UBS’ $175,000 autocalls on Freeport-McMoRan miss the entry point, contrarian investor says

By Emma Trincal

New York, Jan. 21 – UBS AG, London Branch’s $175,000 of trigger phoenix autocallable optimization securities due Jan. 20, 2023 linked to the common stock of Freeport-McMoRan Copper & Gold Inc. pose too much risk to investors due to the elevated valuation of the underlying stock, said Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments.

If Freeport-McMoRan’s stock closes at or above the trigger price – 75% of the initial share price – on a monthly observation date, the issuer will pay a contingent coupon for that month at the rate of 19.08%, according to a 424B2 filing with the Securities and Exchange Commission. Otherwise, no coupon will be paid that month.

If the shares close at or above the initial price on a monthly observation date, the notes will be called at par plus the contingent coupon.

If the notes are not called and Freeport-McMoRan’s shares finish at or above the trigger price, the payout at maturity will be par plus the contingent coupon. Otherwise, investors will be exposed to the share price decline from the initial price.

Base metal

“I’ve been tracking the company for many years,” said Kaplan.

“The stock has been one of the biggest percentage winners in the past couple of years, especially since March 2020.

He noted that in comparison, gold miners (VanEck Gold Miners ETF) have posted a lackluster performance.

“Freeport-McMoRan is one of the world’s largest copper producers. It doesn’t trade like gold. It trades like a copper mining company,” he said.

Kaplan drew the distinction between gold and copper as he is bullish on the former and bearish on the latter.

“Freeport-McMoRan’s valuation is extremely high, unlike the gold miners. This is not a good time to buy,” he said.

Big rally

The strong bull trend for Freeport-McMoRan started when the market crashed in March 2020 as with the overall equity market, he noted.

The stock has surged 760% in the last 22 months.

“In March 2020 the share price was low. That’s when many insiders were buying. The P/E was about half of profit growth. Anytime you see that type of distortion between price and fair value, you can be sure the company’s top executives are going to buy aggressively,” he said.

Freeport-McMoRan has an “excellent track record” of insiders’ buying and selling at the right time, he noted.

“They buy when prices are low and sell when they’re high. This company does it very consistently,” he said.

Strong following

The insiders’ pendulum however has swung. But the price is still rising.

“First you have the insiders buying at bargain prices. They don’t move the market. They just send a signal to groups of savvy investors, hedge funds and value-oriented institutions who buy as well. When the rally becomes visible, momentum investors join in. They buy high. That’s what they always do. Anytime a stock goes up, the crowd piles in and buys at increasingly higher prices. In fact, the stock just hit a new high on Jan. 18. So, we still have momentum around the name despite the heavy insiders’ selling.”

Downside risk

Too much buying and too much popularity around a name is a red flag for this contrarian.

“Buy when the price is depressed, not at a peak,” he said.

“When valuations reach extreme like this, experienced market participants come in and sell. It’s a signal worth paying attention to. The market is always regressing from one direction to another.”

Kaplan downplayed the upside risk and reinvestment risk associated with the notes.

“There’s a 50% chance you can be above the initial price on the first call date,” he said.

“If that happens, good for you. You pocket 1.59% in one month.

“The call risk is not anything to worry about,” he said.

Instead, investors should be concerned about the notes not getting called, a risk that rises as the number of missed calls increases.

“If you still hold the notes at maturity, you could incur extremely high losses,” he said.

Insufficient barrier

Kaplan said the risk of breaching the 75% barrier was real.

The stock closed at $44.08 on the Jan. 14 trade date. It was as low as $31 last summer, he noted.

“If we go back to that level, you’re looking at close to a 30% drop.”

An ever-worse scenario would be revisiting the low of March 2020. The stock traded at $4.77 then.

“Now we’re talking about a decline close to 90%,” he said.

“When you’re investing in such a volatile stock, when prices can go to extremes, you need a much more generous barrier,” he said.

Not a hedge

Kaplan conceded that the March 2020 sell-off was extreme. But he envisioned an even more severe bear market due to the current market, which he sees as a dangerous speculative bubble concentrated around mega-cap growth stocks.

A company like Freeport-McMoRan would be especially at risk based on historical observations.

“Each time we had a severe bear market, copper had very large percentage losses. We’ve seen that pattern during the 1972, 2000 and 1929 bear markets.

“Meanwhile gold miners were going up,” he said.

Value principles

In conclusion, Kaplan said the notes were too risky.

“A more generous barrier would be a good thing. But it’s not enough. No barrier can do a better job than buying at the right price and at the right time,” he said.

“The structure itself is not bad. But if you want to use it, take a different underlying. Buy something that has already dropped a lot, like Chinese internet stocks for instance. Those securities are real bargains.”

Kaplan is long the KraneShares CSI China Internet ETF. He said he saw a few notes tied to this fund, but perhaps not enough.

“You want to start from a low point. If you enter your trade at a high P/E, your chances of success are limited,” he said.

UBS Financial Services Inc. and UBS Investment Bank are the underwriters.

The notes settled on Wednesday.

The Cusip number is 90302T144.

The fee is 1.25%.

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