SOUTHERN COPPER CORP quarterly report, Q3 FY2018

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Southern Copper Corporation — Q3 2018 Form 10-Q

Business and period: Unaudited results for the three and nine months ended September 30, 2018, compared with the same periods in 2017. Southern Copper is an integrated copper and by-product producer operating primarily in Peru and Mexico; Grupo Mexico indirectly owned 88.9% at quarter-end. Amounts below are U.S. dollars unless stated otherwise.

Financial performance and position

  • Third quarter: Net sales were $1.724 billion, up 2.8%; operating income was $696.7 million, up 0.6%; and net income attributable to SCC was $369.4 million, down 8.1%. EPS was $0.48 versus $0.52. Operating margin was approximately 40.4%, compared with 41.3%.
  • First nine months: Net sales were $5.402 billion, up 12.8%; operating income was $2.258 billion, up 26.2%; and SCC-attributable net income was $1.250 billion, up 23.0%. EPS was $1.62 versus $1.31. Operating margin was approximately 41.8%, versus 37.3%.
  • Drivers and costs: Nine-month revenue growth reflected higher metal prices and stronger silver and zinc sales volumes, partly offset by 1.1% lower copper sales volume. Copper represented 80.6% of nine-month sales. Operating costs and expenses rose 4.8% to $3.144 billion. The effective tax rate increased to 39.2% from 35.7%, principally due to U.S. tax-law changes, including GILTI and reduced foreign tax credit benefits.
  • Cash flow and investment: Nine-month operating cash flow was $1.789 billion, up 39.8%. Capital investment was $831.8 million, up from $710.4 million; investing cash outflow was $1.030 billion and financing cash outflow was $774.0 million, mainly reflecting $773.0 million of dividends. Cash ended at $967.3 million, down from $1.005 billion at year-end 2017.
  • Liquidity and debt: Current assets were $3.273 billion and current liabilities $1.208 billion (current ratio approximately 2.7). Cash plus short-term investments totaled $1.204 billion. Long-term debt was $5.959 billion, broadly unchanged from $5.957 billion at year-end; debt fair value was reported at $6.653 billion. Cash and short-term investments less reported long-term debt imply net debt of approximately $4.755 billion.
  • Production and unit costs: Nine-month mined copper production was 1,430.1 million pounds, down 0.3%; copper sales volume was down 1.1%. Molybdenum and silver production increased, while zinc production declined. Non-GAAP cash cost per pound, net of by-product revenues, improved to $0.83 from $0.93; before by-product credits it rose to $1.53 from $1.49.

Material changes and developments

  • Q3 net income fell despite higher sales and nearly flat operating income, with higher income taxes contributing to the decline. For the nine-month period, higher prices and sales supported substantially higher earnings.
  • Q3 LME copper averaged $2.77/lb, down 3.8% year over year; the nine-month average was $3.01/lb, up 11.5%. Nine-month average molybdenum prices rose 48.9%, while silver prices fell 6.5%.
  • Buenavista’s lower SX-EW copper output weighed on year-to-date production. The company began a 12-month corrective program focused on leach-pad placement and ore fragmentation.
  • Toquepala expansion was 98% complete, with production expected to begin in Q4 2018; the company reported $1.192 billion invested against a project budget of about $1.3 billion. Michiquillay was acquired under a $400 million agreement: $12.5 million paid, another $12.5 million accrued, and the $375 million balance due only if SCC elects to develop the project.
  • The company paid a $0.40-per-share dividend in August and declared a further $0.40 dividend payable November 21, 2018. Nine-month dividends paid per share were $1.00 versus $0.34 in 2017.

Outlook, risks and contingencies

  • Management expected 2018 copper production of 885,000 tons, including 14,000 tons from the new Toquepala concentrator, and forecast 17.1 million ounces of silver, 73,200 tons of zinc, and 21,900 tons of molybdenum. Separately, management described a strategic plan to exceed one million tons of copper production in 2018 and reach 1.5 million tons by 2025; investors should reconcile this ambition with the 885,000-ton 2018 forecast.
  • Management anticipated a copper-price recovery, citing demand growth and constrained future investment, but emphasized trade tensions and commodity-price volatility. Metal prices, operating costs, ore grades, foreign exchange, permitting, labor, environmental matters, and political and operating conditions are identified risks. A $0.10/lb copper-price change was estimated to affect remaining-2018 net income by $30.9 million, assuming stated production, sales, and tax assumptions.
  • Tia Maria’s construction permit remained delayed amid opposition; management expected a permit in 2018, but timing was uncertain. The approximately $1.4 billion project had $355 million invested, and related lawsuits remained pending. The company said potential losses on these cases could not be reasonably estimated.
  • Peruvian soil contamination studies and a remediation plan remain in progress; potential loss is considered reasonably possible but not estimable, with meaningful estimation expected after studies substantially progress, then anticipated in Q1 2020. Separate Tia Maria and Pasto Grande litigation contingencies also were not estimable.
  • Buenavista spill-related lawsuits remained pending, although the criminal complaint was dismissed in Q2 2018. SCC said the proceedings were without merit and not expected to have a material effect. A separate corporate lawsuit settlement proposes a $50 million payment by Grupo Mexico or Americas Mining, less court-awarded legal fees, for distribution to eligible public shareholders as a special dividend; court approval was pending, with a hearing scheduled for November 27, 2018.
  • The San Martin mine’s rehabilitation was in progress with a budgeted cost of $77 million after authorization to restart operations; Taxco remained suspended pending labor litigation. The company also had approximately $1.383 billion committed for capital projects.
  • ASC 606 adoption had no cumulative financial-statement adjustment. The company was evaluating the effect of the lease standard, effective January 1, 2019. The interim financial statements received an independent accountant’s review, not an audit; the reviewer reported no material modifications needed for GAAP conformity.

Key facts for investors to verify

  • Progress and realized output from the Toquepala expansion, and the basis for the differing 885,000-ton forecast and “exceed one million ton” strategic-plan statement.
  • Whether the Buenavista leach-pad corrective program restores SX-EW copper production, and the resulting production and cost trends.
  • Commodity-price and by-product assumptions underlying earnings, cash-cost performance, and the stated price sensitivities.
  • Funding and timing of capital commitments, including the conditional Michiquillay payment, and the sustainability of elevated dividend distributions relative to capital spending and cash generation.
  • Developments in Tia Maria permitting and litigation, Peruvian soil remediation estimates, spill-related cases, and approval and funding of the proposed $50 million shareholder settlement.
  • Effects of the higher effective tax rate, foreign-currency movements, and adoption of the lease standard on future reported results and liquidity.