is yes, and it comes from the so-called energy transition.
Simply put, electric vehicles (EVs) require significantly more copper (used in batteries, motors, wiring, and charging technology) than internal combustion engines. The International Copper Association estimates that copper demand from EVs will rise to 1.74 million tonnes per annum (mtpa) in 2027 from less than 0.2 mtpa a decade earlier. This is compared to the current total copper consumption of 30 million tonnes.
In addition, renewable energy (solar and wind power) also requires significantly more copper (transmission, distribution, and storage), with some industry figures estimating an additional 4.35 mtpa of copper demanded by 2027. It all adds up to at least a 20% increase in demand for copper within a decade. That's a favorable scenario for copper producers like Freeport-McMoRan. Given the reduction in capital spending on projects in recent years, it could be a while before production ramps up. Again, it's a favorable backdrop for the price of copper.
Data centers are also a driver of copper demand, and they are set for excellent long-term growth. Just ask shareholders in data center REIT Equinix.
The long-term demand outlook for data is excellent. 5G networking will create an explosion in demand and stimulate the creation of new sources of demand, such as investment in artificial intelligence (AI), internet of things (IoT) based solutions, digital wallets, and even blockchain applications. In addition, the digitization of the industrial world will inevitably increase, driven by advancements in analytics capability, AI, and virtual reality applications.
It all adds up to a robust long-term demand environment, and Equinix's data centers are at the heart of it. The key number to follow with data center REITs is adjusted funds from operations (AFFO). Equinix has paid out around 43% of its AFFO in dividends in recent years, and as you can see below, AFFO continues to grow strongly.
Equinix's share price will inevitably be buffeted around by speculation over interest rates (the company holds $11.3 billion in gross debt and needs financing to expand capacity), and power makes up around 22% of its expenses. Hence, investors need to keep an eye on those two variables.
That said, 95% of Equinix's revenue is recurring, and earnings before interest, taxation, depreciation, and amortization (EBITDA) margin is around 47%, with only 3% of the revenue needed to fund recurring capital spending. As such, Equinix has a very stable business model and should be able to borrow money at favorable rates, and power costs have tended to be stable at 11% to 12% of revenue in the last decade.
All told, Equinix should be able to grow its dividend for many years to come.
Everyone knows that burgeoning e-commerce growth creates a growth opportunity at package delivery giant UPS. However, the key question is whether it will be growth that leads to a profit margin expansion, or a contraction. The jury has long been out on the matter.
However, there's growing evidence to suggest that UPS is making real progress on the issue. For example, U.S. domestic packages volume and yield are now growing together strongly, meaning that UPS can grow e-commerce deliveries and raise prices simultaneously.
It's a testimony to the company's success in targeting the small and medium-sized business market, and in doing so, increase its focus on growing deliveries at more profitable accounts. The COVID-19 pandemic certainly helped develop the strategy, and if UPS can carry on expanding margins, then more of the revenue increase will drop into earnings. That's something that usually leads to substantial stock price appreciation.