Early this morning, Jefferies announced it is raising its price target on the copper, gold, and oil miner. Jefferies has been steadily raising its valuation on the stock all year long, starting at $5, then raising that to $6.50 per share, then $12.50, and now $15. What's more, as we learned this morning from StreetInsider.com, Jefferies has decided to officially upgrade Freeport-McMoRan stock to buy.
This, by the way, is a move we predicted way back in February. But now it's official. Jefferies says: "It is time to buy FCX now."
But why? Here are three things you need to know.
Thing No. 1: Freeport might grow by shrinking
Central to Jefferies' optimism over Freeport-McMoRan stock earlier this year was its hope that the company would follow the lead of rival miners such as Glencore and begin selling off assets to raise cash. In particular, and given the funk that metals commodities markets had been in, Jefferies was looking for sales of copper mine assets.
And indeed, Freeport has been selling some such assets. Sales of interests in its Morenici and Timok projects, for example, brought in $1.3 billion last quarter, with the sale of some "oil and gas royalty interests" raised an additional $100 million. Additionally, Freeport just announced last week that it will sell its cobalt mining interests in TF Holdings Limited for up to $2.77 billion.
So the asset sales are under way.
Thing No. 2: Times change, and minds change, too
What's truly curious about Jefferies' increasing optimism about Freeport-McMoRan stock, though, is this: In today's upgrade, the analyst argued that "accretive asset sales" are one plus to the stock. But another is "a recovery in the copper price as the market shifts to deficits later this decade." So at the same time as Jefferies is praising Freeport for selling copper assets, it's also hoping the company will hold on to enough copper assets to profit from a long-term gain in the price of the metal.
That suggests that Freeport-McMoRan has undertaken a bit of a juggling act. It must sell assets to pay down debt. At the same time, every asset Freeport sells is a potential profit-maker it gives up.
Thing No. 3: Weighing the options
Of course, Freeport is currently not profitable at all, having lost $12.30 per share over the past 12 months. And Jefferies itself admits that its hoped-for profits might not arrive anytime soon. (I believe the words "later this decade" were used). Meanwhile, Freeport's debt problem is now.
At last report, Freeport-McMoRan had just $331 million in the bank, weighed against debt of nearly $20.8 billion. And even Freeport's latest asset sale, TF Holdings, will raise only enough cash to address about 14% of that debt. This suggests that additional asset sales are forthcoming -- and future profits will be all the smaller as a result.
One more thing: Valuation is the most important thing
So what is it about this whole situation that Jefferies finds so appealing? You have to figure that the rough tripling of Freeport-McMoRan's stock price off its January lows colored Jefferies' views somewhat. With such strong price momentum already, it's only natural that Jefferies might hope for more of the same -- and choose to upgrade the stock now, so as to not miss out on future gains.
But even so, I have to say I'm not convinced by this analyst's buy thesis. Jefferies argues that "lower costs and capex" at Freeport are leading the company into "a period of strong FCF" in the very near future. And indeed, most analysts who follow the stock predict the same future. According to S&P Global Market Intelligence data, the consensus on Wall Street is that Freeport will generate positive free cash flow of $1.1 billion this year, after burning $3.1 billion in cash last year.
Even if they're right, though, valuing Freeport on its current market capitalization adjusted for debt, the stock is selling for an enterprise value of $38.8 billon. Adjust that for the expected proceeds of the TF Holdings sale, the EV on the stock drops to $36 billion.
Divided by $1.1 billion in (hoped-for) 2016 free cash flow, that works out to an enterprise value-to-free-cash-flow ratio of more than 32 on Freeport-McMoRan stock. And for a shrinking business, tied to fluctuating commodities markets that may hurt it just as well as help it, that seems way too much to pay.
Long story short? Yes, Freeport-McMoRan has tripled in price since the year began -- and now it costs too much. That's a reason to downgrade the stock, not upgrade it.