This Just In: Upgrades and Downgrades


At the Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

Freeport in a coma
"[Freeport] in a coma, I know
I know-it's serious ...
Do you really think
She'll pull through?"
(With apologies to The Smiths)

After a few frenzied hours of selling on Wednesday, in the wake of Freeport McMoRan Copper & Gold's astounding, colossal blunder, Wall Street has been knocked into a veritable coma. Frozen. Unable to decide what to do next.

Initially, as panic over the size of Freeport's gaffe in shelling out $9 billion to acquire Plains Exploration and McMoRan Exploration took hold, Wall Street had only one response. As a certain well-known, goateed pundit might have put it: "Sell-Sell-Sell!" But now that shares of Freeport have fallen more than 20% from their pre-deal price, what next?

Wall Street seems at a loss. On Thursday, each of Citigroup, RBC Capital, BMO Capital, Macquarie, and Goldman Sachs cut their ratings on Freeport. But all five analysts now rate Freeport's stock a "neutral," or some variant thereof. As in, neither a "buy" nor a "sell."

This is similar to the cash-burning oil businesses that Freeport has purchased. Raymond James, Capital One, and Global Hunter all downgraded Plains Exploration to neutral yesterday, and you can see why. Considering the size of the premium that Freeport is paying -- a whopping 39% -- there's basically zero room for that stock to rise any more, either. Likewise with McMoRan. Bought for a staggering 74% premium, it's now been assigned a neutral rating by former fan Ladenburg Thalmann.

Meanwhile, at their current valuations, it seems the only direction these stocks can go now is down. But you can't even sell them short, unless you think Freeport can somehow be convinced to un-buy them. So what's an investor to do?

Clearly, you can't buy Plains or McMoRan Exploration at the crazy prices Freeport is willing to pay. There's just no upside. Just as clearly, you can't short the stocks on the assumption that Freeport will come to its senses. The company has proven itself clinically brain-dead at best, or terminally conflicted at worst, and cannot be depended upon to act in the best interests of shareholders.

The only path open, it would appear, is to admit defeat and move on in search of a better company to own. Fortunately, Citigroup thinks it has found one.

Here's an idea ...
No longer able to recommend Freeport, Citi began casting about for an alternative play that it could recommend to copper investors. Yahoo! Finance suggests a couple of possibilities as rivals to Freeport. There's Newmont Mining , of course. But that one's burdened by debt, burning cash, and tarred with an unconscionably high P/E ratio -- a nosebleed 204 times earnings.

The alternative, Southern Copper , looks quite a bit more attractive. So, surveying the landscape for an untainted copper investment yesterday, Citi decided to recommend it.

At 16 times earnings, Southern Copper costs a bit more than Freeport does (post-sell-off). On the other hand, with a 10% projected growth rate, the company's growing quite a bit faster than Freeport was expected to grow (pre-sell-off).

Southern Copper is a bit light in the free cash flow department, granted. FCF over the past 12 months was just $1.3 billion, versus reported income of $1.9 billion. But if you factor in a monster dividend (Southern Copper just paid one out at $2.75 a share last month, and has been similarly generous in recent years), the combination of earnings growth and dividends probably justifies the P/E ratio.

Foolish takeaway
Result: At the same time as it was downgrading Freeport yesterday, Citigroup upgraded Southern Copper to "buy." I agree.

At today's prices, Southern Copper looks, at worst, fairly priced, and, arguably, even cheap. One thing's for certain: Investors who buy Southern Copper know, at least, what they're getting.

That's more than you can say for Freeport, which looks less and less like a play on an essential global commodity, and more and more like a Frankenstein's monster -- half copper, half gold, and strangely, now, also half oil and gas -- and a target for class action lawyers. Caveat investor on that one.

After putting together a blockbuster deal to expand into the oil and natural gas industry, Freeport-McMoRan will have plenty on its plate as it tries to adapt to the new industry, as expanding into oil and gas carries plenty of inherent volatility. FCX had a profitable copper business and, on top of this foray into a new industry, it still has to contend with mining industry bellwether BHP Billiton. To find out if Freeport-McMoRan is a buy or a sell, simply click here now to check out the Motley Fool's brand new premium report on the company!

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Fool contributor Rich Smith regrets to admit that he owns shares of Freeport-McMoRan Copper & Gold. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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