Business Context and Reporting Period
Company: Southern Peru Copper Corporation (SPCC)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and nine months ended September 30, 2004
Business Overview: SPCC is engaged in the production and sale of copper and metallurgical by-products (molybdenum, silver) from mines in Peru (Cuajone and Toquepala). The company operates under a socially conscious mandate and is currently undergoing a major modernization of its Ilo smelter to meet environmental regulations.
Key Financial Metrics
| Metric (in thousands) | 3 Months Ended Sep 30, 2004 | 3 Months Ended Sep 30, 2003 | 9 Months Ended Sep 30, 2004 | 9 Months Ended Sep 30, 2003 |
|---|---|---|---|---|
| Total Net Sales | $428,085 | $209,486 | $1,091,164 | $552,712 |
| Operating Income | $211,717 | $59,170 | $540,275 | $131,809 |
| Net Earnings | $131,946 | $36,091 | $339,668 | $76,057 |
| Earnings Per Share (Basic/Diluted) | $1.65 | $0.45 | $4.25 | $0.95 |
| Operating Cash Flow | $192,882 | $53,704 | $416,298 | $116,995 |
| Cash and Cash Equivalents (Sep 30, 2004) | $418,617 | |||
| Total Debt (Current + Long-term) | $294,043 | |||
| Dividends Paid (9 Months) | $125,386 |
Non-GAAP Metric: Operating cash cost per pound of copper sold was 22.8 cents for the quarter ended September 30, 2004, compared to 36.8 cents in the prior year period. This reduction is largely attributed to higher molybdenum revenue credits.
Material Changes vs. Prior Period
- Revenue Surge: Net sales increased 104% for the quarter and 97% for the nine-month period compared to 2003. This was driven by significant increases in copper prices (average $1.29/lb vs. $0.80/lb) and molybdenum prices (average $16.90/lb vs. $5.67/lb).
- Profitability: Net earnings increased 266% for the quarter and 347% for the nine-month period. Operating income rose from $59.2 million to $211.7 million in the quarter.
- Cost Increases: Cost of sales increased due to higher fuel and power costs, the sale of third-party copper (purchased for tolling), and a $7.9 million provision for a new Peruvian royalty tax.
- Production: Despite a 13-day illegal strike in Q3, copper production increased 4.1% to 226.0 million pounds. Molybdenum production increased 15.5% to 6.3 million pounds.
- Liquidity: Cash and cash equivalents grew from $295.5 million at year-end 2003 to $418.6 million at September 30, 2004, exceeding total debt by $124.6 million.
Guidance, Outlook, Risks, and Contingencies
Management Commentary and Outlook
- Merger Proposal: On October 21, 2004, the Board approved a merger agreement to acquire Minera Mexico (MM), the Mexican mining assets of its largest shareholder, Grupo Mexico. The deal involves issuing 67.2 million shares to Grupo Mexico and paying a $100 million special transaction dividend. The transaction requires shareholder ratification.
- Capital Projects: The Ilo smelter modernization project is on schedule for completion by January 2007. The estimated cost to complete is $500 million (including $94 million already spent). The Toquepala leaching project is expected to save $25 million annually in operating costs upon completion in mid-2005.
- Dividends: A quarterly dividend of 82.45 cents per share ($66 million) was declared on October 21, 2004. The company obtained a waiver to pay up to 100% of net income in dividends for the remainder of 2004 and Q1 2005.
Risks and Contingencies
- Tax Disputes: The company is under audit by the IRS for tax years 1997-2002 regarding inventory valuation and capitalization of costs. In Peru, the company is appealing assessments by SUNAT regarding depreciation and interest deductions for years 1996-1999. A $3.4 million letter of credit was issued for a 1996 penalty appeal.
- Legal Proceedings: Approximately 3,000 former employees have filed lawsuits seeking "investment shares" and dividends. The company believes it has meritorious defenses and has not recorded a provision, but a loss could negatively impact cash flow and minority interest.
- Regulatory Changes: New Peruvian laws regarding mine closure and remediation obligations are pending final regulations. The company cannot currently estimate the financial impact but anticipates increased asset retirement obligations.
- Commodity Price Volatility: Earnings are highly sensitive to copper and molybdenum prices. A $0.01/lb change in copper price impacts annual EPS by approximately $0.06.
Investor Verification Checklist
- Merger Approval: Verify the outcome of the shareholder vote required to ratify the acquisition of Minera Mexico by Grupo Mexico.
- Smelter Project Costs: Monitor the $500 million budget for the Ilo smelter modernization for potential overruns or financing needs beyond current cash reserves.
- Tax Resolution: Track the status of the IRS audit (1997-2002) and Peruvian tax court appeals (1996-1999) for potential material tax liabilities.
- Employee Litigation: Watch for rulings on the lawsuits filed by former employees regarding investment shares, which could alter the capital structure.
- Regulatory Impact: Review final regulations for the new Peruvian mine closure law to assess the magnitude of future asset retirement obligations.