Southern Copper Corporation — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; compared with Q1 2018 unless otherwise noted. Southern Copper is an integrated copper and by-product producer operating principally in Peru and Mexico. Its majority indirect owner, Grupo Mexico, held 88.9% of its capital stock. Financial statements are unaudited; the independent accountant performed a review, not an audit.
Financial and operating performance
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Net sales | $1,753.4 million | $1,841.1 million | (4.8%) |
| Operating income | $693.7 million | $773.3 million | (10.3%) |
| Net income attributable to SCC | $388.2 million | $470.7 million | (17.5%) |
| Diluted EPS | $0.50 | $0.61 | (18.0%) |
| Operating margin | 39.6% | 42.0% | Down 2.4 percentage points |
| Net cash from operating activities | $371.3 million | $649.8 million | (42.9%) |
| Capital investments | $173.1 million | $295.7 million | (41.5%) |
| Common dividends paid | $309.2 million | $231.9 million | $0.40 vs. $0.30 per share |
Cash from operations less capital investments was $198.2 million, versus $354.1 million in Q1 2018. The cash-flow decline chiefly reflected lower earnings and a $243.2 million use of cash from changes in operating assets and liabilities, including lower accounts payable and accrued liabilities and higher receivables. Cash and cash equivalents ended the quarter at $737.0 million; short-term investments were $213.5 million.
At March 31, 2019, current assets were $3,182.4 million and current liabilities $1,123.4 million. Long-term debt was $5,960.9 million. The company also reported $1,092.5 million of lease liabilities, including $65.8 million current. The lease balances followed adoption of ASC 842 on January 1; management said adoption materially increased reported assets and liabilities but did not materially affect earnings or cash flows.
Copper accounted for 80.7% of sales. Copper sales volume rose 6.9% to 501.4 million pounds and mine production increased 11.6% to 504.0 million pounds, helped by the Toquepala concentrator ramp-up. LME copper averaged $2.82 per pound, down 10.8%; average zinc, silver, and molybdenum prices also declined. Net sales fell despite higher copper sales volume. Operating expenses decreased 0.8%, but depreciation, amortization and depletion increased to $181.6 million from $162.0 million. The effective tax rate rose to 38.1% from 33.6%.
Performance varied by segment: Mexican open-pit operating income was nearly flat at $550.8 million; Peruvian operating income fell 23.6% to $144.7 million; and IMMSA operating income declined 88.7% to $4.4 million.
Outlook, projects and management commentary
- Management expected 2019 copper production of 986,700 tons, up 11.7% from 2018, with higher silver, zinc and molybdenum production also forecast. It targeted copper production growth to 1.5 million tons by 2025 through a developing organic growth plan.
- Management expected the Toquepala expansion to reach full production in Q2 2019. It expected copper production to benefit from the new concentrator and forecast a recovery in copper prices, 2.5% refined-copper demand growth in 2019 and a slight market deficit. These are forward-looking expectations, not guarantees.
- The company expected to receive the Tia Maria construction license in the first half of 2019, but noted there was no assurance. The approximately $1.4 billion project had $333.3 million invested at quarter-end; construction remained subject to permit delays and community opposition.
- San Martin mine rehabilitation had a $87 million budget, with $34.9 million spent through March 31. The company expected to restore copper production in Q2 2019. Taxco remained suspended pending labor resolution.
- The company reported $177.7 million of commitments for capital investment projects and said it expected to fund investments from cash on hand, internally generated funds and, if needed, external financing. It reported no material change in contractual obligations.
Risks, contingencies and unusual items
- Commodity prices are a major earnings risk. Management estimated that, for the remaining nine months of 2019, a $0.10-per-pound copper price change would change net income by approximately $97.2 million, assuming stated production, sales and tax assumptions and excluding hedging effects.
- Environmental soil studies and remediation plans for Peruvian operating sites were in progress. The company said a potential loss was reasonably possible but could not estimate an amount or meaningful range; estimates were expected to become possible after studies substantially progressed, anticipated in 2020. The asset-retirement obligation increased by $28.1 million in Q1, mainly from revised estimates.
- Litigation includes pending Tia Maria-related cases and claims related to the 2014 Buenavista spill. The company said it could not estimate certain contingencies and considered the spill-related proceedings not likely to materially affect its financial position or results. In April 2019, a new derivative suit was filed concerning contracts with Grupo Mexico affiliates; it had not yet been served as of the filing and the company said it believed it had a meritorious defense.
- The Delaware derivative-action settlement was approved in December 2018. Grupo Mexico or AMC funded a $36.5 million special dividend to eligible public shareholders and $13.5 million in legal fees; these amounts were not a company-funded distribution. Separately, the company paid its $309.2 million regular Q1 dividend. On April 11, the board authorized another $0.40-per-share dividend payable in May.
- Related-party dealings include purchases, services and power arrangements with Grupo Mexico affiliates; the company stated its Audit Committee reviews related-party transactions. Investors should consider the controlling shareholder’s 88.9% ownership alongside these relationships.
- The filing identifies exposure to metal prices, foreign-exchange movements, weather and operating conditions, ore grades, permitting, labor, litigation and environmental requirements. Management reported disclosure controls effective at quarter-end and no material change in internal controls other than lease-accounting implementation.
Most important facts to verify
- Whether Toquepala reached full production as expected and whether 2019 production guidance was achieved.
- How copper and by-product prices, sales volumes and the company’s cash costs developed after Q1.
- Whether operating cash flow can support dividends and capital spending, given Q1 working-capital outflows and substantial debt and lease obligations.
- Progress on Tia Maria permits and community matters, and the eventual cost and outcome of environmental remediation and litigation contingencies.
- Whether the San Martin restart and other project timelines and budgets remained on track.