Southern Copper Corporation — FY 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. This is an annual report, not a standalone fourth-quarter filing; unaudited quarterly results are summarized below. Amounts are U.S. dollars unless stated otherwise.
Business context
Southern Copper is an integrated copper producer operating mines, smelters and refineries in Peru and Mexico. It also produces molybdenum, silver, zinc and other by-products. The company reports three segments: Peruvian operations, Mexican open-pit operations and Mexican underground operations (IMMSA). Grupo Mexico indirectly owned 88.9% at year-end.
Financial and operating performance
| Metric | FY 2016 | FY 2015 | Change |
|---|---|---|---|
| Net sales | $5,379.8 million | $5,045.9 million | Up 6.6% |
| Operating income | $1,564.2 million | $1,414.4 million | Up $149.8 million |
| Net income attributable to SCC | $776.5 million | $736.4 million | Up 5.4% |
| Diluted earnings per share | $1.00 | $0.93 | Up $0.07 |
| Operating cash flow | $923.1 million | $879.8 million | Up $43.3 million |
| Capital investments | $1,118.5 million | $1,149.6 million | Down 2.7% |
| Cash and cash equivalents | $546.0 million | $274.5 million | Up $271.5 million |
| Total debt | $5,954.2 million | $5,951.5 million | Approximately unchanged |
FY 2016 gross, operating and net margins were 31.6%, 29.1% and 14.4%, respectively, compared with 31.9%, 28.0% and 14.6% in 2015. The current ratio was 2.57. Net debt was $5,356.9 million and net debt to net capitalization was 47.7%, versus 48.9% in 2015. Debt was dollar-denominated and fixed-rate, with a weighted average rate of 5.89%.
Operating cash flow was below capital investment spending. Cash used in investing activities was $452.0 million, reflecting $1,118.5 million of capital expenditure alongside sales of short-term investments and a related-party loan repayment. Cash used in financing was $210.7 million, including $139.3 million of dividends and $71.7 million of share repurchases. Year-end current assets were $2,566.1 million and current liabilities $999.0 million.
Fourth-quarter context (unaudited): Net sales were $1,398.9 million, operating income $470.5 million and net income attributable to SCC $171.9 million; diluted EPS was $0.22. In Q4 2015, these were $1,254.6 million, $187.5 million, $60.9 million and $0.09, respectively.
Changes versus comparable periods
- FY sales rose as copper sales volume increased 18.3% and silver volume increased 18.9%, despite lower copper and molybdenum prices. Average LME copper price fell 11.6% to $2.21/lb; COMEX averaged $2.20/lb.
- Copper production reached a company record of 899,955 metric tons, up 21.1%, primarily as Buenavista’s expanded concentrator ramped up. Buenavista mined copper production increased 57.2%.
- Silver production increased 21.7% and zinc production 19.5%; molybdenum production fell 6.9%.
- Operating costs and expenses increased 5.1% to $3,815.6 million, including higher sales-related costs and depreciation from expansion assets. Depreciation, amortization and depletion rose $136.4 million. Lower fuel costs and reduced environmental remediation expense partly offset increases.
- Operating cash cost per pound of copper, a non-GAAP measure, decreased to $1.45 excluding by-product credits and $0.95 including them, from $1.65 and $1.11, respectively, in 2015.
- Compared with 2014, FY 2016 sales, operating income and SCC-attributable net income remained below 2014 levels; copper prices and earnings had fallen sharply in 2015.
Outlook, capital plans and management commentary
- Management expected 2017 copper production of about 900,000 metric tons, silver production of 16.6 million ounces, mined zinc of 80,800 metric tons and molybdenum production of 19,700 metric tons. These are forecasts, not guarantees.
- The 2017 capital investment plan was $1,105.2 million; planned exploration spending was approximately $56.9 million. Management targeted copper capacity above one million tons by mid-2018 and 1.5 million tons by 2023.
- The $1.2 billion Toquepala concentrator expansion was 53% complete at year-end, with completion expected in Q2 2018; planned capacity increases include 100,000 tons of annual copper and 3,100 tons of molybdenum. The 2018 company production forecast was 972,300 tons.
- Tia Maria, a planned 120,000-ton-per-year copper project with a $1.4 billion budget, had environmental approval but still required a construction license; community opposition and litigation had delayed it. The company had invested $363.5 million by year-end.
- Management described a possible 2017 copper-market supply deficit and expected stronger zinc prices. Market prices remain a key uncertainty; a $0.10/lb change in copper price was estimated to change annual SCC-attributable net income by $113.4 million, assuming other specified conditions.
Risks, contingencies and unusual items
- Commodity exposure: Copper represented 78.4% of 2016 sales. Metal-price volatility, demand shifts and provisional pricing can materially affect revenue and earnings.
- Environmental spill: The 2014 Buenavista copper-sulfate spill led to remediation costs and litigation. The company reported $136.4 million of estimated total damages, with about $74.9 million deposited in a trust and $42.5 million paid from company funds. SEMARNAT reported the remediation plan complete except for biological monitoring through the first half of 2019; PROFEPA closed its investigation in January 2017 and the trust was closed in February 2017. Related lawsuits and a criminal complaint were disclosed; the company disputed the claims.
- Other legal and regulatory matters: Tia Maria lawsuits and community opposition remain relevant. A Peruvian former-employee labor-share case and other claims, a dispute concerning the Pasto Grande tailings area, and a shareholder derivative action involving Grupo Mexico-related power arrangements were pending. Some contingencies could not be reasonably estimated.
- Labor: Taxco and San Martin mines in Mexico had been on strike since July 2007 and remained suspended. The company reported six worker fatalities in 2016, versus one in 2015.
- Tax uncertainty: The company reported $304.0 million of unrecognized tax benefits, relating to U.S. tax matters, and an IRS examination of the 2011–2013 AMC consolidated tax group. A February 2017 agreement provides that AMC will bear and indemnify the company for specified incremental tax liabilities associated with the 2012 judgment.
- Other exposures: Risks include water availability, energy costs, mine slope stability, reserve estimates, environmental regulation, currency movements, political conditions in Peru and Mexico, debt covenants, and related-party conflicts. The $216.5 million asset retirement obligation and $1,447.2 million of capital-project commitments are also significant.
- Unusual item: A 2016 restructuring plan cost $6.9 million and resulted in 231 employees accepting severance packages. Management and the auditor concluded internal control over financial reporting was effective at year-end; the auditor issued unqualified opinions on the financial statements and controls.
Important facts for investors to verify
- Whether production, unit-cost and capital-spending forecasts are being met, particularly the Toquepala expansion schedule and capacity targets.
- Whether Tia Maria receives remaining permits and community support, and how its project timing and investment assumptions change.
- The final financial and legal consequences of the Buenavista spill, remaining biological monitoring and any outstanding related claims.
- Debt-service capacity and liquidity after planned capital spending, dividends, energy commitments and other contractual obligations.
- Exposure to copper and by-product prices, including provisional sales pricing and the actual sensitivity of earnings.
- Progress on tax audits and utilization of foreign tax credits, and the scope and enforceability of AMC’s indemnity.
- Developments in the long-running Taxco and San Martin strikes, other pending litigation, and related-party transactions under Grupo Mexico control.