All posts from Amanda
Amanda in MUST HAVE,

Who’s afraid to buy this high-risk, high-reward commodity stock?

With Freeport-McMoRan, be greedy when others are fearful

Every investor should know the perils of commodity stocks by now.

Commodity prices are in free fall, with everything from oil to copper tumbling for the past year or so. And given the slowdown in China, it’s safe to expect that trend to continue as supplies remain big and global demand remains soft.

Throw in a strong dollar — and yes, contrary to what Federal Reserve haters would like to believe, the dollar is very strong as measured by the U.S. Dollar Index — and it’s difficult to see the age of cheap commodities ending any time soon.

But as the saying goes, the time for investors to be greedy is when others are fearful. And if everyone is terrified of miners and commodity stocks, it may be worth considering the other side of the trade.

I think long-term investors may be able to make a responsible bet on select stocks in the industry — primarily the much-maligned Freeport-McMoRan Inc.FCX, -0.46%

And here’s why:

Freeport-McMoRan is not going bankrupt: Let’s squash that rumor right now. For starters, Freeport had $466 million in cash on the books as of last quarter. While the company doesn’t have AAA bonds, they are in investment-grade territory with a BBB- from Standard & Poor’s. That means the company still has plenty of access to capital. Last but not least, Freeport-McMoRan is expected to break even when it reports third-quarter numbers and report a small profit the quarter after. So forget the hysterics out there and ignore the bankruptcy talk, because it has no basis in fact.

The current dividend is safe: Freeport already has slashed its dividend from 31 cents quarterly in 2014 to just 5 cents as of this spring. That was an ugly development, to be sure, and the shares were punished as a result. But now the total cost of dividends each quarter is manageable at around $220 million or so, putting the entire annual burden at less than what it paid each quarter last year. And with that projected return to positive earnings in the fourth quarter of 2015, as well as projected profitability for the next couple of fiscal years, it’s highly unlikely the dividend is at continued risk. So while a 1.6% yield isn’t exactly thrilling, investors can have confidence that those payouts will persist.

Aggressive cost cutting: In August, Freeport-McMoRan announced it would bereducing mining expenses by 25%, or about $700 million, next year, and that capital expenditures for both mining and energy operations would drop by 29%, or $4 billion. That will “right-size” Freeport for the current environment, which is admittedly hostile and may persist for some time. Considering the commodity giant is expected to be out of the red before the bulk of those cost reductions take place next year, that’s a good sign for future earnings potential.

Debt reduction at long last: At the same time, Freeport has been selling non-core assets and looking to reduce debt. While investors were disappointed by news in January that debt-cutting efforts were going to be delayed, the third quarter could be the first quarterly report in ages where Freeport McMoRan actually posts a decline in its total debt. It may be a modest drop given the nearly $21 billion Freeport currently owes, but such a move could signal a turning point as the company finally begins to deliver on its promise to deleverage operations.

The past is past: In 2013, Freeport doled out $9 billion for McMoRan and Plains Exploration & Production. Considering that the former was actually previously spun off from Freeport-McMoRan and that the total market capitalization of all operations now is less than $15 billion, that was undoubtedly a massive self-inflicted wound. But deepwater-drilling deals made years ago shouldn’t be considered current issues — beyond the expenses and the debt, of course, which we know Freeport is working on. And if you’re worried that the old regime is still running the show, take heard that Carl Icahn is now a big player in Freeport-McMoRan with an 8.5% stake and two board seats. He’s not exactly the kind of guy who will take wasteful spending and CEO hubris lying down, and investors can have confidence that this will be a much different company in 2016 than in years past.

Acquisition potential: Regardless of short-term pricing fluctuations, Freeport reserves are undoubtedly attractive. Freeport-McMoRan has large reserves of copper, Indonesia to Africa to South America, and those sites could be attractive to mega-miners including Rio Tinto RIO, -0.08% and BHP Billiton BHP, -0.05%Those bigger players could theoretically streamline operations even more with their scale, and use a deal to restructure existing Freeport debt under much more favorable terms. Even an energy giant like Exxon Mobil XOM, +1.65% might take a flier on the long-term potential of its recently added deepwater operations if the price is right.

Recent uptrends: For what it’s worth, Wall Street also seems to think the worst is over for Freeport-McMoRan. The shares are up by more than 60% from their 52-week low in August, and the median target on the stock is $14. (The stock closed at $13 on Wednesday.) With positive momentum before next week’s earnings report, we could see a heady response from investors as Freeport narrows its loss and pays down its debts. Remember, you don’t want to be too early to rebound plays, but you also don’t want to wait until things are 100% in the clear, because then the gains have already been had. The 60%-plus bounce from the bottom a few weeks ago could signal that the worst is over and investors now can buy with confidence.

More from MarketWatch