Freeport-McMoRan Copper & Gold (NYSE:FCX) stock has been range-bound over the last two years, primarily due to depressed economic activity in China. This article looks at the silver lining, which makes Freeport-McMoRan a value investing option.
Pick-up in investment cycle
The company's investment cycle is important to discuss as current investments translate into future cash flows. Freeport-McMoRan's capital expenditure bottomed out at $1.4 billion in 2010 and has gradually picked up to $5.3 billion in 2013.
The expected capital expenditure for the next three years is more significant and indicates a sustained turnaround in the investment cycle. Freeport-McMoRan expects capital expenditure of $7.1 billion, $7.3 billion, and $6.6 billion in 2014, 2015, and 2016 respectively. This is likely to translate into renewed growth and higher cash flows.
Rio Tinto (NYSE:RIO), on the contrary, expects to reduce its capital expenditure from $12.9 billion in 2013 to $11 billion in 2014 and $8 billion in 2015.
The reason for this diverging investment cycle is Freeport-McMoRan's investment in its oil and gas assets, which will have a meaningful EBITDA contribution. For 2014, Freeport-McMoRan expects 68% EBITDA contribution from mining and 32% from oil and gas. The EBITDA mix will change further for reasons to be discussed later.
Accelerating the de-leveraging cycle
As of March 2014, Freeport-McMoRan had a total debt of $20.2 billion and the company intends to de-leverage significantly over the next few years. By the end of 2016, Freeport-McMoRan intends to have a debt of $12 billion.
The company has already initiated the de-leveraging process with a $3.1 billion sale of Eagle Ford shale interests to Encana. Simultaneously, the company also acquired $1.4 billion in deepwater interest in the Gulf of Mexico. The net proceeds of $1.3 billion from the transactions will be used to repay debt.
De-leveraging, along with high level of investments, is a positive combination and the company's robust operating cash flows will support the investment cycle. For 2013, Freeport-McMoRan has an operating cash flow of $6.1 billion and with the ongoing investment cycle, the operating cash flow is likely to remain robust.
Positive Implications of investment in oil and gas assets
Of the company's total capital expenditure of $21 billion for 2014-16, 50% is allocated to the oil and gas segment. Freeport-McMoRan expects to increase oil and gas sales to 78,000 mmboe by 2016 from 38,100 mmboe in 2013 through these investments.
The biggest positive is the change in EBITDA mix and a change in EBITDA margin as oil and gas sales increase. For 2013, the company's cash operating margin from the copper segment was 54.8% while the cash operating margin in the oil and gas segment was 77.7%.
Clearly, the EBITDA margin is likely to get a boost as oil and gas sales increase. Freeport-McMoRan's investments in oil and gas are well timed with geopolitical tensions in key oil producing regions resulting in firm oil prices.
Sesa Sterlite (UNKNOWN:SSLT.DL) has embarked on a similar path to boost EBITDA margin and the company expects the oil and gas segment EBITDA margin to be 74% as compared to 29% for the copper segment and 47% for the consolidated entity. This gives a sense of the kind of EBITDA margin gap between the two segments.
Freeport-McMoRan is trading at an EV/EBITDA valuation of 6.8 and this is attractive on a relative basis. Sesa Sterlite currently trades at an EV/EBITDA valuation of 8.3 and Southern Copper (NYSE:SCCO) trades at an EV/EBITDA valuation of 10.0.
I believe that Freeport-McMoRan's stock is likely to trend higher after two years of stagnation as the company embarks on an ambitious investment plan along with de-leveraging.
Freeport-McMoRan, in all probability, has seen the worst and the pickup in investment cycle signals better times ahead. In addition to attractive valuations, the company also offers a dividend yield of 3.6%.
China growth concerns might remain, but Freeport-McMoRan is repositioning itself toward a more diversified revenue profile. I am bullish on this natural resources giant and the stock can be considered as a good value pick.