Should You Catch This Falling Knife?

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

The precious metals sector has had a rough week, as commodity prices for metals went into a free fall after negative economic news out of China. Gold prices led the way with a drop of over 15% from April 11 to April 15. Copper similarly experienced a large price move, dropping from $342.5 to around $315 per pound.

Freeport-McMoRan Copper & Gold (NYSE: FCX) is often thought of by the market as a pure-play proxy for copper, and was similarly hit by the bad economic news and experienced a sell-off. In addition, the company also recently released its first quarter earnings report. The question for investors is whether now may be a good entry point for initiating a position in the company, or whether the share price has further to fall. The trading adage goes that you shouldn't try to catch a falling knife. With Freeport's recent expansion into the oil and gas field, along with a reasonable dividend yield for the stock, the company deserves a closer look by investors.

The financials

Freeport-McMoRan is a copper, gold and molybdenum mining company. It has large open-pit and underground mining operations in North America, South America and Africa. Freeport-McMoRan released its Q1 earnings for 2013 on April 17, announcing that net income attributable to common stock was $640 million, or $0.68 per share, compared to net income of $764 million, or $0.80 per share, for Q1 of 2012.

Operation net cash flows were estimated to be $5.5 billion for 2013. The company had sales of 954 million pounds of copper, 214,000 ounces of gold, and 25 million pounds of molybdenum, representing an increase in the sale of copper and molybendum versus Q1 of 2012, but a reduction in the amount of gold sold. Net cash costs increased to $1.57 per pound of copper, versus $1.26 for Q1 of 2012.

Freeport-McMoRan anticipates that its proposed acquisitions of Plains Exploration and Production (PXP) and McMoRan Exploration (MMR) will be completed in the second quarter of 2013. The company stated it had completed $10.5 billion in debt financing for these acquisitions, with a weighted average interest rate of 3.1%. These acquisitions would expand Freeport-McMoRan’s activities into oil and gas exploration and development. It is uncertain how the newly diversified focus on both mineral extraction and oil and gas will impact operations, and what the ultimate impact on the bottom line will be.

How’s the stock price action been lately?

Freeport-McMoRan has had a rough ride in the market as of late, down over 14% in the past week, and down over 28.44% in the past six months. The share price is trading well below the 50 and 200 day SMA, with the daily RSI indicator showing the stock is oversold. The price reached a multi-year low of $7.85 in December of 2008. There appeared to be longer term support around $30, but the recent break below that level could be bearish. The company has a P/E ratio of 8.64, and a reasonable dividend yield of 4.46%.

There is some short interest in the stock, with a short ratio of 4.13%, and a short ratio of 2.28. Over 36 million shares were being shorted as of March 28. It appears that the short interest increased after the announcement of the company's proposed acquisitions, whereby the short interest may be driven by merger arbitrage trading.

How are the hedgies trading it?

Some hedge funds were betting on the company in accordance with the most recent 13F SEC filings. John Paulson of Paulson & Co. bought 9 million shares in Q4 of 2012, according to Insider Monkey's database, representing 1.89% of his total portfolio. Investors may want to look at other companies in the sector if they believe that precious metal prices will eventually bounce back.

What other sector peers have been hurt by gold?

Newmont Mining (NYSE: NEM) is a gold producer, and has been also hit recently by the gold price drop. It’s worth pointing out that because Freeport’s fate seems to be tied to the precious metal so heavily going forward, logic would hold that it’s worth considering the health of some purer-play gold producers as well. Newmont, in particular, has seen its share price drop over 15% on the week, and down 39% in the past six months. Newmont still carries a dividend yield of over 5%, and it sports a forward earnings multiple of 7.5x—a 17% premium to Freeport McMoRan.

Barrick Gold (NYSE: ABX) is another gold and mining development company with additional oil and gas activities. Like Newmont and Freeport, Barrick was down a punishing 27% last week, and is trading at $17.91, a level not seen since October of 2008. Barrick consistently trades with greater volume than Newmont of any of the other gold equities, and in this light, it’s a much closer peer to Freeport than Newmont or Goldcorp (NYSE: GG) for example. Barrick’s valuation is even more attractive than that trio, as it trades at a meager 4.2 times forward earnings and a book multiple that’s a whopping 20% below parity.

Speaking of Goldcorp, in this stock, we’ve got another gold miner that has fallen more than 10% in the past week. The key play that Goldcorp offers is growth; Wall Street expects the miner to generate annual earnings growth in excess of 14% over the next half-decade. This mid-teens forecast is far above what’s expected of Barrick (7.7%) and Newmont (-1.8%), and is actually third highest of the 53-stock, U.S.-listed basket of “gold” industry stocks.

If pressed to choose a pure gold peer to pair with a bullish bet in Freeport, we at Insider Monkey would have to go with Goldcorp because of this growth advantage. An investor confident in a rebound in precious metal prices would be best served by taking a diversified position in copper with Freeport, while “attacking” gold with the soundest growth-play available in Goldcorp.

What’s the best move?

With that being said, investors may want to wait on investing in Freeport-McMoRan and the other companies discussed above until a solid bottom has set in in the precious metals markets. It may be difficult to time the bottom though. The dramatic price drop in metals appeared to catch a lot of people off guard.

Gold bugs were still long gold as of late, but this needs to be re-examined in the wake of the recent drop. Investors may want to continue to monitor whether hedge funds cut their positions in the stocks mentioned herein. Still, the story in the precious metal sector is still unfolding. Although the dividend yields on some of the companies mentioned here look somewhat attractive, the sector as a whole may be in for further turbulent times.

The Freeport-McMoRan-falling knife may still be dropping, whereby investors may want to stay out of it for the time being. A well-timed trade on the turnaround could be fruitful, but timing this trade is the difficulty.


This article is written by Joshua Reider and edited by Jake Mann. Insider Monkey's Editor-in-Chief is Meena Krishnamsetty. Joshua has a long position in FCX. 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!

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