I don't think it's an exaggeration to say that some percentage of Freeport McMoRan (NYSE:FCX) shareholders, or former shareholders, hated the company's decision to acquire Plains Exploration and McMoRan Exploration. These shares are down about 22% from the time just before the announcement, though miners like BHP Billiton (NYSE:BHP), Rio Tinto (NYSE:RIO), and Southern Copper (NYSE:SCCO) haven't fared dramatically better in what has been a pretty unpleasant market for basic materials stocks.

With the deals done, it's time to get over the disappointment regarding the oil and gas transactions and just accept Freeport McMoRan for what it is today – an incrementally more diversified natural resources company with a hefty amount of debt and high leverage to global economic growth. Given that I do not believe that the oil & gas properties will be value-destructive (in total) from this point on and that the valuation already prices in further copper price erosion, Freeport McMoRan stock does hold some appeal at these prices.

SEE: How To Choose The Best Stock Valuation Method

Copper Still The Driving Force, But Driving Conditions Look Treacherous
Even with the multi-billion dollar diversification, mining (and copper mining in particular) is still the driving force. Nearly 60% of the company's business is in copper, with the Indonesian Grasberg complex the primary value driver of copper.

Grasberg is still a premium asset, with exceptionally low per-pound cash costs. Unfortunately, a fatal accident outside the mining areas on May 15 has led to a temporary production halt as the company and authorities explore the cause of the accident. At a minimum, the accident serves as a reminder that even high-quality operators of high-quality assets can have these setbacks, and the production halt will negatively impact production (and EBITDA) for the year.

The broader operating environment for copper is also more challenging. Prices have rebounded from the lows around the end of the first quarter of 2013 (below $3.10), but prices are still trending lower than in 2012 and may challenge the average price of the 2006-2011 period. It's also worth noting a detail pointed out by Morningstar's analyst Daniel Rohr – not only has China grown to about 40% of global copper consumption, but global consumption ex-China actually has declined about 1% per year since 2000.

The “China question” is a major issue for every global miner. With China being the source of so much incremental demand for coal, iron, copper, and other resources, China's economic growth and materials consumption is vital to the demand/supply and price equations. At this point, it doesn't look so good for companies like Freeport, Rio Tinto, and Vale (NYSE:VALE) and those investors and analysts hoping for a repeat of the huge move between 2009 and 2011.

SEE: Top 6 Factors That Drive Investment In China

Oil And Gas – The Potential For Upside Is There, But Will The Company Under-invest?
Freeport management certainly went to some lengths to ensure that its oil and gas acquisitions went through – throwing a $3 special dividend to Plains Exploration shareholders to sweeten the pot, and offering all shareholders a supplement $1 dividend post-close.

For all of that trouble, oil and gas is still only about 25% of the business. On the plus side, the acquired assets bring significant oil-heavy reserves in Eagle Ford, Haynesville, and California, as well as riskier (but high-potential) Gulf of Mexico assets (and smaller reserves in the Rockies).

The question is whether management will properly handle these assets – Freeport management has already said they will fund oil and gas capex out of the cash flows produced by that business and will otherwise limit capex. Well, if that's the plan, why buy the oil and gas assets? I appreciate that simply throwing money at oil and gas properties doesn't really work (as Hess (NYSE:HES) learned the hard way), but potentially under-funding exploration and production after making such expensive purchases would be like buying a shiny new Porsche and then running it on used tires and low-octane gas just to save a few bucks every month.

SEE: Evaluating A Company’s Management

The Bottom Line
If investors say they no longer want to bother with Freeport McMoRan shares because it is no longer a pure play on copper, gold, and molybdenum, I have no objections. Likewise, I'm very sympathetic to investors who see the diversification into oil & gas as “diworsification” and a black mark against management's judgment and stewardship of shareholder capital. For that matter, investors who want to invest in diversified natural resource companies can choose from Rio Tinto, BHP Billiton, Teck (NYSE:TCK), Anglo American, and Glencore Xstrata.

On its own “going forward” merits, though, it may be premature to dismiss Freeport McMoRan. Valuation is near the bottom of the company's historical range and would seem to already be pricing in a further 15-25% drop in copper prices. With relatively conservative estimates generating a price target in the mid-$30s, this could be an interesting stock to consider for investors who believe there is a rebound trade to make in the natural resources sector.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Investing Basics

    The Copper King: An Empire Built On Manipulation

    Find out how Yasuo Hamanaka's actions in the copper market forever changed the rules for commodity traders.
  2. Active Trading

    Uncovering Oil And Gas Futures

    Find out how to stay on top of data reports that could cause volatility in oil and gas markets.
  3. Trading Strategies

    Guide To Oil And Gas Plays In North America

    Oil and gas shales in North America have been known for decades, but most investors don’t know it exists, or what is produced.
  4. Fundamental Analysis

    Guide To Measuring Oil And Gas Companies

    Here are some important stats to look for when measuring oil and gas companies.
  5. Fundamental Analysis

    5 Biggest Risks Faced By Oil And Gas Companies

    Before investing in gas and oil stocks, consider such factors as political and geological risks.
  6. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  7. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  8. Mutual Funds & ETFs

    ETF Analysis: iShares Morningstar Small-Cap Value

    Find out about the Shares Morningstar Small-Cap Value ETF, and learn detailed information about this exchange-traded fund that focuses on small-cap equities.
  9. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  10. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Profit Margin

    A category of ratios measuring profitability calculated as net ...
  3. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis ...
  4. Debt Ratio

    A financial ratio that measures the extent of a company’s or ...
  5. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing ...
  6. Net Present Value - NPV

    The difference between the present values of cash inflows and ...
RELATED FAQS
  1. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>
  4. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  5. What is the difference between the return on total assets and an interest rate?

    Return on total assets (ROTA) represents one of the profitability metrics. It is calculated by taking a company's earnings ... Read Full Answer >>
  6. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!