Whether you like it or not, buying a cyclical stock like Freeport-McMoRan (FCX 1.07%), a copper miner, always implies taking a view on the future direction of prices for the metal -- even if that view is "no view." In other words, even if you've decided not to guess where the price is headed and plug in the current price, you are still assuming the direction of the price. However, you can decide whether to buy the stock on a risk/reward calculation that assumes the current price. On that basis, I think Freeport-McMoRan is undervalued. Here's why.
Copper prices drive profit
The price of copper, like most commodities, is volatile. In the past decade, it's been as low as $1.90 per pound in the commodities slump of 2016 and around $2 per pound during the worst of the lockdowns in the spring of 2020. It soared to almost $4.80 per pound as the economy recovered in the spring of 2021, then rose more to nearly $4.90 at the onset of the conflict in Ukraine, before slumping on recession concerns. It has now settled at about $3.70.
Of course, the price movements have a significant impact on the profitability of Freeport. For example, management believes the company currently has earnings before interest, taxation, depreciation, and amortization (EBITDA) sensitivity of $430 million for every $0.10 per pound move in the price of copper. Putting that into context, if the price of copper falls by $1 per pound in a year, then Freeport's EBITDA will be reduced by $4.3 billion and vice versa. For reference, Freeport's EBITDA was around $10 billion in 2021.
Whichever way you cut it, the price of copper -- and any assumptions about the direction of those prices -- is critical to making an investment decision. As you can see below, Freeport's EBITDA and free cash flow move around violently, and so does its stock price.
The "no view" view
Freeport looks undervalued based on the "no view" view of copper prices. By this, I mean simply taking the current price and assuming that it is the long-term price.
The current price of copper is around $3.70 per pound, and management gave estimates for EBITDA and operating cash flow in 2023/2024 based on various scenarios for copper prices. According to Chief Financial Officer Kathleen Quirk on the earnings call, "$6 billion per annum at $3 copper to $15 billion per year at $5 copper, with operating cash flows ranging from $4.5 billion per year at $3 copper to over $11 billion per year at $5 of copper."
Interpolating conservatively from those projections would produce rough figures of around $9 billion in EBITDA and $6.45 billion in operating cash flow based on today's copper price of $3.70. Penciling in capital expenditures of $2 billion (the average over the past five years) gives free cash flow (FCF) of $4.45 billion. Based on the current market cap, that would put Freeport on a price-to-FCF multiple of 10.2 and an enterprise value (market cap plus net debt)-to-EBITDA of 5.4.
Those are very attractive multiples. For example, a price-to-FCF multiple of 10.2 times implies Freeport is generating almost 10% of its market cap in FCF. That means it could theoretically pay a dividend that worked out to a 10% yield, much higher than today's 1.9% forward yield.
Don't forget the risk
For those who want to take a more proactive view of where the price of copper might be heading, you also have to factor in risk. There's no guarantee that the long-term price of copper will be $3.70 or that Freeport will have the resources to continue producing copper with the costs embedded in its current profitability assumptions.
That said, there's also the chance that copper prices rise because of its surging use in electric vehicles, renewable energy, and the trend toward electrification in the economy. Meanwhile, Freeport has copper-producing assets and significant expansion plans in the U.S. and investment-friendly Indonesia.
All told, it strikes me that if you see the copper price's long-term downside and upside risks to be in balance, then the current share price means Freeport is an excellent value stock.