If I were a day trader, or even an investor who tried to time the market, a company involved in the mining of gold or copper might not be the most attractive option to go long on right now. Both metals have struggled in the open markets lately, and the miners have suffered across the board. In just the past year alone, copper prices have plunged 16%, and gold, not to be outdone, took it a step further and has declined 26%.
The fact that these declines have persisted for over a year hints at a natural cooling off period rather than traders hounding the market and taking profits after years of rising commodity prices. Since 2011, industrial and precious metals, as a group, have been on a steady decline. While one could argue that precious metals like gold don't necessarily ride high in times of global growth, copper most certainly has a place on the coat tails; hence my surprise that the price of copper is still so low after a year or so of great news coming out of the automotive and residential housing sectors.
One company that has unfortunately been exposed to both markets is Freeport-McMoRan Copper & Gold (NYSE:FCX). The past three years have seen shares tumble 44%. Over this same time frame, Freeport-McMoRan's book value per share has continued to climb, leaving the company trading more cheaply than it has in the past five years at just over 1.5 times book value.
The name says it all, well, it used to at least
Granted, 2008 was a tough comp year since the company took nearly $17 billion in writedowns and impairment charges which lead to years of negative retained earnings ex post facto. Since then, though, Freeport has been churning out profits which helped reverse this balance sheet blemish.
More recently, a key reason why Freeport-McMoRan's book value has climbed higher is the fact that it issued 91 million more shares, totaling $2.9 billion, to help finalize the $16.3 billion acquisition of Plains Exploration & Production Company. As a result, the company's "Capital in excess of par value" account increased the equity value on the balance sheet, translating to a higher book value. This, combined with the McMoRan Exploration Co. acquisition, make up Freeport's foray into the oil and gas sector.
Now that oil and gas has entered into the picture, Freeport-McMoRan is a one-stop shop for access to both the materials and energy industries. What has this deal done to the company's diversification? Well, not much...yet, which is a big reason why I am adding it to my Real Money Portfolio sooner rather than later. I want access to these assets before they start to become a bigger part of the overall picture at Freeport.
With its newly purchased oil & gas assets scattered around the United States in attractive locales, Freeport displayed some tremendous cash operating margins during its initial quarters of production. In its second largest producing region – the Eagle Ford – Freeport was able to turn out a cash operating margin per barrel of oil equivalent (boe) of 85%. Effectively, it only paid $11.42 to produce a barrel of oil equivalent. While it does expect these costs to be a touch higher in 2014, it still compares mighty favorably with peers.
Casting off the anchor
In my mind, two things have been holding the company back lately. I'll start with the obvious: market prices for the resources it produces. I've already mentioned the free fall that copper and gold prices have been on. That being said, I think many investors have failed to take into account the unit costs that Freeport is expecting to incur for both copper and oil & gas.
With respects to its copper operations, management has forecast the unit cost to mine copper of only $1.45 per pound. This is less than half the current spot price, which means the margins for its largest mining segment should remain well over 50%. Additionally, its unit cost per boe should only be around $20. So, what we have here is the ability to produce its namesake and its growth product well below expected market prices. I like this security blanket, which is buffeted by the values it uses to calculate its reserves.
That brings me to the second area of fear I believe has kept investors from mining for additional shares: potential for asset writedowns. Write-downs have plagued the mining industry of late due to some miners using gold prices north of $1,300 per ounce to account for reserves.
Thankfully, either by prudence or prescience, Freeport has chosen to value its reserves with a long-term price for gold of just $1,000/oz. This provides tremendous wiggle room when compared to peers. Because of this, I believe it is highly likely that Freeport will avoid asset writedowns on its reserves; especially to the degree you have seen at peers like Barrick Gold (NYSE:GOLD) which took $6.4 billion in asset impairment charges and $2.3 billion in goodwill impairment in just the first nine months of 2013. Its assumption for $1,500/oz was clearly ambitious and investors paid the price right along with the company.
Fool's gold... and copper, oil and gas
In my mind, opportunities abound for Freeport-McMoRan Copper & Gold. So far, it appears that management is poised to take advantage of all of them. With plans to spend $4.1 billion on its mining segments and $3 billion toward oil and gas in 2014, even in a flat year for commodity prices, I see solid growth potential. Just because copper and gold make up 50% of the company's name, that doesn't mean it will suffer the same fate as miners of those individual metals; a classic case of not judging an book by its cover. Based on the chapters that I have read, Freeport-McMoRan will be finding its way into my Real Money Portfolio next week.
If you haven't learned from Warren Buffett, why not start now?