Markets move in mysterious ways, and there aren't many bigger mysteries to resolve than the move in copper prices over the last couple of months. The decline in the price of copper from more than $4.80 per pound in mid-April to less than $3.20 per pound in mid-July caught many investors by surprise, as it did the management of leading copper miner Freeport-McMoRan (FCX +1.72%).
With the miner's stock price also trashed in the process (down nearly 37% over the last three months) and the company recently releasing its second-quarter results, it's time to appraise whether the stock is a good value.
What happened
As noted, the price of copper has dropped, and so has Freeport's share price, but CEO Richard Adkerson argues that there is a "disconnect in today's physical market and the current copper price." Given Freeport's position in the market, management talks to customers about their end-market demand and views copper inventories. Adkerson believes that conditions are similar to when copper "was at $4.50."
NYSE: FCX
Key Data Points
As always, the market is concerned about a drop-off in demand from China -- often seen as the swing factor in determining industrial commodity price trends --but Adkerson said that there wasn't any "unusual trading" in building inventories at Chinese commodity trading companies. If there's a slump in demand, these companies should see their inventories growing as they fail to sell them on.
However, according to Adkerson, that isn't happening right now. Moreover, in the Asia markets that Freeport does sell directly into (Japan, South Korea, and Taiwan), Adkerson doesn't "see any impact on demand."
Instead, Adkerson sees the move as coming down to "market sentiment." CFO Kathleen Quirk agrees that "the reality is that this has been a financially driven anticipatory move in copper prices." In other words, what Adkerson and Quirk are saying is that, by selling off copper, the market is anticipating demand declines that haven't actually taken place yet. As such, if demand doesn't drop off, there could be upward pressure on the price of copper.
The bears' view
That said, the price of copper has declined, which means Freeport will make less profit. All things being equal, management believes Freeport's earnings before interest, taxation, depreciation, and amortization (EBITDA) will go up or down by $430 million with every $0.10 move in the price of copper.
Moreover, in an implicit recognition that the fall in the copper price will significantly impact the industry, management openly discussed reviewing opportunities to cut spending, with Quirk noting that cutting capital expenditures is the quickest way to increase cash flow. That commentary is a concern for a company like Caterpillar, as it may presage a pullback in spending on mining equipment -- something to look out for if commodity prices continue to weaken.
Furthermore, there's no denying that China's growth stalled in the first half of 2022 as the company's COVID-19-related lockdowns took their toll.
Meanwhile, there's no shortage of concerns about the trajectory of global economic growth. As such, the bears see the fall in the price of copper as anticipating where global growth is heading.
The bulls' view
On the other hand, there's still a lot to like about the case for copper over the long term, Freeport-McMoRan's positioning within the market, and the stock's value proposition.
For example, management outlined the following scenarios for its profitability, given a range of copper prices. For reference, EV is enterprise value (market cap plus net debt). Given that the current price of copper is $3.34 per pound, it seems evident that the market is pricing in further falls in the copper price on the back of a sustained period of economic weakness. If this doesn't actually occur, then there's significant upside to the stock.
|
Price of Copper |
EBITDA |
EV/EBITDA |
|---|---|---|
|
$3 per pound |
$6 billion |
7.3x |
|
$4 per pound |
$10.5 billion |
4.1x |
|
$5 per pound |
$15 billion |
2.9x |
Data source: Freeport-McMoRan presentations.
In addition, the long-term case for copper remains intact, driven by the electrification trend in the economy (such as electric vehicles, industrial automation, transmission and distribution, and the Internet of Things) and long-term global growth. Freeport stands well positioned, with 36% of its sales volumes and 37% of its sales volumes currently coming from the U.S. and Indonesia and significant expansion projects in both countries -- seen as more politically stable and miner-friendly than Chile and Peru.
Freeport also has substantial operations in Peru, but since Chile and Peru produce 40% of the world's copper output and Freeport only generates 23% of its volumes from South America, it's relatively underexposed.
Looking ahead
On a risk/reward basis, Freeport looks attractive. If the economy avoids a severe slowdown and the markets are pricing into copper/Freeport's share price, then there's upside potential.
Of course, that's not to say the moderate slowdown scenario will happen, but if it does, Freeport is precisely the sort of stock investors would want exposure to.
