Neutral On Freeport-McMoran Copper & Gold Due To High Volatility

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Freeport-McMoRan Copper & Gold Inc. engages in the exploration, mining, and production of mineral resources. The company primarily explores for copper, gold, molybdenum, cobalt hydroxide, silver, and other metals, such as rhenium and magnetite. It holds interests in various mines located in the Grasberg minerals district in Indonesia; Morenci minerals district in North America; South America; and Tenke Fungurume minerals district in the Democratic Republic of Congo.

Freeport-McMoRan Copper & Gold Inc. (NYSE: FCX) is the world’s largest publicly traded copper miner, selling 4 billion pounds of copper annually, equivalent to about a 10th of global mine output. The stock closed yesterday’s trading session at $75.52. In the past year, the stock has hit a 52-week low of $42.31 and 52-week high of $48.96. Technical indicators for the stock are bullish but the company’s fundamental failed to impress.

GROWTH AND BALANCE SHEET

FCX missed estimates last quarter after beating forecasts in the prior two. In the second quarter, the company reported profit of 74 cents per share versus a mean estimate of net income of 75 cents per share. In the first quarter, the company beat estimates by 11 cents. The company’s annual earnings growth rate over the past five years is 7.5%. In the second quarter, earnings fell 48.1% to $710 million (74 cents a share) from $1.37 billion ($1.43 a share) the year earlier, missing analyst expectations. Revenue fell 23% to $4.47 billion from $5.81 billion. The total debt/equity of 21% stands at reasonable level.

Management has stated that they will spend roughly $275 million on exploration in 2012 compared to $221 million last year. The company expects copper production to increase by approximately 25% over the next 3 years but we think that figure is very optimistic.

VALUATION

Over 3/4 of FCX’s revenues come from the sale of refined copper, of which over 75% is bought by third-parties for use in construction or the manufacture of electrical appliances and industrial machinery. FCX has a market cap of $40.20 billion. The P/E of 12.72 is attractive and close to the industry average. The stock is currently trading above its fair value of $39. The beta of 2.26 implies high volatility of the stock with respect to the S&P 500, and we suggest the stock only for aggressive investors.

RECOMMENDATION for next 6 months: We initiate our coverage with NEUTRAL. The company has demonstrated a pattern of bullish technical signs but we are not impressed by the earnings performance. Shares are up 15.14% year to date as of the close of trading yesterday.

For trading we suggest a long put at $39 strike price for the January 2013 expiration for $1.51 per contract.

Freeport-McMoran Copper and Gold (NYSE:FCX) will unveil its latest earnings on Monday, October 22, 2012.NEWS and CALENDAR

Tuesday, September 16, 2012 – Freeport Copper Third Quarter Earnings Preview

Wednesday September 26, 2012 11:03 AM – Freeport-McMoRan Copper & Gold Inc. (FCX) today declared a cash dividend of $0.3125 per share payable on November 1, 2012 to holders of record as of October 15, 2012 for its common stock.

FCX Strengths

• International diversification
• China-India commodity demand
• Global market leader
• Potential to expand sulfide production

FCX Weakness

• Volatile commodity prices
• Geo political risk

Stock valuation model

The model rates stocks from 1 to 10, with 10 being the best using a system of advanced mathematics to determine a stock’s expected risk and return. I am using different fundamental and technical factors in order to rank a stock.

Intrinsic value of the stock

Investors should buy stocks selling at a discount to their intrinsic value, and then patiently wait for the fair value of their investments to be realized.

FCX’s intrinsic value is $39.00 the current price is $42.31 that makes the stock overvalued.

Financials

We evaluate all the financial ratios of the company to determine financial health.

Sentiment

This is the investor’s sentiment for the stock.

Analyst ratings

The model assigns a value according to analyst’s recommendation for the stock.

Earnings Consistency

Each year’s EPS numbers should be better than the previous year’s. One dip is allowed, but the following year’s earnings should be a new high. FCX’s annual EPS before extraordinary items for the last 5 years (from earliest to the most recent fiscal year) were 3.70, -14.86, 2.93, 4.57, 4.78. This type of earnings action is favorable.

Total Debt/Equity

The company must have a low Debt/Equity ratio, which indicates a strong balance sheet. The Debt/Equity ratio should not be greater than 20% nor should it be less than the average Debt/Equity for its industry

FCX’s Total Debt/Equity of 21.25% is acceptable.

Quarterly EPS Change Quarter Over Quarter

The EPS growth for this quarter relative to the same quarter last year should be above the minimum of 15% to be considered as good growth for the company. Stocks with improving earnings are worthy of your extra attention.

FCX’s EPS growth for this quarter relative to the same quarter a year earlier is -48% and this is below our target.

Annual Earnings Growth

This model looks for annual earnings growth above 12%, but prefers higher than 20%.

FCX’s annual earnings growth rate over the past five years is 7.50% which is below our target growth.

Current Price Level

Traders should keep an eye open for stocks that are trading within 10% of their 52-week highs, as it is likely to continue in its upward trend.

FCX’s 52 week high is $48.96 current price is $42.31, 15% below the 52 week high. FCX fails in this criterion.

P/E Ratio

The Price/Earnings (P/E) ratio, based on the greater of the current P/E or the P/E using average earnings over the last 3 fiscal years, must be moderate, which in this model states is not greater than 15. Stocks with moderate P/E are more defensive by nature.

The company has a slightly higher P/E ratio of 12.72 compared to the the average industry P/E ratio of 12.50. On the other hand, FCX P/E is less than the S&P 500 P/E ratio of 17.00

Insider Ownership

When there is strong insider ownership such as 12% or more, management is more likely to act in the best interest of the company, as their interests are right in line with that of the shareholders.

Insiders own only 0.83% of FCX stock. Management’s representation is not large enough. This does not satisfy the minimum requirement, and companies that do not pass this test are less attractive.

Technical Analysis

Several technical indicators (MACD, RSI, MFI, OBV, position indicators)  are used to forecast the trend of the stock for 6 and 12 months, and assign a value.

FCX stock has formed a bullish MACD crossover signal, the money flow index is bullish. Resistance is at $43. The stock is currently building up momentum to break out, and a weekly close above $44 should result in a retest of the highs. Our indicators overall give a bullish view on FCX.