Freeport Shares Worth $45 Despite China Woes: Opinion

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( Trefis) -- China's reduction of its GDP target growth rate for the first time in eight years has sent ripples across shares of global miners including Freeport McMoRan ( FCX), Vale ( VALE) and Rio Tinto ( RIO).

Although commodity prices have reacted negatively to this news in the short term, we expect the Chinese appetite for commodities to remain strong and drive prices higher in the long term.

In its recent fourth quarter and full year 2011 results, Freeport reported 13% and 26% year-on-year declines in copper and gold volumes, respectively, due to labor disruptions at its Indonesia mine.

However, it realized 7% growth in net income to $4.6 billion, backed by higher commodity prices compared to 2010.

We have revised our estimate price for Freeport to $45, which is about 15% above the current market price. We have updated our analysis to incorporate the latest earnings, made adjustments to forecasts for copper, gold and molybdenum volumes and changed the discount rate for the company to account for prevailing market conditions.

See our full analysis of Freeport McMoRan here.

All About China

China is consistently one of the largest metals consumers due to its industrial and economic growth, and it remains a net importer. Therefore, any movement in the Chinese economy affects the mining sector as a whole.

Mining giants like Freeport derive a major chunk of their revenues from copper exports to China.

This week, China cut its GDP target growth rate for 2012 to 7.5% annually, from 8% previously and 9.2% growth in 2011. This is the first time the country cut its target growth rate in eight years.

The Chinese government stated that the move was an effort to make the country's economy more efficient, and we do still expect China to be the primary growth engine for metals demand. However, Freeport's dependence on China for copper demand does raise some concerns.

Copper Fundamentals Still Strong in the Long Term

Copper prices have seen a major correction following the eurozone debt situation and the Chinese demand slowdown.

Chinese import figures are showing an increase in inventories, implying that the copper on hand isn't being put to use.

This could lead to short-term pressure on copper demand and prices. However, the metal is still getting scarcer due to its widespread applications and declining reserves.

Copper consumption in China is expected to rebound in the next couple years thanks to growing demand from the renewable energy sector and several other industries.

Further, rising input costs have made mining more expensive, thus discouraging large mining investments. This is causing the demand-supply gap to widen. As the global economy eventually picks up from the recent slowdown, prices will likely move higher until new capacity (and thus, more supply) comes online. Copper makes up almost 78% of our valuation price for Freeport's stock.

Decline in Volumes May Offset Gold Price Strength

Gold has seen significant price appreciation on the back of economic uncertainty and demand from India and China. We expect this to continue for the most part, largely due to the Federal Reserve's plan to keep interest rates near zero.

However, Freeport's bleak near-term outlook for gold volumes is likely to offset any benefit from further price increases. We expect long-term growth in gold volumes, but compared to previous years the growth will not be substantial. Gold makes up almost 18% of our valuation price for the company's stock.

Indonesian Government Could Hurt Investments

According to Reuters, the Indonesian government is planning to limit foreign companies' stakes in the country's mines by the 10th year of production. The government may require that domestic ownership be at least 51% by the 10th year, which could discourage foreign investment.

As of now it is unclear whether the regulation will be applicable to existing investments or only to new mining investments. This move could hurt Freeport, which owns the world's largest gold mine, Grasberg, in Indonesia. Once we have more clarity on this matter, we will update our analysis to reflect these risks.

What to Do With Rising Costs?

In 2011 Freeport's net cash costs increased significantly, primarily due to labor bonuses following disruptions at its mines. Rising energy prices and other input costs are also adding up for the company. We expect further cost increases going forward, some of which could be offset by rising commodity prices.

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This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.