The materials sector could possibly be the last group of companies to still be on sale, as most are trading well below their 52-week highs and even below their 2009 financial crisis lows in some cases. One of the best bargains in the sector is possibly Freeport-McMoRan Copper & Gold (FCX +2.69%), the world's second-largest copper producer, which is leveraging the current environment in the sector in hopes of reaping the rewards once a turnaround comes. Let's take a look at Freeport and see where it may be heading in the future.
Freeport: more than just copper
As mentioned, Freeport is one of the world's largest copper producers, and also has gold and molybdenum production operations. The company produced about 3.7 billion pounds of copper last year, in addition to 958,000 ounces of gold and 85 million pounds of molybdenum. Freeport has enough reserves to keep itself busy for years to come, with proven reserves currently at 116.5 billion pounds of copper, 32.5 million ounces of gold, and 3.4 billion pounds of molybdenum. It also has a significant oil and gas operation, which is the newest venture of the company (more on that later).
The company is very geographically diverse, with about one-third of its reserves in North America, another third in South America, and the rest divided between Indonesia (27%) and Africa (7%).
As far as Freeport's revenue goes, copper makes up the vast majority at 79.3% of last year's $18 billion in total sales. About $11.7 billion of this figure comes from Freeport's international operations, with a strong presence in the emerging markets, especially in South America.
Why is the copper sector underperforming?
The main reason for the poor performance of metals and mining companies is simple supply and demand. As a result of increased investment by the industry as a whole, supplies of copper and other metals are at or near record levels, and the trend seems to be continuing -- at least for the time being. The supply of copper is expected to increase by more than 5% in 2014, and the forecast is even worse for other metals.
This oversupply comes at a terrible time, as Chinese demand (which had been fueling a great deal of the supply increases) appears to be slowing from the rapid growth pace of the past decade or so. For example, Chinese copper demand is projected to rise by about 3.9% next year. Since supply is expected to grow by more than this amount, it is easy to see why oversupply can become a problem. This oversupply is putting pressure on the prices of metals and is therefore driving down profits for many companies in the sector.
Even the rock solid giants of the metals sector, such as Rio Tinto (RIO +0.45%), are feeling the oversupply issues. However, Rio Tinto has been able to offset some of its underperforming copper business with pretty solid performance in iron ore, the company's largest business segment, which composes about 44% of total revenue.
The iron ore business in general has done a much better job of adapting to the slowing demand, and this is helping to keep Rio's profitability at historically high levels. The company has a projected earnings before interest, taxes, depreciation, and amortization of about $21 billion for this year, which would make this the third most profitable year in Rio's history.
The trouble in the copper industry is even more apparent when looking at Southern Copper (SCCO +3.22%). Southern Copper operates mining, smelting, and refining facilities in Central America and South America, and has lost about 32% of its share price since the highs reached earlier this year. As the world's largest publicly traded copper-mining company, it has really felt the sting of declining global demand and prices.
Recent investments and what they might mean for Freeport
One of the main reasons I like Freeport is that it is taking advantage of weakness in the industry in order to expand its own operations. In June, the company acquired Plains Exploration & Production and McMoran Exploration for $20 billion. While these activities have given Freeport a much higher debt level than the company is used to (about $21 billion), I believe that this is offset by the value these assets have added.
The moves made Freeport an instant player in the oil and gas sector, as the two acquired companies combined for 46 million boe (barrels of oil equivalent) in 2012. The acquisition also adds proven oil and gas reserves of about 688 million boe.
One of the key points to realize is that Plains and McMoran are domestic oil producers. As the trend to reduce our dependence on foreign oil and gas continues, companies that produce oil in the U.S. are likely to be the main beneficiaries. While the level of energy independence the U.S. will ultimately achieve remains to be seen, this is definitely a strategic step in the right direction for Freeport.
Bottom line
Times are tough for copper right now, but Freeport is taking steps in the right direction to further diversify and add value to its operations. I'm not sure that you'll be too happy with your investment in the next few months or even the next few years, but when the natural economic processes bring supply and demand closer together, you'll be glad you got in on the current weakness and rode out the share price roller coaster in this well-run and ambitious company.
