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This article first appeared on Simply Wall St News.
With the inflation pressures now undeniable, the question of finding a place to park the cash becomes a dire necessity for some.
Yet, with the real estate peaking, stock market overheating and commodities not yielding, turning to thematic investing might be an ultimate solution.
All Hail the King of Green Metals
As a hard commodity, copper generally does well in the inflationary environment, yet it could do particularly well in the 2020s. Sometimes titled "The king of green metals," copper is a principal component in many pressing environmental solutions. From solar power, hydropower, wind power, and electric vehicles.
According to estimates, a pure electric car needs 20% more copper on average than a typical gasoline-powered one. While this adds to the costs of automotive manufacturers, it presents an opportunity for copper miners and their investors.
As a long interest of traditional miners, copper is catching interest from digital miners as well, with the launch of Cuprum Coin - a copper-backed cryptocurrency currently in the pre-sale phase.
Given the trends, established copper miners like Freeport-McMoRan Inc. (NYSE: FCX) provide an excellent opportunity to hedge against inflation while earning a dividend yield. If they're undervalued, as our intrinsic analysis suggests, that is just a cherry on the top of the cake.
The company reported a solid third-quarter result with improved earnings, revenues, and profit margins.
Third-quarter 2021 results:
Revenue: US$6.08b (up 58% from 3Q 2020).
Net income: US$1.40b (up 329% from 3Q 2020).
Profit margin: 23% (up from 8.5% in 3Q 2020).
The increase in margin was driven by higher revenue. Over the last 3 years, on average, earnings per share have increased by 3% per year, but its share price has risen by 49% per year, which means it is tracking significantly ahead of earnings growth.
Estimating the Intrinsic Value
We generally believe that a company's value is the present value of all cash it will generate in the future. However, Discounted Cash Flow (DCF) model is just one valuation metric among many, and it is not without flaws. If you still have some burning questions about this type of valuation, look at the Simply Wall St analysis model.
Crunching the numbers
We will use a two-stage DCF model, which, as the name states, considers two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second "steady growth" period. To begin with, we have to get estimates of the next ten years of cash flows. Where possible, we use analyst estimates, but when these aren't available, we extrapolate the previous free cash flow (FCF) from the last estimate or reported value.
We assume companies with shrinking free cash flow will slow their rate of shrinkage and that companies with growing free cash flow will see their growth rate slow over this period. We do this to reflect that growth tends to slow more in the early years than in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) forecast
Levered FCF ($, Millions)
Growth Rate Estimate Source
Est @ 9.39%
Est @ 7.16%
Est @ 5.6%
Est @ 4.51%
Est @ 3.74%
Est @ 3.21%
Present Value ($, Millions) Discounted @ 7.0%
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$57b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after these ten years. For a number of reasons, a very conservative growth rate is used that cannot exceed that of a country's GDP growth.
In this case, we have used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. In the same way, as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 7.0%.
Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$11b× (1 + 2.0%) ÷ (7.0%– 2.0%) = US$218b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$218b÷ ( 1 + 7.0%)10= US$110b
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$168b. In the final step, we divide the equity value by the number of shares outstanding. Compared to the current share price of US$37.7, the company appears potentially underpriced at a discount of over 50%.
While this can mean we are looking at a bargain, it also mandates examining the model numbers further as there might be some hidden reasons why the stock appears that cheap.
We would point out that the most critical inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows.
The DCF also does not consider the possible cyclicality of an industry or a company's future capital requirements, so it does not give a complete picture of its potential performance.
Given that we are looking at Freeport-McMoRan as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC), which accounts for debt. We've used 7.0% in this calculation, which is based on a levered beta of 1.158.
Beta is a measure of a stock's volatility compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
While the DCF model is not a perfect valuation tool, it helps us assess the company's overall picture.
Although there might be more to the story, investing in copper remains one of the best ways to offset the inflation in the 2020s and mandates further look into the company.
For Freeport-McMoRan, we've compiled three fundamental factors you should further research:
Risks: For example, we've discovered 2 warning signs for Freeport-McMoRan (1 is a bit unpleasant!) that you should be aware of before investing here.
Future Earnings: How does FCX's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
Other Solid Businesses: Low debt, high returns on equity, and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks, search here.
Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.