3 Reasons to Avoid This Miner

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

Freeport McMoRan Copper & Gold (NYSE: FCX) is one of the few companies that are significantly influenced by copper prices. Freeport is one of the world’s largest copper miners and the strength of the company’s financial position significantly depends upon the strength of copper prices. The overdependence on copper prices is one of the biggest business risks faced by the company, and this is one of the reasons why Freeport has decided to reduce its dependence on the copper business by diversifying its business. In an attempt to pursue diversification, the company has recently acquired two oil and gas exploration companies: McMoRan Exploration and Plains Exploration and Production.

 Lack of growth opportunities

Another reason why Freeport has decided to undertake businesses other than copper mining is the lack of opportunities for business growth in the future. The CEO of the company, Richard Adkerson said that new projects “were limited by the time frame that's required to take resources and take them into development stage and turn them into cash flow projects. External growth projects were limited for factors that [the investment community] is well aware about.”

The main objective of any company is to create value for the shareholders, and it is also preferable to do so in a reasonable period of time; however, in the case of the company’s copper projects, it was becoming increasingly difficult to make a project profitable in a reasonably short period of time. The main reasons were: the negative trend in copper's price as presented by the London Metal Exchange, and the slow worldwide demand for copper. Therefore, the company decided to move away from the copper business in order to create higher value for shareholders in a short period of time.

Freeport is not the only company that is facing slow profit generation in the copper business. BHP Billiton (NYSE: BHP) is a very well diversified natural resource company with multiple segments, and the company recently shelved its $20 billion Olympic Dam project due to the lack of timely cash generation. The project, had it been completed, would have produced 750,000 tonnes of copper a year; but the weakening prospects in the copper market drove the company to let go of the project and focus on other segments of the business. With regard to business risk, in comparison with Freeport, BHP is highly secure as it currently operates in diversified segments. The loss from one segment can be offset against profit in another segment. However, in the case of Freeport, any loss in the copper business will have a dramatic effect on the financial performance of the company.

Market competition is another factor that may influence Freeport’s prospective financial performance. The direct competitor of Freeport is Southern Copper (NYSE: SCCO). The current financial data suggests that Freeport is in a better shape as compared to Southern. The EPS of Southern Copper stands at $2.31 which is lower than FCX’s $3.19. The quarter growth of Freeport at 0.08% has also been higher than that of Southern Copper at -0.11%.

Weak worldwide demand

The price of copper is driven by its demand, and the ongoing slowdown in demand for copper has influenced the price. The major market for copper is China and the decline in demand for copper in China has caused a major setback for the relevant companies. Copper is extensively used in residential construction; however, China is currently focusing on construction of infrastructure such as dams, and highways, instead of real estate.

Bearish call

Last month, Goldman Sachs downgraded the stock from ‘buy’ to ‘neutral’ along with bringing the target price down to $38 from $46. The reason behind the downgrade is the uncertainty surrounding the prospective financial performance of the company. The shares of the company are currently being traded within the range of $34.18 and $34.49, which is toward the lower end of the 52 week range of share price i.e. $30.54 and $48.96. The following chart represents the trend of FCX over the past year:

<img src="/media/images/user_13010/fcx_large.jpg" />

The chart represents a highly volatile market performance, and with the plan for diversification through two new businesses, Freeport's volatility is also expected to continue in the current year. After the analysis of multiple factors relevant to the financial and market performance, investors should hold their investments in the company. There is a high level of uncertainty regarding the market performance of the company. If FCX succeeds in diversifying its business, investors could highly benefit from the situation. However, due to uncertainty, buying the shares at this point may not be a favorable decision.

muhammadbazil has no position in any stocks mentioned. 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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