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Tuesday, June 18, 2013 - 10:00

The $10 Million Deck That Buffett Built

Tuesday, June 18, 2013 10:00 AM

The CEO of the world's largest copper mining company bought 1 million shares of his company's stock at $31.16 per share on June 3.

At the time of this writing, shares are trading around $29.32.

Now, I don't want to suggest blindly following the investment moves of every industry insider. But when a CEO makes a $31 million purchase of his company's stock, which is trading for the cheapest it's been since 2008 -- I think a closer look is in order.

Regular readers may already know that mining stocks have not fared as well as the broader market so far this year. Commodity prices for precious metals have been lagging, which creates headwinds for producers and drives share prices down. In another example, Barrick Gold (NYSE: ABX) (which I covered two weeks ago), has been trading for the cheapest valuation we've seen since 2004.

The company I'd like to take a look at today is Freeport-McMoRan (NYSE: FCX).

According to regulatory filings, James C. Flores, CEO and president of Freeport-McMoRan Oil & Gas, just bought 1 million shares of his company's stock. To be clear -- this was not an "acquisition" or an exercise of stock options -- this was a buy order.

So the questions that immediately arise are "Why now?" and "What does the future look like for the company?"

Why now? Put simply, the stock is cheap. In April, share prices dipped to $28, which was as cheap as the stock has been since 2008. Even at today's asking price, shares are still trading for only 8 times forward earnings and a price-to-book ratio of 1.6.

There are two main reasons for the current depressed prices. The first is the price of copper.

Copper Prices
Although it also mines gold and molybdenum (used to make steel alloy), Freeport is the world's largest publicly traded copper miner. The company sells an average of 3.9 billion pounds of copper every year.

Since the heady days of 2011, when copper was trading up to $4.50 a pound, prices have been in decline. This is mostly due to decreased demand from China, which consumes approximately 40% of the world's copper supply for industrial purposes.

While the short-term decline may appear to bode ill for miners like Freeport, it's important to also take note of the enormous gains copper has made over the past decade.

Even at today's slightly lower prices, the metal is more than three times as valuable as it was 10 years ago.

Some analysts argue that the recent sell-off has been overdone. As Bloomberg recently reported:

While prices have suffered on concerns China's economy may slow, [Goldman Sachs] said the country's "underlying cyclical growth is likely stronger than the headline figures suggest."

Copper in warehouses monitored by the Shanghai Futures Exchange is being drawn down, it said. The bank estimated bonded stockpiles at 510,000 tons from 715,000 tons in early March and noted that futures in Shanghai are in backwardation.

Backwardation is a market condition which means that the price of a futures contract is trading below the spot price at maturity. This situation usually arises when a commodity faces a positive demand or negative supply shock.

Freeport is able to produce copper for about $1 per pound. So even if future prices remain relatively stable at current rates, the company will have no trouble turning a profit.

Recent Acquisitions
The other factor possibly weighing on Freeport's share price is investor concern over a pair of large acquisitions.

Freeport finalized the purchase of oil and gas producer Plains Exploration on May 31 for $16.3 billion. Just a few days later, on June 3, Freeport announced shareholder approval to buy Gulf of Mexico gas and oil explorer McMoRan for $2.2 billion.

In order to complete these purchases, Freeport issued 91 million additional shares of common stock.

Stockholders are never too happy when the value of their shares is diluted by additional issuances. But in this case, the future benefits for Freeport could far exceed any short-term pain.

The Plains acquisition gives Freeport access to an impressive portfolio of oil production facilities in California and the Gulf of Mexico, as well as large stakes in both the Eagle Ford and the Haynesville Shale plays.

The McMoRan acquisition gives the company a leading position in the emerging shallow-water, ultra-deep gas trend on the shelf of the Gulf of Mexico and onshore in south Louisiana.

StreetAuthority analyst and natural resources expert Nathan Slaughter has been covering these emerging energy plays for years...

He recommended McMoRan Exploration to subscribers of his Junior Resource Advisor newsletter last October, eight months before the merger with Freeport took place. So far, his subscribers are up almost 50% on the recommendation.

Whether these acquisitions were smart or not remains to be seen. But the recent $31 million share purchase by Freeport's CEO could be a sign that at least one well-positioned insider is willing to bet big on its future.

Risks to Consider: Nineteen billion dollars in acquisitions is a lot for a $28 billion market cap company like Freeport to digest. Future success will depend not only on volatile commodity prices, but how well management incorporates the new acquisitions with the existing business.

On May 14, the company had a serious mining accident during safety training at one of its top mines in Indonesia. Twenty-eight workers were killed. Freeport has announced that halted production at the mine has so far resulted in a production loss of 80 million tons of copper and 80,000 ounces of gold.

Fortunately, this looks like an isolated event, not part of a larger pattern or deficiency on the part of Freeport. It's the first such incident of this magnitude in the company's 40-year history.

Action to Take--> Freeport-McMoRan is now one of the premier U.S.-based natural resource companies. Shares offer a 4% yield with a manageable payout ratio of 40% over the past 12 months. Consider buying Freeport at today's prices with a goal of $43 a share over the next 12 to 18 months.

P.S. -- Nathan Slaughter just discovered a tiny oil company sitting on a huge reserve. Recent estimates indicate there are billions of barrels underneath the surface, plus the company acquired 134,000 acres of this oil-rich land for dirt cheap. You can learn more about the details on this discovery and other recent developments here.

Chad Tracy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of FCX in one or more of its “real money” portfolios.