4 Copper Mining Stocks: Which Are Buys?

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Investing in copper miners is largely a China bet. Copper producers like Sumitomo are expanding productive capacity in the face of lower margins, pinning their prospects on growing demand. Much of this demand is hoped to come from the PRC (People's Republic of China).

I don't want to burst any bubbles, but this is only half of the story. Copper prices could decline if demand fails to meet expectations. Supply could grow faster than demand. Which copper stocks, if any, offer low-enough valuations for this macro risk?

Excellent Forecasts for Copper Demand

Barclays (BCS) predicts that shortage in copper supply will continue into the first half of next year. China's recovering economy will stimulate demand that could outpace supply by an estimated 316,000 metric tons, enough to wipe out the current volume stored in London Metal Exchange (LME) warehouses, before surplus in supply emerges in the second half.

Global demand will increase 3.4% to 20.85 million tons in 2013, compared to a 1.5% gain this year, while supply will expand by 3.5% to 20.83 million tons resulting to a shortage of 19,000 tons for next year. The 316,000 tons deficit in the first half will be only be filled by the 297,000 tons surplus in the second half of 2013.

China's copper consumption is projected to rise as much as 5.5% to 8.1 million tons, more than a 4.8% increase this year. China, which consumes 41% of the world's copper output, is about to recover from seven consecutive quarters of slowing GDP growth aided by $161 billion in government spending for infrastructure approved in September. The infrastructure plans which include subway projects in 18 cities, extra spending on railways and 2,000 kilometers (1,250 miles) of roads, are expected to grow the nation's economy until at least the middle of 2013, according to estimates compiled by Bloomberg.

Contributing to the increase in demand is the record number of housing starts in the U.S., the second largest copper consumer, and stimulus pledges central bankers. Europe and Japan account for 18% and 5% of world's copper consumption, respectively. UBS (UBS) wealth-management unit head for Singapore Dominic Schnider said "Economic activity doesn't have to be that strong in China for inventories to get drawn down and you could see a rally in the first half, but then you come into the second half where mine supply comes in on the strong side."

Freeport-McMoRan (NYSE: FCX) may report net income of $4.52 billion in 2013, a 44% increase from $3.14 billion this year, due to the projected increase in copper prices, according to analyst estimates compiled by Bloomberg. Copper accounts for 78% of Freeport 2011 sales.

Sucden Financial director Jeremy Goldwyn said, "Next year will be slightly more positive than this year. That's predominantly based on improvement in Chinese conditions, marginally better in the U.S. and pretty much the same in Europe." This view is supported by Macquarie Group noting that global supply expectations for next year are somewhat optimistic, given the various constraints that beset the mining industry ranging from power shortages, rising labor costs and declining ore grades, which may curtail production.

Freeport Chief Executive Officer Richard Adkerson believes that the PRC will find a way meet their five-year plans targets. This perspective considers the recent reports of decreasing copper purchases as temporary. Richard Adkerson said, "Presently we're not seeing physical evidence of a significant change. Sentiment has certainly changed and concerns about China both within the country and from outside observers are changing, but China continues to consume significant copper."

Supply and Demand

Clearly, price forecasts try to compare the demand and supply of copper and determine which will be stronger than the other. The ambitious investments in new mining projects suggest there is a risk that supply could outpace demand.

Goldman Sachs (GS) slashed copper projections by 11%, a conclusion that is opposed to Freeport-McMoRan's still has plans increase production capacity by over 25% in three years.

Sumitomo Metal Mining, one of Japan's largest Copper producers, anticipates higher processing fees based on the increase in supply of raw materials from the mining fields. The treatment and refinery fees (commonly referred to as TC/RCs) for metals such as copper, are likely to rise above this year's level, lowering profit margins.

President of Sumitomo, Nobumasa Kermori, said, "Spot TC/RCs have been increasing as the yen's strength against the dollar reduced margins for Japanese smelters and Chinese buyers were reluctant to purchase concentrate because of the unfavorable difference between prices in Shanghai and London." Mr. Kemori next described how Sumitomo Metal Mining plans to expand its operations globally by targeting three mining fields in South America. These expanded operations could attain a production output of 300 thousand tons by 2020, more than double its 120 thousand ton current output. This target is to be divided into two phases, the first phase is the Sierra Gorda Mine which could generate 70 thousand tons while the remaining balance will be generated from other foreign mining fields the company plans to acquire.

Confidence is to be expected from executives who are in the business of mining copper. I think there is a bias in management to expand, even if it is not clearly in the best interest of shareholders. Don't be surprised if they don't stop capital expenditures until they are forced to stop.

In contrast, investors can opt out of the copper industry. Investors should consider this as a possible investment strategy if these stocks are not compelling.

Finding Value in Copper

Not all the valuations of copper-mining stocks reflect their exposure to macro risks:

<table> <tbody> <tr> <td> <p><strong>Ticker</strong></p> </td> <td> <p><strong>Company</strong></p> </td> <td> <p><strong>P/E</strong></p> </td> <td> <p><strong>P/S</strong></p> </td> <td> <p><strong>P/B</strong></p> </td> <td> <p><strong>D/E</strong></p> </td> </tr> <tr> <td> <p>RIO</p> </td> <td> <p>Rio Tinto</p> </td> <td> <p>22.23</p> </td> <td> <p>1.62</p> </td> <td> <p>1.65</p> </td> <td> <p>0.38</p> </td> </tr> <tr> <td> <p>FCX</p> </td> <td> <p>Freeport-McMoRan Copper & Gold</p> </td> <td> <p>12.67</p> </td> <td> <p>2.1</p> </td> <td> <p>2.16</p> </td> <td> <p>0.21</p> </td> </tr> <tr> <td> <p>SLT</p> </td> <td> <p>Sterlite Industries</p> </td> <td> <p>9.39</p> </td> <td> <p>0.89</p> </td> <td> <p>0.82</p> </td> <td> <p>0.35</p> </td> </tr> <tr> <td> <p>SCCO</p> </td> <td> <p>Southern Copper</p> </td> <td> <p>15.92</p> </td> <td> <p>4.59</p> </td> <td> <p>4.67</p> </td> <td> <p>0.42</p> </td> </tr> </tbody> </table>

As commodity producers, these companies have no economic moats, yet somehow, Southern Copper (NYSE: SCCO) and Rio Tinto (NYSE: RIO) trade at price-to-earnings ratios above the S&P 500 average. Of these stocks, the only one that trades at attractive price multiples is Sterlite Industries (NYSE: STL).

No Crystal Ball Needed

Can I predict commodity market price swings? No, and I strongly doubt you can either. Who could know if the actions and reactions of miners, speculators, and government officials will land on the side of higher or lower copper prices. Fortunately, you don't have to be psychic to note that the price multiples of copper miner Sterlite are low enough that they are appropriate for a commodity firm. On the other hand, shares of Rio Tinto and Southern Copper trade at valuations that are just too high for commodity producers. Freeport-McMoRan Copper & Gold would need to trade at lower multiples to become attractive.

BillEdson11 has no positions in the stocks mentioned above. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus