Freeport & Barrick: Gold Kings In 2012
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It has been considered for some time now that gold is more akin to currency rather than falling squarely into the ‘commodity’ category. Investors have long sought gold as a hedge against the ‘unpredictability’ in life, such as growing national debt, social unrest, or social fiat currency crises. One need only look around and notice that in the last few years, ‘Cash-for-Gold’ stores have been opening en masse.
Like all precious metals, gold can be held against inflation, deflation or currency devaluation. Thus, it is no wonder that companies that focus on precious metal and mineral resources have seen significant performance. I believe this trend will continue with companies such as Freeport-McMoRan Copper & Gold (NYSE: FCX) and Barrick Gold (NYSE: ABX).
What Has Happened
Inevitably, when one mentions Freeport-McMoRan, the flow of conversation immediately shifts to the Grasberg strike. The Grasberg Mine, located in Indonesia, is the largest gold mine and the third largest copper mine in the world. While exploration reached as far back as the 1930’s, actual mining in the area began in the 70’s by then named Freeport Sulphur. In 1988, Grasberg was opened and quickly began producing results, despite the civil unrest in the area that broke out against the damages done by the company and the mine.
Violence surrounding the mine ignited in 2009 when a worker and several security guards were shot. Two years later, a car full of employees was set afire by a group of fighters/protesters. It was this incident that incited the strike with workers calling for better security and increased wages.
The strike shut down operations for only a week, but the lingering disruption in production over the next several months all but crippled the mine. Finally ending in December 2011, the workers were awarded a 37% increase in wages and improved housing allowances.
That was not the end of the disruptions. A new wave of worker walkouts came in February, however, these lasted a much shorter three weeks before production resumed.
What affect did this have on Freeport-McMoRan? Last week, the company said it would revise consolidated first-quarter sales to down by almost 30 percent for gold and 10 percent for copper to reflect the production interruption. Its fourth-quarter earnings for 2011 had dropped 59 percent, with a revenue dip of about 25 percent.
What Is Happening
The mineral and resources industry is cyclical, highly competitive and has historically been characterized by excess of supply over demand. Profitability for individual companies largely depends not only on how big they are, but on how well they operate. For example, bigger companies are able to discover and develop new deposits, thereby boosting reserves, while the smaller ones own fewer mines and can produce only limited supply.
As of December 2011, Freeport’s consolidated reserves included 119.7 billion pounds of copper, 33.9 million ounces of gold, 3.42 billion pounds of molybdenum, 330.3 million ounces of silver, and 0.86 billion pounds of cobalt. With operational mines on four continents, this company is one of the powerhouses in the industry. This positions it to remain competitive even with recent worker disruptions which, leadership has demonstrated the ability to handle appropriately.
In comparison, company strategy also plays a role in the sustainability and success of a company. In some cases, diversification of interests is beneficial, as Freeport has shown by its branching out into oil and gas. Mergers and acquisitions have typically been the growth strategy for mining companies. However, in other cases, narrowing the focus can also prove wise as proven by Barrick Gold. This company, all though it holds interest in oil and gas as well, draws almost 90 percent of its revenue from gold compared to Freeport’s 40 percent. Because of their focus, the company has seen significant benefit from recent economic uncertainty.
What Will Happen
In an industry plagued with rising energy and raw material costs, increasing productivity and reducing costs are the keys to success. As economic factors level out, I predict those companies such as Freeport and Barrick that hold sufficient resources will benefit from the recovery of their (and other) industries. In turn, they will be able to use said resources to build enough cash reserve to see them through market fluctuations.
Even so, being ‘too big to fail’ isn’t everything. Competitive producers must find a sustainable market for its goods. Demand in the metals and mining industry has benefited from the strong growth in emerging markets and estimates claim this could double in the near future. China is the world’s largest consumer of metals and is expected to remain so in the future. Emerging markets such as India and China will increase global metal demand and improve the standing of these companies. Expansion in low-cost countries will ensure lower labor costs and also help tap their growth potential.
Freeport’s strength comes from its diversification in copper, gold, oil, and gas. Its leadership has shown strategic execution of issues that arise while maintaining its position in the market. To cite a recent analysis with which I strongly concur:
It trades at a respective 8x and 7.1x past and forward earnings … Assuming a multiple of 9.5x and a conservative 2013 EPS of $5.34, the rough intrinsic value of the stock is $50.73. Analysts rightfully rate the stock a "strong buy". Consider these 3 reasons why you should buy Freeport: (1) attractive fundamentals, (2) deep value discount, and (3) consensus is on your side.
Summary
While some investors seek companies with no bad press and that have proven relatively ‘drama-free’, I submit that ‘diamonds are formed under pressure’. Freeport’s strength amid recent struggles shows its staying power. Likewise, as emerging markets increase demand, I recommend both Freeport and Barrick as ‘buys’.
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