Copper miner Freeport-McMoRan's (NYSE:FCX) stock is up a whopping 213% over the last year and, despite a recent pullback, is up 39% in 2021 alone. But, of course, when stocks make such drastic moves, it's usually time to take a breather, and at the very least, start to consider reducing your position. Is it too late to buy into the stock, or could it have even more room to run?
To answer the question, you have to start and finish with a discussion on the price of copper. In principle, a mining stock should be valued based on an investor's estimate of the long-term weighted price of copper multiplied by its reserves. However, in reality, the market tends to price stocks based on the current price of the commodity in question.
That's why commodity stocks like Freeport tend to move violently up and down with the near-term movement in copper. So it's not that a committee of investors is quietly nudging its long-term estimate for the price of copper from, say, $2.90 per pound to $3 per pound, but rather that the market simply prices in what the price of copper is right now into stock valuations.
In this context, it's no surprise to see Freeport's stock price follow the price of copper.
Freeport and Southern Copper (NYSE:SCCO) are the only major U.S.-listed pure-play copper stocks. Southern Copper does tend to have higher earnings margins and lower cash costs. However, Southern Copper's production is set to decline over the next couple of years and it's about to enter a multi-year capital spending phase that contains risk and could constrain free cash flow growth. As such, Freeport is better positioned for investors over the medium term.
Mining stocks have no memory
It makes no sense to attach some sort of "memory" to commodity stock movements, so whether the stock has gone up 200% in the last year or declined precipitously, the important thing is where the underlying commodity price is going from here.
In addition, investors also factor in the miner's reserves and those it can bring online, and its cash cost. Miners calculate the latter differently, with Freeport including site and production costs, treatment charges, royalties and duties, and by-product credits in its calculation.
The sensitivity of a miner's earnings to movements in commodity prices is highlighted in the guidance it gives. For example, in the first-quarter earnings presentation, management outlined that a $0.10 move in the price of copper per pound (currently $4.28 although it's been as high as $4.75 earlier in the year) between 2022 and 2023 would result in a change of $435 million in Freeport's earnings before interest, taxation, depreciation, and amortization. For reference, Freeport's EBITDA was $4 billion in 2020, and Wall Street analysts are forecasting $10.3 billion for 2021.
Supply and demand
Management continues to see the supply and demand fundamentals as being favorable for long-term pricing. On the demand side, there's a sense that the copper market could be entering a super cycle of demand growth. The gist of the argument, outlined by CEO Richard Adkerson on the last earnings call, is that before 2000, copper demand was aligned with economic growth in developed countries. China's emergence characterized the post-2000 era as the dominant swing factor in demand.
Today, demand growth is much more balanced and, arguably, more structural. Of course, China will still be a significant factor, though not as singularly crucial as before, as its growth rate is slowing. Still, other developing countries are now contributing to demand. In addition, copper is a critical component of the "clean energy transition" globally, particularly in the developed world.
Freeport's management argues that electric vehicles use four times as much copper as internal combustion engines, and renewable energy uses four to five times as much copper as fossil fuel power generation. Meanwhile, the general growth in electrification in the economy (electric vehicles, charging points, automation, digitally connected buildings, etc.) means more demand for copper wiring.
As for the supply side, Adkerson thinks "meaningfully higher prices" are required before miners make a significant investment in new capacity, and the difficulty of acquiring permits for production is likely to constrain supply growth.
Time to buy Freeport-McMoRan
If you buy the long-term theme of buying into Freeport as a way to gain exposure to a rise in the price of copper, then you should ignore the 213% rise over the last year and the double-digit slump in the previous month. Both are backward-looking movements. Based on analyst forecasts for 2021, Freeport will trade on an enterprise value (market cap plus net debt) to EBITDA of 5.5 times at the end of 2021. That's a figure in line with historical valuations.
As such, if you think copper prices are headed higher, then Freeport-McMoRan remains attractively priced, and it's nowhere near too late to buy into the stock.