freeport mcmoran copper and gold inc-fcx

Freeport McMoRan Copper and Gold (FCX) Investment Valuation

December 13th, 2012 Posted by Investment Valuation No Comment yet

Freeport-McMoRan Inc. (FCX) is a leading international mining company with headquarters in Phoenix, Arizona. The company operates large, long-lived, geographically diverse assets with significant proven and probable reserves of copper, gold, and molybdenum. FCX is the world’s largest publicly traded copper producer. FCX’s portfolio of assets includes the Grasberg minerals district in Indonesia, one of the world’s largest copper and gold deposits, and significant mining operations in North and South America, including the large-scale Morenci minerals district in Arizona and the Cerro Verde operation in Peru. Source: FCX website

Value Investing Approach on FCX    

This model is prepared in a very simple and easy way to value a company, it adopts the investment style of the Father of Value Investing Benjamin Graham. Graham believed in fundamental analysis and was looking for companies with a sound balance sheet and with little debt. The basis for this valuation is the company’s five years of historical financial records, the balance sheet, income statement, and cash flow statement. We calculated first the enterprise value as our first step. We believed this is important because it measures the total value of the company.

The Investment in Enterprise Value on FCX 

The concept of enterprise value is to calculate what it would cost to purchase an entire business. Enterprise  Value (EV) is the present value of the entire company.  Market capitalization is the total value of the company’s equity shares. In essence, it is a company’s theoretical takeover price, because the buyer would have to buy all of the stock and pay off existing debt, and taking any remaining cash.

Enterprise Value = Market Capitalization + Total Debt – (Cash and Cash Equivalent + Short Term Investment)

Explanation

The above table tells us that FCX has $35 billion average with exceptions in 2008 where the market cap dropped to 76 percent.  The total debt represents 14 percent on average, while the cash and cash equivalent were an 8 percent average, thus the enterprise value was greater by 6 percent against the market value. The movement in the market was at a rate of 4 percent average.

The buying price of Freeport-McMoRan Copper and Gold Inc’s entire business to date, October 30, 2012, was $42585 at $53.63 per share. If you decided to buy this entire company, then you will be buying the equity for 94 percent and total debt for 6 percent. The market price to date was $39.07 per share.

Price-to-Ore Ratio

Enterprise Value / Value of Proven and Probable Reserves (all Minerals) 

This is the most powerful valuation for evaluating a company’s share price relative to its mineral resources since it takes into account all minerals.  The lower you get, the better.  There are changes daily that took place with the stock price and metal prices. This valuation is also useful in comparing companies with the same or different minerals.

The value of total mineral resources can be the same as the proven and probable reserves (all minerals). These reserves that we were talking are the principal assets of a mining company. The term as used in the reserve data presented here is the part of the mineral deposit which can be economically and legally extracted or produced at the time of the reserve determination.

Proven Reserves

According to Freeport-McMoRan Copper and Gold Inc, the term “proven reserves” means reserves for which (1) quantity is computed from dimensions revealed in outcrops, trenches, workings or drill holes; (2) grade and/or quality are computed from the result of detailed sampling; and (3) the sites for inspection, sampling and measurements are spaced so closely and the geologic character is sufficiently defined that size, shape, depth and mineral content of reserves are well-established.

Probable reserves

Likewise, the term “probable reserves” means reserves for which quantity and grade are computed from information similar to that used for proven reserves but the sites for sampling are farther apart or are otherwise less adequately spaced. The degree of assurance, although lower than that for proven reserves, is high enough to assume continuity between points of observation.

FCX EV ORE

Explanation

We have already discussed the enterprise value in the first part of this valuation, now, let us analyze the value of proven and probable reserves, as it is seen in the table that the value was increasing at the rate of 21 percent average, impressive.  The EV/Total Resources or EV/Value of Proven and Probable Reserve shows, that in 2007 and 2010 the price was expensive because the enterprise value was greater than the value of total resources. While during the period of 2008, 2009 and 2011, the price was cheap because the enterprise value was lesser than the value of total resources.

FCX Reserves

Explanation

FCX determined reserves using the long-term average prices of $2 per pound for copper, $750 per ounce for gold and $10 per pound for molybdenum.

Net Current Asset Value (NCAV) Method

The Net Current Asset Value (NCAV) is a method from Benjamin Graham to identify whether the stock is trading below the company’s net current asset value per share, specifically two-thirds or 66 percent of net current asset value. Meaning they are essentially trading below the company’s liquidation value and therefore, the stocks is trading in a bargain, and it is worth buying.

FCX NCAVPS

Explanation

The net current asset value (NCAV) approach for FCX indicates that the stock traded at an overvalued price because the market price was greater than the 66 percent result of the NCAV, therefore, the price was expensive. In other words,  the stock of Freeport-McMoRan Copper and Gold Inc did not pass the stock test of Benjamin Graham because the stock was trading above the liquidation value of the FCX.

Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation

Calculating the market capitalization over the net current asset value of the company, we will know if the stock is trading over or undervalued. The result should be less than 1.2 ratios for Graham to buy stocks.

FCX MC NCAV

The MC/NCAV valuation for FCX tells us that the stock was trading at a price that is overvalued from 2007 to ttm2012 because the ratio was greater than 1.2.  The net current asset value was 14 percent of the market price.

The margin of Safety (MOS)

According to Graham, the investor should invest only if the market price is trading at a discount to its intrinsic value. Value investing is buying with a sufficient margin of safety. Graham considers buying when the market price is considerably lower than the intrinsic or real value, a minimum of 40 to 50 percent below. FCX MOS

Explanation

The margin of safety indicates that there was a margin of safety from 2007 to 2011, while the trailing twelve months (ttm), 2012 was a zero. The average margin of safety was 57 percent. Knowing how we arrive at those results is like a breath of fresh air. With that,  Cris shared to me the formula for intrinsic value below:

Intrinsic Value =  Current Earnings x (9 + 2 x Sustainable  Growth Rate)

FCX IV

Explanation

EPS or the company’s last 12-month earnings per share; G or the company’s long-term (five years) sustainable growth estimate; 9 for the constant which represents the appropriate P-E ratio for a no-growth company, and 2 as the average yield on high-grade corporate bonds.

The average intrinsic value was $879, the company suffered losses in its net earnings at a rate of 62 percent, this is the reason why it’s earnings per share was negative because of EPS factors net income.

Freeport McMoRan Copper and Gold Inc

FCX SGR

Explanation

Return on equity and the payout ratio factors SGR.

Freeport McMoRan Copper and Gold Inc

The return on equity factors net income as well and the average shareholders’ equity. Since 2008 the net earning of FCX was negative at 62 percent, the result of ROE was negative also. This is the reason why the intrinsic value soared up very high at 1348 percent in 2008.

Freeport McMoRan Copper and Gold Inc

Explanation

We have already learned why the red line soared up so high in 2008 at that level as per our prior discussion. If we put in figures or in percentage, this distance is 57 percent average from 2007 to ttm2012. Buying the stock of FCX to date will have no margin of safety.

Freeport McMoRan Copper and Gold Inc

Explanation

There are other approaches in calculating the sustainable growth rate and this affects the intrinsic value and the margin of safety. This is by using the relative and the average return on equity. I have summarized the difference between using these two approaches as shown in the table above.

By comparing, we can say that the average method produces a higher result in the growth of the FCX.

FCX Relative Valuation Methods

The relative valuation methods for valuing a stock is to compare the market values of the stock with the fundamentals (earnings, book value, growth multiples, cash flow, and other metrics) of the stock.

Price to Earnings/Earning Per Share (P/E*EPS)

This method will determine whether the stocks are undervalued or overvalued by multiplying the Price to Earnings (P/E) ratio with the company’s relative Earning per Share (EPS) and comparing it to the enterprise value per share, we can determine the status of the stock price.

Freeport McMoRan Copper and Gold Inc

In 2008 to 2012, the stock was trading at an overvalued price. Because the enterprise value was greater than the P/E*EPS ratio. The P/E*EPS ratio was 44 percent of the enterprise value, this means price was overvalued. The result of P/E*EPS indicates that the stock was expensive.

Relative and Average Approaches

FCX Relative PE

The result in using the relative value was favorable with FCX because it doesn’t show a negative P/E*EPS ratio.

Enterprise Value (EV)/Earning Per Share (EPS) or (EV/EPS)

Freeport McMoRan Copper and Gold Inc

The price (P/E) was 29 percent and the earnings (EPS) was 71 percent. This indicates that the price was undervalued. The result of this valuation will depend on upon the discretion of the analyst’s, or whatever the analyst deemed appropriate

Enterprise Value (EV)/ Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA).

This metric is used in estimating business valuation.  It compares the value of the company inclusive of debt and other liabilities to the actual cash earnings. This metric is useful for analyzing and comparing profitability between companies and industries.  It gives us an idea of how long it would take the earnings of the company to pay off the price of buying the entire business.

FCX EV EBITDA

Explanation

EV/EBITDA valuation indicates that it will take 4 years or 4 times the cash earnings to cover the costs of buying the entire business.  Moreover, this valuation also shows the profitability of the company.  It tells us that the earning before income tax of FCX was negative during 2008 at a rate of 75 percent. On the other hand, its net earnings at 62 percent, but have recovered the succeeding periods with favorable margins.

In conclusion

The enterprise value was stable at $35 billion, except in 2008, where the market drops at 76 percent.  While total debt was 14 percent and cash and cash equivalent was an 8 percent average. Thus, making the enterprise value greater by 6 percent than the market capitalization.

Buying the entire business to date, October 30, 2012, would be $42585 at $53.63 per share.  The market price to date was $39.07 per share.

The EV/Value of Proven and Probable Reserves tells us that the price was expensive in 2007 and 2010. Because the enterprise value was greater than the value of total reserves.  While, during the period of 2008, 2009 and 2011. It shows that the price was cheap because the enterprise value was lesser than the value of total reserves.

Net Current Asset Value

On the other hand, the net current asset value approach indicates that the stock was trading at an overvalued price. Since the enterprise value was greater than the 66 percent of NCAV. Meaning, the stock was trading above the liquidation value of the FCX.  Moreover, the price was overvalued because the ratio was over 1.2, therefore, the price was expensive.

Further, the margin of safety tells us that there was a margin of safety from 207 to 2011. Howbeit in ttm2012, there was zero margins of safety. The average margin of safety from its 5 years of operation was 57 percent.  The intrinsic value soared up very high in 2008 at 1348 percent. While SGR was $5, and the annual growth was $18. In addition, the return on equity (ROE) was $9, not impressive.

Relative Valuation

Likewise, the price was overvalued from 2008 to ttm2012. In 2007 the price was fair in the P/E*EPS valuation. The enterprise value was greater than the P/E*EPS result. The price to earnings ratio in relative approach was $12 while using the average ratio, the result was -$6.11.

While the EV/EPS valuation tells us that the price (P/E) was 29 percent and the earnings (EPS) was 71 percent. On the other hand, the EV/EBITDA valuation shows a result of 4 years or 4 times.  This means that buying the entire business will take 4 times the cash earnings to cover the costs of buying.

Overview

The EV/Value of Proven and Probable Reserves shows that the price was cheap, in general.  The margin of safety was 57 percent average. On the other hand, the P/E*EPS and the EV/EPS indicate price was undervalued. A BUY position is recommended on the stocks of Freeport-McMoRan Copper and Gold Inc (FCX).

Research and Written by Criselda

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