3 Factors To Consider Before Investing In Natural Resource Stocks

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If you are interested in buying shares of natural resource companies, there are several variables to consider: (1) diversification, (2) market (ie. supply and demand) trends, and (3) multiples. In this article, I provide a look at 3 companies with these variables in mind. Specifically, I make the case for investing based on risk/reward preference and buying into the uncertainty only when the long-term market trends are stronger than recognized.

A Look At Southern Copper (NYSE: SCCO)

Southern Copper is an integrated miner that has gained 26.7% for the year to date. According to Citigroup, the firm is a "buy" for its Tier 1 copper assets that require minimal capital expenditures to sustain. These low-cost operations are particularly noteworthy in light of copper supply shortages that will hit an accelerating Chinese economy. The emerging market is on track to double its growth in global consumption of the metal. A shortage of 316,000 metric tons in the first half of 2013 will provide for strong prices and cash flow ahead of the surplus expected to emerge in the second half of the year. Bear in mind, however, that the company is trading at a premium to peers with a 7.1x book value versus 4.3x for the industry average. Return on invested capital is still 1,206 bps greater than the industry average at a stellar 36.5%. And, of course, there's the obvious 9.7% dividend yield.

Analysts are still largely uncertain about Southern Copper. Only half of the reporting analysts rate the stock better than a "hold." And this uncertainty will increase with the strikes planned at the Toquepala and Cuajone copper mine and Ilio smelter operations. Labor is protesting management's decision to deny the proposed 15% annual wage hike. Management has instead offered a 4-year deal with a 5.5% annual wage hike. Negotiations have been evidently tense--in late August, the company announced that it was holding its third round of talks. This may create complications for short-term investors, but I encourage investing based on the long-term. Although EPS fell 67% y-o-y in the third quarter, volume was still up 11.2% y-o-y, and "world economies are getting prepared for a period of growth." Refined copper's global demand is expected to rise by around 3.5%, which outpaces a 1% expected supply growth.

Freeport (NYSE: FCX) Vs. Goldcorp (NYSE: GG)

Investors have long looked at Freeport as a solid copper play with some added gold exposure. But with the decision to enter the oil & gas industry, Freeport has fallen 28.8% from the 52-week high amidst a wave of shareholder anger. Why the anger? Freeport acquired Plains Exploration for $6.9 billion and McMoRan Exploration for $3.4 billion. Wall Street has turned against conglomerates since the '80s under the belief that the market can better value assets when they aren't forced to bundle them with other unrelated assets.

The absence of a shareholder vote on these two deals, which represent two-thirds of Freeport's market cap makes the matter much worse. Further, the $12.5 billion loan package for the buyouts are facing bank pushback--the banks find that that their share of the the bridge loan is too small. According to Deutsche Bank, however, investors will put aside their hostility and come to accept the oil & gas exposure as a way to gain leverage to high growth potential in the Gulf of Mexico. And, in terms of financial position, this deal is good in the longer-term. Moody's still rates the company three notches above "junk" and argues that Plains will add incremental EBITDA and cash flow to easily pay off the interest.

In light of this diversification, investors may consider backing more of a purer play, such as Goldcorp. Though the stock looks relatively expensive at 19.5x past earnings, analysts have a consensus $57.12 price target. 15 of 19 reporting analysts are calling the stock a "buy" or better, and none say "sell." In mid-October, Barclays came out with an "overweight" report and a $62 price target, which is at around a 75% premium to the prevailing price. With such a large margin of safety, a clean balance sheet, and 50% less volatility than the broader market, Goldcorp is an ideal investment for those worried about Freeport's risk.

TakeoverAnalyst has no positions in the stocks mentioned above. 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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