All That Glitters Is Not Gold, but It Might Be Copper

One of the many overlooked components of a well-managed portfolio is original data - data which is often sanitized, re-analyzed, or downright omitted by the time it hits the news wires. Freeport-McMoran's recent call was particularly enlightening.

A week ago on the 24th of January, the company declared earnings of $0.11 per share, a miss of over 47% compared with aggregated Wall Street estimates, and the stock (FCX:US) reacted accordingly. One could be forgiven for being skeptical of the company given recent numbers. But where Wall Street can be fickle in its short-term outlooks, a deeper dive into the numbers and company strategy on the actual earnings call - which I find fewer and fewer people actually listen in to in today's age of automated analysis and robo-trading - reveals a much cheerier long-term outlook.

Global resource markets continue to show strength beyond what can be seen in the charts. Reportedly, Freeport McMoran - the world's foremost supplier of copper - has been having to buy copper to meet robust US demand. Freeport has repeated for some time now on its earnings calls that demand has been far more consistent than analysts have given the market credit for, mainly in the face of slowdown concerns out of China (who have been in the midst of a long-term building boom). This has only been further exacerbated by the shift in today's economy from a carbon-based energy system to more renewable, more variable generation, which requires more of such things as batteries, wires, and magnets. These by extension require different mixes of resources to produce than traditional gas plants and generators - resources such as lithium and, happily for Freeport, copper. Company executives have repeatedly pointed out the gap between operating mines and robust demand has widened in recent years, with little in the way of immediate new supply in the pipeline. Freeport owns three of the largest five mines, all of which will need to be replaced or expanded to meet demand 10 years out.

In a leap of logic, which many seem hesitant to make in the face of this broader market risk, I should like to point out that it is a time and capital-intensive process to both prospect and exploit new resource reserves. So, in the meantime and in the absence of a short-term boost in supply, it should follow from basic economic principles that prices can and should increase.

Yet, when we look at the copper market, it seems to more readily favor shorter-term concerns over softening Chinese demand. While reasonable, we here at the Woodworth Contrarian Fund believe that these concerns are overblown in the face of apparently growing global demand. Market realities seem to be mismatched with investor sentiment.

In the meantime, Freeport McMoran is still making money hand over fist even taking into account lower prices, and is poised to make a heck of a lot more ($319 million per year per 10¢/lb change in price) in the event of a rebound. Even many of the political issues which have dogged the company for the last several years are all but melting away in the face of a shared ownership deal with the Indonesian government at their Grasberg mine in Papua. In the words of the Freeport McMoran CEO Richard Adkerson himself, "In a complicated, dysfunctional world, we're very excited about where we are."

Freeport has over $1.8 Billion in free cash flow alone, with working capital needs of only ~$200 million, and reserves to burn from their deal with the Indonesian government over the Grasberg mine. Based on value to re-create company assets, the company (which as of writing on Thursday last closed at $11.64) is conservatively worth $24-31 per share today, nevermind any re-valuation assuming responsible re-deployment of these resources to replace and expand existing assets. Short-term hiccups notwithstanding, the company seems well-poised to take advantage of future trends.  Markets are fickle, but like an over-stretched rubber band they tend to snap back to reality eventually. I would encourage those value hunters to look beyond the panic of the day, and ask whether what some view as fool's gold could really be tomorrow's shining copper.

About the Author: Drew Millegan with his brother, Quinn Millegan, (23 and 20 years old respectively) manage the Woodworth Contrarian Stock & Bond Fund, a hedge fund based in McMinnville, Oregon. They grew up in the finance world, and specialize in contrarian investment strategies in the US Public and Private markets.

Disclosure: I/we are currently long FCX and are long FCX from time to time, and may or may not initiate positions in FCX within the next 72 hours.