Freeport McMoRan Earnings Preview: Cheap, But Worth the Risk?

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

Freeport-McMoRan (NYSE: FCX) is one of the world’s largest copper producers, in addition to being a major producer of gold and molybdenum.  The company operates mines in North America, South America, Indonesia, and Africa.  The company’s stock price has been on a roller coaster ride over the past five years or so, from a split-adjusted high of $63.62 in mid-2008, before the entire market began to collapse, to a low of $7.85 just four months later, then steadily climbing back to the $35 levels the stock trades at today. With the company set to report earnings on Monday the 14th, investors may be wondering if this very cyclical and economically sensitive company is worth a look, or if the gains have all been had, for now.

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Freeport produces just less than 4 billion pounds of copper annually, and has approximately 120 billion pounds of proven reserves.  Other proven reserves include about 34 million ounces of gold (mostly in Indonesia) and 3.4 billion pounds of molybdenum (all in either North or South America).  Copper currently accounts for 78% of the company’s sales, gold 12%, molybdenum 6%, and 4% of its sales from other revenue streams. 

The general mining industry has seen a lot of consolidation over the past century, due to the enormous sums of money required for exploration and construction of mines.  As a result, the number of major competitors has decreased substantially, which further strengthens the companies that remain.  Freeport’s largest competitors include BHP Billiton (NYSE: BHP), Rio Tinto (NYSE: RIO), Southern Copper Company (NYSE: SCCO), and a handful of others.  As Freeport is the first of the major copper producers to report, their results and comments could very well set the tone for the rest.

What investors will be most curious to hear will be the company’s status updates on their pending mergers to Plains Exploration and Production and McMoran Exploration Company.  Freeport plans to acquire Plains for $6.9 billion and 91 million shares of stock, and McMoran for $2.1 billion for the 64% of the company that Freeport doesn’t already own.  As of the announcement of Dec. 5, Freeport expects the deal to close during the second quarter of 2013.

Analysts (and the market) tend to have an unfavorable view of this deal.  The deal would cause Freeport to further diversify their operations into oil and gas, which could hinder their dominance as a copper producer.  Plus, Freeport would not enjoy the same competitive advantage it enjoys as one of the major players in the copper game in its new oil and gas ventures.  Also, the debt level the company is planning to undertake as a result of the merger is seen as very risky, especially if there is a downturn in the price of copper or the economy in general.  Look for Freeport to address any of these issues.  It is not likely that the marketplace will embrace this deal without what it feels are adequate answers to these questions.

However, with these added risks comes cheaper valuation.  Freeport is expected to report earnings of $3.24 for 2012, which consensus estimates expect to increase to $4.61 for 2013 and $5.04 for 2014.  Listen for the company’s guidance in relation to these estimates.  Regardless, if these estimates prove to be accurate, Freeport looks like an attractive investment right now, trading at 10.9 times current year earnings, and only 7.6 times forward earnings.  In contrast, Southern Copper trades at 15.9 times 2012 earnings and 15.3 times forward earnings.  BHP Billiton trades at 12.5 times 2012 earnings, which are expected to drop by 12% in 2013.  Also worth noting is the generous 3.77% dividend yield paid by Freeport.

When you look at all of the numbers and the valuation of its peers, Freeport certainly seems like the most attractively valued copper producer out there.  However, this implies to me that the market is pricing in a tremendous risk associated with the pending merger.  The company needs to ease investor’s tensions by reassuring investors and clarifying how they intend to grow as a result of the deal.  Until investors are satisfied in this regard, Freeport will continue to trade at a nice discount.

KWMatt82 has no position in any stocks mentioned. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold, Inc.. 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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