It might be impossible to catch a falling knife, but given a company’s fundamentals, it can be possible to see when current market sentiment regarding a company’s future earnings power has reached a panic-level peak. Shares of Freeport-McMoRan Copper & Gold (FCX) fall perfectly into that category.

Freeport-McMoRan, which is currently trading for $45, hit an all-time high of $126 per share in mid-May. Additionally, from Sept. 26 to the close on Friday, Oct. 3, shares have fallen from $65 to $45, down a whopping 35%, as the great commodity unwind takes place.

In our view, this hideous decline in shares of Freeport-McMoRan represents a generational buying opportunity.

Freeport-McMoRan is one of the world’s largest copper, gold and molybdenum mining companies in terms of proven reserves and production levels. The company has worldwide reveres of copper of around 90 billion pounds, 1.8 billion pounds of molybdenum and 41 million ounces of gold, with production levels since mid-2008 of 4.35 billion pounds of copper, 85 million pounds of molybdenum and 1.8 million ounces of gold. In 2007, mining revenues by commodity were comprised of 78% copper, 12% molybdenum and 10% gold. In mid-2006, Freeport and Phelps Dodge announced that they signed a definitive merger agreement under which Freeport would acquire Phelps Dodge for approximately $26 billion dollars in cash, creating the world’s largest publicly traded copper company.

Since Sept. 3, copper prices have fallen off a cliff, going from $3.40 to $2.80, as market sentiment about a global slowdown (see the Baltic Dry Index), the impact of a slowing Chinese economy and the strength of the U.S. dollar have all acted as negative tailwinds for shares of Freeport.

However, current world supply of copper is still very tight, at around 22,000 tonnes, which represents less than five days of total global consumption. Since 2005, copper production has not met end-client expectation/demand, as the three-year production shortfall average is 800 kilotons each year. In 1980, China consumed less than 5% of global output for copper; by 2000, consumption was more than 10%, and by 2005 consumption was north of 25%. From 1985 to 2007, the world consumed 300,000 kilotons of copper. From 2008 to 2020, consumption is expected to be 300,000 kilotons, of which 32% will be bought by China. Basically, the world needs as much copper in the next 12 years as it did in the last 22 years.

The current spot price for copper is trading at $2.80 per pound. For its third-quarter 2008 guidance, Freeport is using $3.14 as its “base” price for making its estimates. Since it costs Freeport about $0.75 per pound to extract copper from the ground, analysts' estimate cuts make no sense, because operating margins will still come in north than 40%.

Copper sales in billions of pounds went from 3.6 in 2006 to 4.1 in 2008, with projected sales of 4.8 by 2010. EBITDA on $3 copper is around $11 billion, with annual operating cash flow of $7 billion. If copper moves plus or minus 20 cents per pound, that will affect the cash flow numbers by nearly $800 in EBITDA and roughly $500 million in operating cash flow.

Freeport is also sitting on a massive amount of gold (just under 50 million ounces), worth about $50 billion. Margins here are also north of 40%, because it costs Freeport around $250 an ounce to mine the gold from the ground. Gold sales in millions of ounces went from 1.9 in 2006 to 2.3 in 2007, with projected sales of 2.1 by 2010. If gold moves up or down by $50 an ounce, that will affect the cash flow numbers by about $90 million in EBITDA and $50 million in operating cash flow.
Sales of molybdenum, a key element to strengthen steel went from 69 million pounds in 2006 to 75 million pounds in 2008, with projected sales of 100 million pounds. If molybdenum moves up or down by $2 per pound, that will affect the cash flow numbers by about $140 million in EBITDA and $100 million in operating cash flow.

Summary: Freeport is the world’s premier publicly traded copper company worldwide. It is also the world’s largest molybdenum producer, with significant gold operations as well. Its business is geographically diverse, with attractive project pipeline growth. As of Sept. 25, Freeport bought back 6.3 million shares with an average price of $79.15. Under its 30-million-share buyback program, management still has 23.7 million shares to repurchase by the end of this year. The yield is currently 4.4%.
 
Know What You Own: Freeport operates in the industrial goods industry, and some of the other stocks in its field include Southern Copper (PCU), Newmont Mining (NEM), Barrick Gold (ABX) and Gold Fields (GFI). These stocks recently closed at, respectively, $4.83, down 4.9%; $34.40, down 3.3%; $30.01, down 6.5%; and $6.89, down 12%. For more on the value of knowing what you own, visit TheStreet.com's Investing A-to-Z section.

Posted on Oct. 6, 2008