Buy or Sell: Freeport-McMoRan

It's been a challenging year for investors, and a stock like copper miner Freeport-McMoRan (FCX -1.10%) provides a good example. With the market concerned about rising commodity costs, investors favored stocks that benefited from rising commodity prices -- in this case, copper. As such, Freeport's stock was up nearly 25% on the year to late March. Fast forward to the start of July, and recessionary fears have now taken the stock down 30% on the year. Go figure. What's happening, and is the stock a buy or a sell right now?

What happened to Freeport-McMoRan stock in 2022

There are two things to look at. First, there's the price of Freeport's key commodity, copper. Second, consider the stock-specific matters around the miner. 

Starting with the copper price, you must go back to the Fall of 2021 to fully understand the big picture. As the economy recovered from the slowdown created by the government's response to COVID-19, the demand for commodities came back strongly in 2021. Consequently, as a commonly used metal, copper soared in price as demand continued to outstrip supply. 

Having hit a price of $2.10 per pound at the height of the lockdowns in the spring of 2020, the price of copper spiked to about $4.70 per pound in the fall, only to drop to around $4.35 at the end of 2021. Entering 2022, the general narrative around industrial companies was that the first quarter would continue to be challenging regarding supply chain disruptions and the cost inflation of raw materials. Still, conditions were expected to improve in the second quarter, and the second half would see a notable improvement in both issues. Ultimately, this implies that the price of raw materials like copper or oil would moderate through the year. 

Unfortunately, at least for the broader economy, that's not what happened as supply chain issues persisted. Meanwhile, raw materials cost inflation continued, and the copper price rose from $4.70 to $4.90 in the spring. 

That's the main reason why Freeport's stock price soared through late March. After that, however, the sharp correction in industrial metals prices (including copper) caused Freeport's share price to crash, as the market began to price in weaker global growth and its negative impact on demand for copper. Similarly, a lot of speculative money likely flowed out of the trade in copper due to the Federal Reserve aggressively raising interest rates to cool inflation. As a result, at the time of writing, the copper price trades at slightly below $3.60 per pound. 

Data by YCharts.

Freeport-McMoRan disappointing earnings 

The company's first-quarter earnings report contained some bad news, demonstrating that Freeport is not immune from the broader issues facing the global economy. For example, the table below shows how Freeport lowered its full-year copper sales volume outlook and raised its net unit cash cost estimate. The former is due to reduced mining activity due to COVID-19 outbreaks, and the latter is due to soaring raw material costs for things like sulphuric acid and explosives. 

Data source: Freeport-McMoRan presentations.

Freeport McMoRan, buy or sell?

The miner is a cyclical stock where earnings and valuation are primarily dictated by the price of copper. You can see that in the chart below. 

Data by YCharts.

Management estimates that it has a $425 million earnings before interest, taxation, depreciation, and amortization (EBITDA) sensitivity to a $0.10 move in copper prices. Therefore, a drop in copper prices from $4.70 per pound to $3.60 per pound is a big deal. If replicated over the year, it means a $4.7 billion reduction in EBITDA. 

However, management also estimates that all things being equal, it would generate more than $10 billion in EBITDA with a copper price of $4 per pound in 2023/2024. Assuming the current price of $3.60 will prevail over that period, then a back-of-envelope calculation would produce, all things being equal, $8.5 billion in EBITDA in 2023/2024. That would be an excellent result on a historical basis, and given the long-term case for copper, notably as a play on electric vehicles, Freeport looks like an even better value stock now. Throw in the potential for a reduction in net unit cash costs due to a drop in commodity prices, and Freeport still looks like a good value.