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Leigh Baldwin & Co.

112 Albany Street, Cazenovia, NY 13035 | Phone: (315) 655-2964 Toll Free: 1-800-659-8044

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Stock of the Week

Freeport McMoran

November 11th 2013 Freeport McMoran
NYSE Symbol: FCX
Industry: Mining/Oil & Gas
Price as of 11/11: $36.46

Happy Veterans Day. Better than expected nonfarm payroll on Friday saved the week lifting most of the major averages to new all-time highs. Interest rates are under pressure once again making bond funds even more difficult to own. Good news for the stock market. Two of the top producing sectors this year, healthcare and consumer discretionary, underperformed the broader market last week. As the healthcare and retail spaces pulled back, the energy, financials and material sectors perked up. Financials benefitted from the rise in rates, but materials are an interesting value play for 2014. If global growth can improve next year, energy and the material space should finally outperform. This week we'll highlight a blue chip material stock that has underperformed until recently and looks poised to outperform once again. The stock of the week is Freeport McMoran (FCX). Freeport has always been a copper play and a barometer for economic and global growth. Last year at this time Freeport's stock took a hit when they acquired two oil and gas plays. In the short term they may have overpaid raising their debt load, but just one year later the acquisitions are starting to pay off, and longer term, should make the company stronger than ever. Recent insider buying with one insider spending $56 million to buy the stock at current levels points to more gains in the future. A dividend yield of 3.4% makes Freeport an attractive investment for income investors as well.

Last month Freeport reported better than expected earnings with net income of $0.79 a share with operating cash flows of $1.9 billion. For the year, management raised its cash flow projection by nearly 10% to $6 billion thanks to fantastic results from its new oil segment, which had cash margins of 80% in the quarter. Below industry average cash costs and high quality reserves in relatively stable nations should be able to provide consistent production levels in a profitable fashion for many years. China's growth has been one of the main concerns for investors putting pressure on copper prices. However China continues to grow at 7.5% and demand has picked up in the last six months. The Chinese government has undertaken a major expansion and modernization of its power grid, which will require significant copper outlays. This project will boost copper demand and immunize it from fluctuations in China's construction market over the next 12-18 months and push copper prices higher in the coming months. Investors should also remember the world is forecasted to demand more copper in the next 20 years than has been mined to this point in human history. The copper story remains compelling.

Freeport has unparalleled mineral reserves. It has 116 billion pounds of proven and probable copper reserves compared to annual production of 3.65 billion pounds. It also has 32.5 million ounces of gold, compared to 1 million ounces of annual production and 688 million barrels of oil equivalents. This reserve base gives Freeport the capacity to at least maintain current production levels for thirty years. Moreover, over time as prices rise thanks to inflation and their scarcity, reserves that are considered uneconomical do become recoverable, suggesting actual production potential is in excess of current reserves. With net copper cash cost of $1.46 a pound compared to market prices of over $3.30, the company has significant cash flow potential. Assuming a constant cash margin of $1.84 and no additional discoveries, its reserves have a total value of $185 billion. With its depletion rate and a discount rate of 10%, its reserves have a present value of $54.38 per share or roughly $55 billion. With its $38.5 billion market cap, there is significant room for upside. Once shares reach $55, there is a long run rate of return of at least 10%. At current prices, investors could return upwards of 15% annually.

At current levels, Freeport is trading for 1.5 times sales, 1.9 times book value of $19.66 a share and 11 times earnings. Earnings are still understating the future earnings power of the oil and gas plays. Operating cash flow has increased from $5 billion to $6 billion to a possible $7 billion per year by the end of 2014 or 2015. The improvement in cash flow should allow Freeport to reduce their debt, maintain the dividend and still have billions left over to maintain operations. In a stock market where value is hard to come by, Freeport looks attractively priced with a great dividend. Heavy insider buying is a good indication that the good news at Freeport should continue.