Potential Money-Doubler is Likely to Return 20% in 2014

There’s a simple pattern that applies to most major financial acquisitions. The company getting acquired surges in value when the deal is announced, as the purchase price must be high enough to please the sellers of that business. And the company that is making the purchase often sees its shares pushed lower. Acquisitions can bring on lots of debt, and there is the risk of poor integration, as well as a distraction from a company’s core focus. 

All three of those concerns dogged miner Freeport-McMoRan Copper & Gold (NYSE: FCX) after it announced plans to spend $20 billion to acquire a pair of established oil and gas drillers. Many investors were left scratching their heads, and shares plunged immediately after the deal was announced in December 2012. 

FCX Stock Chart

Since this swoon nearly 18 months ago, shares have moved back into the mid-$30s, but are still off about 8%. Meanwhile, the S&P 500 is up 35% since then.

Ignace Proot, a well-regarded mining analyst with Sanford C. Bernstein, points out four catalysts that that could help FCX make up for lost time.

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First, FCX has been scuffling with the Indonesian government regarding mining processing at the company’s Grasberg mine. The government would like to see more value-added processing of copper in the country, instead of the current practice of shipping raw copper abroad for processing elsewhere. 

Yet Proot thinks management and the government have been negotiating a settlement that preserves jobs and copper output in Indonesia, and predicts that a resolution to the conflict could boost shares. 

Second, Proot said FCX will garner a higher valuation as it starts to deliver on the promises made during the massive oil-and-gas acquisition of late 2012. Right now, shares trade for a low 4.5 times projected 2016 EBITDA, on an enterprise value basis, according to Merrill Lynch. 

The third catalyst is a big spike in copper output as various new mines come on line. FCX is quickly diversifying away from Indonesia, and management expects to increase copper production 7% to 4.4 billion pounds in 2014.

Finally, Proot cites rising copper prices. Demand for copper slumped in the past year and a half, as China needed to work off massive stockpiles. More recently, China unveiled an economic reform package that is expected to provide support for copper prices. 

As these catalysts kick in, Proot sees shares rising to $42, while Merrill Lynch has a $43 price target. 

Yet, in my view, such price targets are quite myopic. That’s because FCX is in the midst of a massive debt de-levering plan that should help boost its market value, even if enterprise value remains static. I explained that logic in an article written for our sister site, StreetAuthority.com, a few weeks ago. 

Basically, management thinks it can aggressively tackle the $20 billion debt load through rising free cash flow, and Merrill’s analysts agree. They estimate that by 2020, FCX will have net cash on the books, not net debt.

By 2020, no debt on the books and a forecasted $13 billion in EBITDA by Merrill should merit an EV/EBITDA multiple of around 5.

That implies an enterprise value of $65 a share. And with no net debt, that will directly equate to the company’s market value. The company has roughly 1 billion shares outstanding, so that gives us a target price of around $65.

I concluded, “The steadily improving balance sheet should lead investors to look ahead, and shares will likely reflect that set of pro forma financial statements by 2017 or 2018. That may seem to be a long time to wait, but 100% potential upside for a three-to-four-year time horizon is impressive.”

I view FCX as a solid near-term trade and as a great long-term investment. In the near term, focus on a move up to $43. 

Recommended Trade Setup:

— Buy FCX at the market price
— Set stop-loss at $33
— Set initial price target at $43 for a potential 21% gain in six months

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