Freeport Uncommon

[Note to subscribers: the next installment of G-Force investing will be postponed to a future issue that we might bring you a special trading opportunity this week.  Please read on.]

In an earlier edition of the Residual Income Report we introduced you to the preferred mandatory shares of Freeport McMoran Copper and Gold, the world’s largest openly traded copper company and a significant precious metals producer, to boot.

Today, we’re checking back in with the company to highlight the value of the common shares, which feature an uncommon number of reasons to buy – even in the current market environment.  Let’s look at the chart first.

Below is the last decade’s trading in Freeport’s common shares (FCX:NYSE).  The chart shows the move off the company’s all-time trading lows in 2000 through to its all time highs several months ago.

This is a textbook example of a solid stock that got caught in the riptide of panic that swept through the markets last month.  Freeport was “court-martialed, shot and sent to the Russian front” after getting keel-hauled and whipped.  The stock is now trading at a humiliating $32.93 after reaching heights of over $120 this past spring.

But wasn’t the sell-off deserved?  Didn’t copper take a beating in the futures pits this last month?

First, a few facts:

Freeport was closely held by two hedge funds that got wham-doggied in September and have seen wholesale redemptions by fund holders ever since.  The funds in question, Harbinger Capital and Atticus Capital were forced to liquidate massively to give unit holders their payouts.  That meant closing out their respective Freeport trades.

Hedge Funds Go to the Guillotine

The hedge fund industry is a $2 trillion business that has just recently suffered its worst losses in a decade.  In September alone $43 billion was redeemed and more is expected through year-end, 2008.  The forced selling of shares to meet the demands of these redemptions has been largely responsible for the steepness of this last month’s decline – certainly in the commodities – and notably, for us, with FCX.

What’s crucial at this point is whether managers have accurately anticipated their clients’ desire to sell.  If yes, then the wave is likely to be complete.  If not, then we’re likely to see another tidal outflow towards December when managers are expected to meet another payout deadline for unit holders.

According to Trim Tabs, an investment research group that monitors flows of funds, this last week may mark the end of forced selling on the part of hedge funds.  On Thursday they issued a report saying that many have raised enough cash to meet redemptions.

We’ll see.

In the meantime, Freeport’s fundamentals are uncommonly good.

The company is one of the world’s largest copper, gold and molybdenum miners, with worldwide reserves of roughly 90 billion pounds of copper, 1.8 billion pounds of molybdenum and over 40 million ounces of gold.  Annual production levels are 4.35 billion lbs. copper, 85 million lbs. molybdenum and 1.8 million ounces of gold.

As copper production accounts for nearly three quarters of the company’s revenues, the recent nosedive in copper prices clearly exacerbated the Freeport sell off.  Here’s a look at the recent trading in copper.  Note well, that here, too, there has been a marked increase in the number of short contracts seen on the NYMEX.

We’ll be interested to know what happens when these positions have to be unwound.  Particularly with analysts forecasting price rebounds in copper of between 40% and 50% for the coming 12 months, the current bargain basement levels may not be sustained for long.  Morgan Stanley sees the price scaling back up to $3.20 in the New Year from its current $2.20 level.

More than this, supply is very tight in copper, with just 22,000 tons of stock available – amounting to a meager five days global consumption.  Any tie-up in this supply (strike, closure, accident) could dry up inventories and send prices surging.

The dark horse in the picture is, of course, China, which accounts for almost a third of the world’s current and projected demand for the next decade.  Much is riding on Asian expansion, in general, to keep prices high.

That said, demand for copper in the emerging markets has been largely unaffected by recent events.  In the U.S. there are huge dislocations, to be sure, but in China it appears the government’s bailout program will involve shoring up the construction sector – the biggest consumer of copper in the world.

A Fundamentally Sound Snapshot

Freeport reports earnings this Tuesday morning.  At that time, they’ll certainly highlight what’s been said here, along with a few other gems:

• As of month-end September 2008 the company had repurchased 6.3 million shares as part of an overall 30 million share buyback program (recently raised from 20 million).

• Freeport has a dividend yield of 6.07%.  The company just boosted the annual payout by almost 15%, from $1.75 to $2.00.

• The current P/E is a scant 4.30.  Find me anything of quality that approaches that number in this market!

• The shares are selling with a Price to Book ratio of .78 – or ¾ of the company’s break up value.

• 2007 numbers reflect gargantuan growth:

Profit growth: 104.39%
Revenue Growth: 192.53%
Return On Assets:  55.23%
Return On Equity: 121.75%

In short, the shares of Freeport are ridiculously cheap. 

“Where are the new mines?”

So when Jim Rogers talks about the commodities bull lasting for another ten to fifteen years (’til 2022, he says); and when he says, “Where is the copper coming from that’s going to drive down the price and keep it down?  Where are the mines?” – you can be sure that Freeport McMoran is will be in the thick of it for a while yet.  And that the current ridiculously low price and valuations are the opportunity of a decade.

The Residual Investment Report recommends you purchase FCX common shares at $32.93.

And enjoy an uncommon ride against the tide.

All the best,

Matt McAbby
Analyst, Residual Income Report