SOUTHERN COPPER CORP quarterly report, Q3 FY2017

Southern Copper Corporation — Q3 2017 Form 10-Q

Business and period: Integrated copper and other metals producer operating in Peru and Mexico, with exploration in Latin America. This unaudited report covers the three and nine months ended September 30, 2017; comparisons are with 2016. Grupo Mexico indirectly owned 88.9% of the company.

Financial and operating performance

Metric	Q3 2017	Q3 2016	Nine months 2017	Nine months 2016
Net sales	$1,676.5m	$1,400.7m	$4,790.2m	$3,980.8m
Operating income	$692.6m	$362.4m	$1,788.9m	$1,093.7m
Net income attributable to SCC	$401.8m	$197.6m	$1,016.0m	$604.6m
EPS, basic and diluted	$0.52	$0.26	$1.31	$0.78
Operating cash flow	$436.1m	$307.1m	$1,280.0m	$635.9m

• Q3 revenue rose 19.7% and SCC-attributable net income rose 103.3%; nine-month revenue rose 20.3% and attributable net income rose 68.0%. Higher metal prices were the main driver. Q3 LME copper averaged $2.88/lb, up 32.7%; the nine-month average was $2.70/lb, up 26.2%.
• Operating margins, calculated from reported figures, were approximately 41.3% in Q3 and 37.3% for the nine months, versus 25.9% and 27.5%, respectively, in 2016. Attributable net margin was approximately 24.0% in Q3 and 21.2% for the nine months.
• Nine-month operating costs and expenses increased 4.0% to $3,001.3m. Cost increases included fuel, workers’ participation, foreign-currency effects and depreciation; lower exploration costs and a $10.2m environmental-remediation provision reversal partly offset them.
• Nine-month copper production fell 3.2% to 1,435.1m pounds, while copper sales rose 0.6% to 1,468.8m pounds. Lower output at Cuajone and Mexican mines was partly offset by Toquepala. Silver production increased 0.4%; molybdenum and zinc production fell 2.4% and 3.7%.
• Management’s non-GAAP cash cost per pound, net of by-product revenues, was $0.90 in Q3 versus $0.92, and $0.93 for nine months versus $0.94. Before by-product credits, the nine-month measure increased to $1.49 from $1.43.

Financial position and cash flows

• At September 30, cash and cash equivalents were $798.5m, short-term investments $30.5m, and current assets $2,952.4m versus current liabilities of $979.8m. Long-term debt was $5,956.3m; total assets were $13,982.4m and total equity $6,630.1m. Cash plus short-term investments less long-term debt was approximately negative $5,127m.
• Nine-month operating cash flow was $1,280.0m. Investing used $688.6m, including $710.4m of capital investments; financing used $262.7m, principally $262.8m of dividends. Cash increased $252.5m from year-end 2016.
• Capital investments were 15.5% lower than in the prior-year period. The company reported approximately $775.8m of commitments for capital projects as of September 30.
• The nine-month effective tax rate rose to 35.7% from 34.1%; management attributed the increase primarily to expected dividends from Mexican subsidiaries. Interest expense was $285.1m for nine months, versus $270.9m.

Changes, outlook and material matters

• Management reduced its 2017 copper production forecast from 900,000 to 885,000 tons. It expects 980,000 tons in 2018 as the Toquepala concentrator expansion comes on line; it also described a longer-term plan to exceed one million tons by mid-2018 and reach 1.5 million tons by 2023.
• Management expects 2017 production of 16.1m ounces of silver, 75,400 tons of zinc and 21,200 tons of molybdenum. It cited stronger copper demand and possible market supply constraints, but these are expectations, not guarantees.
• The $1.2bn Toquepala expansion was 80% complete, with $743.5m invested, and was expected to finish in Q2 2018. Tia Maria, a proposed $1.4bn project, remained on hold awaiting a construction permit; management expected the permit in Q1 2018. The project had received environmental approval and $350.3m had been invested.
• Key exposures include volatile copper and by-product prices, operating costs, ore grades and recoveries, exchange rates, permits, labor, environmental obligations and political or legal risks. Management’s price sensitivities for the remaining three months of 2017 estimate a $29.4m change in SCC net income for a $0.10/lb copper-price change, assuming production and sales targets are achieved and other stated assumptions hold.
• Environmental soil studies in Peru may identify remediation obligations; the company said a potential loss was reasonably possible but could not estimate an amount or range, with studies expected to progress substantially by Q1 2020. Following the 2014 Sonora River spill, the remediation trust was closed and authorities declared remediation actions complete, but related collective, civil and constitutional lawsuits remained pending; the company said their damages could not be determined and considered them not material.
• Other contingencies include Tia Maria-related litigation, a dispute over the Pasto Grande tailings-dam area, a shareholder derivative suit concerning MGE transactions, and long-running strikes at the San Martin and Taxco mines in Mexico. Management reported no material change in risk factors during the quarter.
• The Board authorized a $0.25/share dividend on October 19, 2017, payable November 22 to shareholders of record November 8. The company reported no material changes in contractual obligations. Its interim financial statements received an independent accountant’s review, not an audit; the reviewer reported no material modifications needed.

Important facts for investors to verify

1. Reconcile the MD&A results table, which labels $402.8m as “net income attributable to SCC” for Q3 2017, with the financial statements’ $401.8m attributable amount. The financial statements report $402.8m as total net income before non-controlling interest.
2. Track copper prices, production and sales volumes, unit costs, and whether the revised 2017 and projected 2018 production targets are achieved.
3. Monitor Toquepala completion and costs, Tia Maria permitting and community issues, and the funding required for committed capital projects and dividends.
4. Assess the outcome and potential exposure from pending environmental, land, labor and shareholder litigation, including the unquantified Peruvian soil-remediation contingency.
5. Review debt maturities and market value: the filing reports long-term debt carrying value of $5,956.3m and estimated fair value of $6,970.8m at September 30, 2017.