Business context and reporting period
Southern Copper Corporation (SCC) filed this unaudited Form 10-Q for the quarter ended September 30, 2009, comparing the three and nine months ended that date with 2008. SCC produces copper and by-products including molybdenum, zinc, silver, lead and gold, through Peruvian open-pit, Mexican open-pit and Mexican underground (IMMSA) operations. The interim financial statements received an independent accountant’s review, not an audit.
Financial and operating highlights
| Metric | Q3 2009 | Q3 2008 | Nine months 2009 | Nine months 2008 |
|---|---|---|---|---|
| Net sales ($ millions) | 1,151.8 | 1,440.1 | 2,598.3 | 4,401.1 |
| Operating income ($ millions) | 508.7 | 675.9 | 956.1 | 2,333.1 |
| Net income attributable to SCC ($ millions) | 312.5 | 417.8 | 566.1 | 1,531.3 |
| Diluted EPS | $0.37 | $0.47 | $0.67 | $1.73 |
| Operating cash flow ($ millions) | 380.6 | 700.3 | 296.7 | 1,612.5 |
| Capital expenditures ($ millions) | 110.6 | 137.6 | 316.7 | 320.6 |
- Year-over-year sales fell 20% in Q3 and 41% for the nine months, primarily reflecting lower metal prices. Operating income fell 25% and 59%, respectively; SCC-attributable net income fell 25% and 63%. Approximate operating margins were 44.2% versus 46.9% in Q3 and 36.8% versus 53.0% for the nine-month periods.
- Average LME copper prices were $2.66/lb in Q3 2009 versus $3.48 in Q3 2008, and $2.11 versus $3.62 for the nine months. Nine-month molybdenum averaged $10.78/lb versus $33.01; zinc and silver prices also declined.
- Production was mixed: Q3 mined copper rose 1.3% year over year to 265.1 million lb, and mined molybdenum rose 14.3%. Nine-month mined copper declined 1.2% to 792.1 million lb; molybdenum rose 10.3%, zinc mining rose 4.2%, and refined zinc rose 4.7%.
- Reported cash cost was 27.4 cents/lb in Q3 2009 versus 18.0 cents in Q3 2008, and 47.5 cents for nine months versus 3.5 cents. Excluding by-product credits, costs were 163.4 versus 202.5 cents/lb in Q3 and 151.3 versus 178.9 cents for nine months. Management attributed lower underlying costs mainly to reduced fuel, power and materials costs, while lower by-product prices reduced credits.
- Q3 operating cash flow was down $319.7 million year over year; nine-month cash flow was down $1,315.8 million. The nine-month result reflected lower earnings and a $501.5 million working-capital outflow, including higher receivables and lower payables/accruals. Nine-month cash flow after capital expenditure was negative $20.0 million.
Balance sheet and liquidity at September 30, 2009
- Cash and cash equivalents were $413.3 million and short-term investments $26.0 million, down from $716.7 million and $62.4 million, respectively, at December 31, 2008. Current assets were $1,403.0 million against current liabilities of $412.1 million.
- Long-term debt was $1,275.2 million, plus $10.0 million current debt; total debt was approximately $1,285.2 million. Debt to total capitalization was 26.1%, versus 27.5% at year-end 2008. Reported fair value of long-term debt was $1,328.0 million.
- Total assets were $5,676.5 million and total equity $3,671.6 million. Dividends paid were $0.10/share in Q3 and $0.26/share for nine months, versus $0.57 and $1.61, respectively, in 2008. In October, the board authorized an additional $0.18/share dividend payable in November.
Material changes and management commentary
- Management cited recovering copper prices through the first three quarters, productivity improvements and higher production/sales as support for Q3 results. It said near-term copper prices could be volatile but viewed the market outlook over the next few years as strong, citing constrained mine supply and expected Asian demand. This is management’s outlook, not formal earnings guidance.
- Management said it had suspended many new and expansion capital investments amid the business environment, while continuing key projects. Tia Maria, with a stated budget of $934 million and $250.4 million spent through September, was expected to produce about 260 million lb of copper annually; its schedule and environmental approvals remained subject to local process. The Toquepala concentrator expansion was expected to add 100,000 tons of annual copper output by the second half of 2012. Elsewhere, the executive overview describes Tia Maria as adding 120,000 tons annually and scheduled for 2011; these stated production figures differ and merit verification.
- Cananea, San Martin and Taxco remained closed amid strikes. Cananea had been shut since 2007; labor-court rulings on contract termination were challenged, and management reported no impairment at September 30, while warning that significantly lower future metal-price estimates could change that assessment. Lost production and strike-related legal outcomes remain material uncertainties.
- Cost of sales fell, helped by lower fuel and power costs, reduced workers’ participation and strike-related lower production costs in Mexico. Higher copper prices and sales volumes during the quarter also increased receivables, contributing to working-capital pressure.
- Grupo Mexico, through AMC, reached 80% ownership in SCC in March. SCC joined AMC’s consolidated U.S. federal tax return from that date; the tax-sharing agreement was still under discussion. The nine-month effective tax rate rose to 36.5% from 33.2%, largely due to U.S. tax on Mexican subsidiary dividends.
- Notable legal exposures include Peruvian former-employee labor-share claims, for which SCC recorded no provision and asserts defenses; an Asarco-related judgment against AMC awarding shares representing about 30.6% of SCC’s outstanding shares plus dividends and interest, stayed pending appeal; and ongoing Mexican royalty and other disputes. Management said it did not expect other cited proceedings to have a material adverse effect, but outcomes are uncertain.
- Peruvian mine-closure plans triggered a $34.5 million asset-retirement obligation at quarter-end; management expected further adjustment after remaining plans were finalized. Annual guarantee installments over 34 years were to begin in January 2010. Tia Maria also faced community opposition regarding water use and a delayed public presentation/EIA process.
- Other exposures include metal-price volatility, foreign-exchange and interest-rate movements, environmental and permitting requirements, customer concentration, and related-party dealings with Grupo Mexico affiliates. Management stated it expected to meet cash requirements from cash on hand, internal cash generation and external financing if required.
Most important facts for investors to verify
- Reconcile the unusual reported nine-month 2008 cash cost of 3.5 cents/lb against the filing’s cash-cost reconciliation and underlying calculation.
- Confirm the Tia Maria project’s stated annual production capacity and expected start date, which differ between the executive overview and project disclosure, and track EIA approval and community opposition.
- Monitor resolution of the Cananea, San Martin and Taxco strikes, Cananea litigation, and the potential effect on production and asset impairment.
- Assess the appeal and potential consequences of the Asarco-related judgment, including its effect on AMC/Grupo Mexico and any resulting pressure on SCC distributions or funding.
- Track the AMC tax-sharing agreement, consolidated-group tax exposure and SCC’s effective tax rate, as well as the continuing working-capital drain and available liquidity.
- Review metal-price sensitivity, provisionally priced sales and the final mine-closure obligation estimates and guarantees.