You'll Never Take This Trader Alive, Copper!

By Ben McClure | December 08, 2008 AAA

The copper commodity cycle took nasty U-turn in 2008 and so too have the companies that produce the red metal. A full-blown financial crisis and plunging commodity prices crippled copper stocks as investors took a hurried flight to safety, and heading into 2009, investors can no longer take comfort in the dividends offered by the copper mining companies. Producers are now in survival mode, dividend cuts will be the fastest and easiest way for them to get much-needed cash.

Until we see the signs a turnaround in the global economy, copper stocks remain a risky place to put your money.
Consider the outlook for a few stocks with high-stake positions in the chaotic world of commodity copper.
Freeport-McMoran Copper & Gold (NYSE:FCX)
All is not well at Freeport-McMoran, which mines and produces copper from its properties in Indonesia, North America, South America and Africa. In the face of plunging commodity copper prices, the company is taking drastic measures to cut production levels plus operating and capital expenditure costs. Based on these moves, it's hard to envision growth any time soon. Even worse, Freeport recently suspended the $2.00 per share dividend that had drawn investors to the stock in the midst of the global slowdown. The stock price, consequentially, has taken a beating. Given the uncertain economic climate, it's probably wise to wait until the dust of the commodity copper market settles before buying.

Southern Copper (NYSE:PCU)
Freeport-McMoran probably won't be the last copper-mining company to slash its payouts to shareholders. At Southern Copper, lower cash generation and high CAPEX requirements will likely stretch the company's earnings and leverage ratios and could translate into big cuts for the stock's hefty dividend. Southern Copper, which mines and produces copper and other minerals in Peru, Mexico and Chile, is cutting back on supply as demand dries up and commodity prices remain down at these levels. Some observers suggest that as the as top ranking holder of total copper reserves of any publicly traded company, Southern Copper represents a pure play on a rebound in the copper price. That may be the case, but it's probably best for investors to take nibbles rather than big bites of the stock. (To spot a dividend cut before it happens, read Is Your Dividend At Risk?)

Sterlite Industries India
(NYSE:SLT)
Sterlite Industries, which went public in the summer of 2007, had big plans for expanding operations around the world, but plunging metals prices are making it tricky for India's third largest mining company to make them happen. Now that conserving cash is Sterlite's priority in the current market environment it's not clear whether its proposed takeover of bankrupt U.S.-based copper miner Asarco for $2.6 billion in cash will go through. Analysts suggest the deal could be a loss-making proposition. That said, the stock has the fallen to levels unthinkable a year ago, making it a contrarian play for the courageous.

Encore Wire (Nasdaq:WIRE)
Encore does not produce copper, but as a maker of copper wire and electrical cable it certainly buys a lot of the stuff. With copper prices falling, you would be forgiven for thinking Texas-based Encore would make an attractive counter-market investment. Indeed, the company was able to produce better-than-expected gross margins in the third quarter. Even so, it's hard to imagine Encore's margin gains compensating for likely top line sales contraction heading into next year. In North America, where Encore gets all of its sales, commercial and residential construction growth is grinding to a halt and demand for materials is drying up more rapidly than anywhere in the world.

Bottom Line
As copper and copper-related stocks fall in value, the risk/reward situation gets better for investors. But assuming that the down part of the economic cycle continues, there is a good chance these stocks could head further down too, making them dicey contrarian plays heading into 2009.

For further reading, see Commodities That Move The Markets and How To Invest In Commodities.

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