Could Freeport-McMoRan Copper & Gold ( FCX) still have some more to give? The stock has more than doubled since the beginning of the year on the back of a buoyant cocktail: Soaring metal prices in each of the miner's main products -- copper, molybdenum and gold -- and the benefit of geographical diversification following its acquisition of Phelps Dodge in March. Maybe the easy money is gone, and some bears would make the case that the commodities bull market that also has pushed miners BHP Billiton ( BHP), Rio Tinto ( RTP) and Southern Copper ( PCU) to 52-week highs could be near its end -- either of which could stall growth for Freeport. But there's still reason to believe the company's stock could go higher. The reason: The tendency among analysts to underestimate the magnitude of swings in commodity prices. "It's typical for all mining analysts to use trailing prices," says John Doody, editor of the Gold Stock Analyst newsletter in Fort Lauderdale Fla. "And that means they are always behind the price curve." Or more simply, analysts underestimate how high metals prices will go on the way up, and how far they'll fall on the way down. Right now, we're still on the way up. A look at recent research on Freeport from Citigroup should be instructive in this case, and shows how the stock could be gearing up for a major rally. John Hill, a Citi analyst in San Francisco, estimates the stock is worth $122, 3.9% above the $117.40 52-week high it achieved Wednesday. It's based on an amalgam of valuation techniques: Cash flow multiple, price/earnings ratio, value of the ore bodies and a discounted cash flow analysis, each weighted 25%.
Those estimates assume copper -- which constituted almost four-fifths of Freeport's 2006 pro forma revenue -- sells for $3.50 a pound and long-term prices for gold, while volatile, will average around $700 an ounce. Both projections are below current levels of $3.63 a pound for copper and $740 an ounce for gold. Gold represents 10% of last year's sales, and molybdenum, which accounts for 12%, rounds out the company's revenue pie. The Citi analysis is a conservative way to estimate the miner's value, but it may lead investors to miss a great opportunity to play a major rally, because they won't see the huge potential for upside surprises. Looking only at the cash flow and earnings estimate pieces, Citi estimates Freeport will earn $11.98 a share in 2008, kicking off $16.47 a share in cash. That's above the consensus expectations of $9.70 in earnings, but still way short of the $13.15 high mark among sell-side research analysts. Either way, using a P/E multiple of 11 or a cash flow multiple of 8 -- both fairly normal for non-ferrous metals producers -- yields a stock price target of $132, using Citi's estimates. That's more than 12% higher than current levels, and a suitable reward for the higher risks involved. But even that may not be doing the stock justice, because it is based on relatively low estimates of metals prices going forward.
And there's plenty of reason to believe metals prices could stay high and at least higher than the Citi forecast. Mitsui Bussan Commodities recently published its copper price forecast for 2008 and for no part of the year does the firm see the price averaging less than $3.63 a pound. That's equivalent to the psychologically important $8,000 a ton level, and almost 4% over the Citi estimate. The price strength will be driven by continued demand from China and a tight supply-demand balance, the Mitsui report indicates. Even Natixis Commodity Markets, which sees copper prices slacking off somewhat according to its newly published forecast, says there are reasonable scenarios in which copper could average as high as $3.74 in 2008. And things look good on the molybdenum front, too. New York-based specialty commodities research firm CPM Group recently published a thorough analysis of the market for the metal, indicating a supply deficit for the foreseeable future. It doesn't hurt that Freeport is the dominant producer of molybdenum in the world. The real point is that during any period in which prices stay higher than forecast, the extra cash should fall directly to the bottom line in increased earnings and cash flow, a phenomenon which should put Freeport in a virtual circle. "The longer the price of copper
or the other metals stays high, the faster Freeport can pay down the debt it used to acquire Phelps," explains Chuck Bradford, a base metals analyst at Soleil in New York. New projects or increased reserves are something Bradford says could also be welcome news for Freeport, although he's not convinced the bull market for metals will last too much longer. Prices could suffer a fall if global economic growth slows down, or if consumers decide to substitute lower-cost aluminum for copper, he explains. He also adds new projects being developed across the globe will eventually increase supply of the metal. "I like Freeport, but I think you have to be careful about the metal prices," says Bradford. But that still doesn't negate the chance of a surge higher and some trading profits for wily investors to be taken if the company can deliver some upside surprises to Wall Street. And it all makes Freeport a lot more attractive as an acquisition target.