"It seems that Freeport can't get anything right these days," a report on the once-mighty Freeport-McMoRan (FCX) begins. "Clearly the prolonged slump in commodity prices has crushed the company. Sentiment is prevailingly negative. But to own Freeport, investors need to accept its risk-reward proposition. Volatility comes with the territory. When commodity prices go south," the report continues, "so, too, do profits and the stock price. But there is an upside as well, which is that if gold, copper and oil go higher, so will Freeport."
The report then offers a compelling perspective: "The stock has been so badly beaten down that to sell FCX now makes little sense to me, considering what whipsaw potential there is if copper, gold and oil prices recover. Freeport trades for 10x 2015 earnings and 1.09x book value. At such low valuations, FCX now looks to be a cheap stock with huge upside potential and a 5% dividend yield is a very nice kicker."
The only problem? The report is dated Dec. 24, 2014, written by an analyst in Seeking Alpha. I will spare you his name because maybe he changed his view, but pretty much everything he wrote was wrong and didn't come to pass, not the least of which is the kicker; the 5% dividend yield is gone, because yesterday the company suspended its dividend.
But let's see the stage. Freeport's stock had been on a roller coaster ever since the great recession, trading from $7 in 2005 up to $58 in May of 2008 and then back to $7 in December of 2008 when it sliced its dividend, only to come roaring back to $58 in January of 2011. Then in December of 2012, with the stock at $37 and oil and $85, FCX paid $20 billion to buy Plains Exploration and Production and McMoRan Exploration for $20 billion.
That deal, unbeknownst to the analyst who sent this bulletin to about 70,000 people, pretty much sealed FCX's fate. Sure, a year ago, when the upbeat report was written, oil was at $55 while now it is $38, copper was at $2.8 and it is now at $2.09 and gold was at $1173, it is now $1077.
But the issue isn't the decline in those commodity prices, which, while severe, shouldn't have sunk this company to $7 where it sits once again on this amazing thrill ride. It's the debt the company took down. That's what made it suspend the dividend, amend its credit agreement, fire-sale assets and continue to sell stock at the market, having raised $1.6 billion since the program was announced not that long ago, leaving "only" $400 million left to sell to raise the $2 billion in equity it needs to service that debt. And is there any wonder why Carl Icahn's down big since the announcement that he had purchased 8% of FCX back on Aug. 28 of 2015 when the stock was around $10? Not even the mighty Icahn can trump that kind of seller.
Now, as daunting and cautionary as this tale of commodity woe is, what makes me most worried about FCX is that the next trip from $7 to $58 might not occur, because the copper market is suffering from a level of glut equaled only by the oil market. FCX was able to recover so quickly not because of our housing market, which did nothing during that period, but because of demand for emerging market infrastructure, mostly that from China. That infrastructure spend seems to have glutted everything that copper's used for in the People's Republic, mostly residential and commercial construction. There will be no snapback this time, and that takes into account the cutbacks that Glencore (GLNCY), another ridiculously bullish back in the day copper miner, announced this morning that sent its stock up as Freeport's did yesterday on its austerity announcements.
Why point all of this out? Simple: sometimes the consensus that had brought that stock down is right. Sometimes the negative sentiment is right. It doesn't always or even often pay to be a contrarian. The 10x earnings in 2015? It's losing money. The 1x book? The book is now astoundingly overvalued. The cash flow protection? Gone. Let this bullishness in the face of oversupply and a lack of demand remind you that when you are dealing with commodities, cheap isn't in the eye of the beholder. It's in the eye of the marketplace.