Consider Playing Oil Through This Copper Company

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

As oil prices continue to rise, investors looking to play the move should consider Freeport-McMoRan Copper & Gold (NYSE: FCX). For most of its history, Freeport had been considered a pure-play copper company with a little bit of gold exposure. However, that all changed when Freeport announced plans to buy McMoran Exploration and Plains Petroleum for a combined total of $9 billion.   

The initial reaction to the deal was quite negative, with Freeport shares falling by more than 14% the day the deal was announced. Since then, as shown by the chart below, shares have continued falling to new lows. The primary reason for Freeport's decline has been falling copper prices, since Freeport is the world's second largest copper producer. 

<img alt="" src="http://media.ycharts.com/charts/c41c37bccc37c775c535804827b738b2.png" />

FCX data by YCharts

Freeport shares have not reacted at all to rising oil prices. Currently, WTI crude oil is trading at a 14-month high. Pure oil exploration and production plays such as Conoco Phillips (NYSE: COP) and Marathon Oil (NYSE: MRO) are trading at 52-week highs. Of course, Freeport is not a pure oil play, and it should not be expected to trade as one. However, because of its recent acquisitions, Freeport does have a significant exposure to the oil business. 

Thoughts on Conoco Phillips & Marathon Oil  

I like both Conoco and Marathon as oil plays. It should be noted that larger integrated oil plays such as Exxon, BP, and Chevron are cheaper on a valuation basis. However, Conoco & Marathon are different as they have spun off their refining businesses into separate companies. I am not bullish on the refining business right now as spreads have tightened considerably of late. Between Conoco & Marathon, my preference would be Conoco because of its 4.25% dividend yield and cheaper valuation. Of course, unlike Freeport, Conoco & Marathon are well known as oil plays and thus have likely priced in much of the recent rise in oil prices.

The main reason why I prefer Freeport to Conoco or Marathon is valuation. Freeport trades at about 7.5 times forward earnings while Conoco and Marathon trade at 10.5 and 11.7 times forward earnings. I believe that Freeport should trade at the same valuation or a richer valuation than these two oil plays, because Freeport has the flexibility to invest money in a more efficient way. For example, if oil prices are strong, as they are today, then Freeport can divert resources (cash) into producing oil instead of copper. Contrastingly, if copper prices are stronger than oil prices, then Freeport can allocate more resources to the copper business. as opposed to oil.  

More on Freeport 

On June 3, 2013, James C. Flores, Vice Chairman of the Board at Freeport, purchased more than $34 million in stock on the open market at an average price of $31.17, well above today's price. This purchase is notable for a two reasons. Firstly, $34 million is a very large transaction. Obviously, Mr. Flores is very confident that Freeport represents value at this level. Additionally, it should be noted that Flores is an oil man. Flores served in senior roles at both Plains and McMoRan before his current role at Freeport. It is likely that Flores sees value in Freeport's oil assets, and that is why he is buying.

The major takeaway here is that this "oil man" is buying a big stake in a company known more as a copper play than an oil play.

Another reason to consider Freeport is the valuation. Currently, Freeport trades at less than eight times forward earnings. Before Freeport's oil deal was announced, the company traded at more than 10 times forward earnings. In addition to cheap valuation, Freeport also pays a dividend of $1.25 or 4.5%.

To be clear, if copper prices move much lower from here, Freeport shares will follow. However, if copper prices are able to stabilize, I think shares can move higher, based on the oil story. To hedge copper risks, sophisticated investors can consider selling short copper futures, copper ETFs/ETNs, or other copper miners.

Conclusion      

The market is not giving Freeport enough credit for its oil business. Given this, investors should consider Freeport as a long idea. That being said, an investment in Freeport also requires a bullish, or at least not bearish, view of copper prices. If you happen to have a negative view of copper prices, but is still interested in buying Freeport as an oil play, then I suggest hedging the position as I discussed above.  


Sammy Pollack 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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