A More Macro Outlook On 2 Mining Stocks

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

While natural resources can be a very daunting sector to value (how do you price commodities), you should take heart into how much of the future commodity trends have already been priced into the stock. What you need to do is look at supply and demand and make an educated guess about whether your outlooks is more rosy, or less so, than the market's. Then look at the company's specific volumes and risk/reward from its various projects. Below, I provide a more macro outlook on two miners.

Multiple Headwinds Limit Newmont Mining's (NYSE: NEM) Upside

Newmont ranks fairly high on my list of least preferred mining stocks. Aside from overly aggressive growth assumptions over the next 5 years in the face of weak recent performance, Newmont has generally weak fundamentals compared to peers. Management recently stated that it will generate negative free cash flow through at least next year in an attempt to grow production. This, in my view, will be poorly timed for pressure on gold prices. Futures have fallen for the fourth consecutive weekly loss. According to Veritas Research, the company experienced "significant" cost inflation in the third quarter.

Third quarter performance was generally weak across the board with earnings falling 26% y-o-y and management guiding for lower producing in gold and copper. In addition, costs, writedowns, and restructuring expenses are forecasted to grow. Gold futures have fallen largely as a result of nonfarm payrolls rising above economist projections. Going forward, I am uncertain about how the company's attempts to cut costs will fare. The possibility of a strike from labor is high given that workers, particularly from Indonesia, have seen wages go up from other miners. For example, miners at Freeport have enjoyed a 37% wage hike recently. Job cuts in Batu Hijau may limit the likelihood of a protest, but it could turn matters from bad to worse by furthering decreasing production. If nothing else, some argue that the Indonesian government could threaten Newmont with nationalization or greater royalty payments to force their hand. My own view is that Indonesia would much rather side with management than labor given Newmont's geographical exposure, but it's still not worth the risk at this point.

Strong "Buy" For Freeport McMoRan (NYSE: FCX)

Over the last three months, Freeport has fallen 16.3%, largely as a result of a widely panned acquisition of an oil & gas company. While that has already been covered by much of the media, not enough attention has been given to how many investors anticipate copper depreciating from greater supply and weaker Chinese demand. In my view, both of these events are unlikely to happen together. If long-term demand from China, copper's largest consumer, falls, production will likely decline--the assumption now that there is copper scarcity relies on the notion that the market has been inefficient for around a decade. Ultimately, China has implemented a stimulus bill that will be largely aimed at infrastructure, which will in turn flow money towards miners.

With that said, over the last 5 quarters, performance has been less than stellar. There have been a series of misses that have caused the stock to stay to trade at a low multiple of 8.3x forward earnings. However, analysts now rate the stock a 1.9 out of 5 where "1" is a "buy" despite only projecting 4.7% annual EPS growth over the next 5 years. In fact, Deutsche Bank has a $50 price target on the stock--it is looking beyond the weak production. Moreover, the market has yet to factor in the planned production reversal over the next few years. Recent performance has been weak due to supply disruptions in Indonesia, but these are isolated events that are not symptomatic of the fundamentals. Equipped with a strong balance sheet (as evidenced by the current ratio of 3.2x and debt-to-equity ratio of 0.2x) and growing margins, Freeport is well positioned to benefit from macro trends. I encourage buying shares on this optimism.

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!

blog comments powered by Disqus