Freeport Valuation Bloated Here

Freeport McMoran (FCX), the largest publicly traded copper company, reported 1st quarter earnings this morning before the open.  The numbers were good: revenues up 24%, operating income up 62% and net income up 81%.  That’s no surprise as copper prices are sky high and their average realized price per pound was $3.69 (FCX Earnings Release).

But I think this stock is overvalued at this point.  At $118, Freeport has a market cap of $53 billion.  It earned about $3.5 billion over the last 4 quarters and forecasts $3.5 billion free cash flow for 2008.  That gives it a multiple around 15.

That’s already a decent multiple for a cyclical commodities business, but it also depends on commodity prices remaining sky high.  Their 2008 forecast assumes $3.75 copper and $900 gold.  Every 20 cent per pound change in the price of copper impacts operating cash flow by $450 million. 

So, for example, a 60 cent drop in the price of copper would reduce operating cash flow by $1.35 billion.  All of a sudden that 15 forward multiple becomes 25 and the stock is really expensive.  Of course, if commodity prices go up the valuation is really cheaper.  But I think there’s a very thin margin of error here and if copper prices come down, Freeport will get hammered.

Longer term, with 41 million proven and probable ounce of gold and 93 billion pounds of copper reserves, I believe Freeport is in excellent shape.  The demand for raw materials is in a long term bull market with the industrialization of the rest of the world, such as China, India, Russia and Brazil.  These reserves are probably worth $200 billion – almost 4 times Freeport’s enterprise value (market cap + net debt).

But shorter term, I think we’ll see pressure on copper prices and therefore on Freeport shares.  If you look at the chart, it is also facing big resistance at $120 (FCX 3 Year Chart).

It’s had a great run but I can’t help thinking it has to come to an end.

Disclosure: Top Gun is short Freeport McMoran (FCX) shares.