Buy This Copper Miner While It's Cheap

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The world is coming to an end.

You only have to read the headlines to know that. Greece is being thrown off the Mount Olympus of the Eurozone, and that's going to cause a second Great Recession -- if not today, then tomorrow for sure. At least so say the pundits, accurate forecasters the lot of them. (In case you missed that, if you believe pundits are accurate, I have a bridge to sell you.) And that kind of mood only serves to make Mr. Market fearful and sell shares cheaply. So what are you doing in this situation?

Me, I'm buying shares of strong companies while their prices are beaten down. Today's example comes with a near-historical low price-to-book -- meaning it's cheap. I'm talking about the mining company Freeport-McMoRan Copper & Gold (NYS: FCX) , which I'm adding to the Messed-Up Expectations portfolio.

The company
Freeport is one of the world's largest producers of copper, gold, and molybdenum (which is used in steel, among other things), with mines in North and South America, Africa, and Indonesia. At the end of last year, it had the following recoverable proven and probable reserves (ore that is well surveyed for economically recoverable metal):

Source: Company's latest 10-K filing.

Its largest mine is Grasberg, located in Papua, Indonesia. This is an open-pit mine that contains the world's largest copper and gold reserves. The company currently expects to continue mining it as an open pit for the next several years and then begin underground mining.

Reasons to buy
First, copper is by far the largest contributor to Freeport's revenue, so the price of copper is important to the company's profitability, as is the cost to produce it. The Grasberg mine's net production cost of $0.28 per pound helps the company maintain a low consolidated net cost of $1.01 per pound. This places it roughly in the middle of its competitors on production costs, with Rio Tinto (NYS: RIO) coming in lower and BHP Billiton (NYS: BHP) coming in higher. With copper currently selling for about $3 per pound, that gives Freeport a nice profit. Even if copper prices were to fall another 50% to reach the long-term price trend prediction of $1.50 per pound, Freeport would still be able to make money. While I don't see that as likely, given the current undersupply of copper, it's a nice backstop.

Second, the financial health of the company is strong. Of its major competitors, it is the only one with a net cash position (sitting at $836 million). It also has the best debt-to-equity level, though several of the others are also not highly leveraged.

Source: Capital IQ, a division of Standard & Poor's.

Third, it appears to be undervalued. As of last night, the price-to-tangible book value is 2.15. The only other quarter where it has traded this low in the past 16 years was the last quarter of 2008. For the rest of the time, it averaged 3.2 or higher, with values usually ranging in the mid-single digits. On a net-net basis, including its proven and probable reserves as a salable asset (and pricing the copper at just $2 per pound), I put the shares at over $42.

Reason to shy away
Copper is primarily used in construction and electrical applications, though industrial machinery and transportation are also significant users. These uses are all influenced by economic activity, so a significant slowdown would tend to lower copper prices, hurting the share price of Freeport and the other miners in the short term.

However, the long-term trend for copper demand is increasing. Plus, supply production is currently lagging demand and is expected to remain that way in the near future, at least. This is a situation that favors copper miners.

Current expectations
As of last night's closing price, the market currently expects free cash flow to significantly shrink over the next 10 years before leveling off at no growth forevermore, even at my usual high hurdle rate of 15% used to discount. While FCF might indeed shrink if we really do enter another global recession, I don't expect that shrinkage to last long. From the depths of the Great Recession, it took Freeport merely two years to grow FCF and exceed the level it had obtained the year before the recession. Given that, the current expectation is messed up, in my view. (Plus, its 3.3% dividend isn't too shabby.)

Tomorrow, the Messed-Up Expectations portfolio will open a position in Freeport, with the expectation of adding to it if the price remains attractive.

Come and discuss this and other investments on my Messed-Up Expectations discussion board, or follow me on Twitter.

Freeport also mines gold, but it's not a pure play for gold. Check outthis special free reportfor a little-known gold company that has the potential for massive profits.

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At the time thisarticle was published Fool analystJim Muellerowns shares of Southern Copper. He's an analyst for theMotley Fool Stock Advisornewsletter service. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool'sdisclosure policyis never messed up.

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