Rebound selections

10/27/2008


In general, we prefer not to fight the majority money opinion. Because share-price performance is among the more effective and forward-looking indicators, we prefer not to recommend a stock under severe selling pressure. But when we recommend a stock because it represents an attractive value — and the stock becomes an even better value because of indiscriminate or excessive selling — we will sometimes buck the trend.

Freeport-McMoRan ($30; NYSE: FCX) has been hit hard by the downturn in commodities and commodity-related stocks, slumping more than 75% since June. Sharply lower copper prices explain most of the sell-off; copper prices recently reached a three-year low near $2 per pound, down from $4 in July. While copper’s drop has been far worse than we anticipated — and our decision to stick with Freeport was a mistake — several factors suggest the stock is a good value at current prices:

• Even among analysts who have revised or confirmed estimates since mid-October, the outlook for 2009 varies widely. Those expecting a rebound in copper prices expect per-share earnings to exceed $7, while those forecasting flat prices expect $3 to $5. Merrill Lynch expects per-share earnings of $11 based on an estimated copper price of $3.79 per pound — but warns that a copper price of $2 per pound would translate into per-share earnings of $3.50. Even based on that lower estimate, the stock is cheap at less than nine times earnings. Prior to 2008, the lowest trailing P/E of the last decade was eight.

• Freeport is a low-cost producer, largely because of its massive mine in Indonesia. Like its rivals, Freeport is already cutting back in higher-cost areas. If copper prices remain below $2.50 per pound, many analysts expect industrywide cutbacks to continue. So, while a drop to $1.50 per pound is certainly possible, we don’t think such a low price would be sustained.

• The company is generating healthy cash flows at today’s copper prices. Long-term debt has been cut to $7.2 billion, down from $11.8 billion in March 2007. Freeport does not face any significant debt maturities in 2009 or 2010. Share repurchases and dividend increases are unlikely until copper prices rebound. But the annual dividend of $2 per share, equating to a 6.7% yield, seems safe for now.

• Freeport, a Focus List Buy, will remain under pressure until copper prices find some support. But the company is one of the better-positioned players in the mining sector, and the stock appears unduly cheap.


Wireless telecom operator NII Holdings ($18; NASDAQ: NIHD), formerly Nextel International, has slumped on expectations of economic weakness in Latin America and a sharp rally in the U.S. dollar. Investors may also be worried by rumors that NII is interested in acquiring Nextel, a struggling U.S. carrier, from Sprint Nextel ($4; NYSE: S).

• NII was scheduled to post third-quarter results on Oct. 23, after this newsletter went to press. While profit estimates for the quarter have come down recently, the company was expected to deliver solid growth in earnings, sales, and subscribers.

• Latin American currencies have plummeted in October, leading to widespread cuts in earnings estimates. Still, among the six most recent estimates in Thomson Financial, the average estimate for 2009 per-share earnings is $3.34, versus the $2.84 expected for 2008.

• Even based on the lowest 2009 profit estimate of $2.50, the stock appears very cheap at seven times earnings. Since NII began trading in 2003, the average trailing P/E ratio is 26. Prior to 2008, the stock had never traded at a P/E ratio below 10.

• If NII’s core markets of Brazil, Argentina, and Mexico face recessions in 2009, the company is likely to have higher cancellation rates and slower customer growth. But an emphasis on higher-end business customers should provide some protection from the most severe price competition, and NII will continue to benefit from the migration toward digital services.

• The company has a solid balance sheet, with about $2.4 billion in long-term debt and limited debt repayments due before 2011. Considering NII’s $1.3 billion cash position and solid cash flow, the company appears to have the wherewithal to pursue its growth strategy.

• With emerging stock markets under severe pressure — and investors worried that Argentina or other Latin American nations could face a debt-repayment crisis — NII shares may remain under pressure in the near term. But, even based on pessimistic forecasts for Latin America, the stock seems undervalued at current prices. NII remains a Focus List Buy.


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