SOUTHERN COPPER CORP quarterly report, Q3 FY2015

Southern Copper Corporation — Q3 2015 Form 10-Q

Business and period: Integrated copper and other metals producer operating mines, smelters and refineries in Peru and Mexico. Grupo Mexico indirectly owned 87.4% at September 30, 2015. This unaudited filing covers the three and nine months ended September 30, 2015; comparisons are with the corresponding 2014 periods. Amounts below are U.S. dollars unless stated otherwise.

Financial performance

Metric	Q3 2015	Q3 2014	Nine months 2015	Nine months 2014
Net sales	$1,133.6 million	$1,474.6 million	$3,791.3 million	$4,316.4 million
Operating income	$286.9 million	$547.1 million	$1,227.0 million	$1,707.3 million
Net income attributable to SCC	$98.4 million	$324.3 million	$675.6 million	$985.0 million
EPS, basic and diluted	$0.12	$0.39	$0.85	$1.18
Net cash from operating activities	$261.9 million	$434.6 million	$817.1 million	$1,116.4 million

Sales fell 23.1% in Q3 and 12.2% year to date; SCC-attributable net income declined 69.7% and 31.4%, respectively. Lower metal prices were the principal cause. Copper sales volumes rose 5.5% in Q3 and 11.0% year to date, partly offsetting price declines. Q3 operating margin was approximately 25.3% versus 37.1%; nine-month operating margin was 32.4% versus 39.6%.

Average Q3 copper prices fell about 24%–25% year over year; molybdenum fell 54.4%, silver 24.2%, and zinc 20.0%. Nine-month average prices also declined: copper about 18%, molybdenum 40.0%, silver 19.6%, and zinc 4.1%.
Operating costs and expenses decreased 8.7% in Q3 and 1.7% year to date. Lower fuel and other production costs, reduced exploration expense, and lower Buenavista spill-related remediation expense contributed; higher depreciation and depletion partly offset the savings.
Non-GAAP operating cash cost per copper pound, excluding by-product credits, was $1.58 in Q3 and $1.64 year to date, down 18.1% and 14.6%. Including by-product credits, it was $1.07 in Q3 (down 4.5%) and $1.06 year to date (up 1.9%), as lower by-product prices reduced credits.

Cash, liquidity and debt

At September 30, cash and cash equivalents were $504.5 million and short-term investments were $882.1 million, compared with $364.0 million and $338.6 million at December 31, 2014. Current assets were $3,010.9 million and current liabilities $865.5 million.
Long-term debt was $5,950.9 million, up from $3,980.9 million at year-end; there was no current portion reported at September 30. The company issued approximately $2.0 billion of unsecured notes in April 2015, including notes due 2025 and 2045, and repaid $200 million of notes due in July. Q3 interest expense increased $24.7 million year over year, principally due to the bond issuance.
Nine-month investing cash outflow was $1,486.7 million, including $845.9 million of capital investments, $100.4 million for the El Pilar acquisition, and net purchases of $543.6 million of short-term investments. Financing provided $803.7 million, including debt issuance, offset by dividends and share repurchases. Cash increased $140.5 million from year-end to $504.5 million.
Capital investment, including the El Pilar acquisition, was reported as $946.4 million for the first nine months, 14.6% below 2014. SCC paid $0.30 per share in dividends year to date and announced a subsequent $0.04-per-share quarterly dividend for November 2015.

Operations, outlook and management commentary

Nine-month copper mine production rose 8.8% to 1,183.0 million pounds, driven primarily by Buenavista’s new SX-EW III plant and higher output at Toquepala and La Caridad. Zinc production declined 10.2%; molybdenum was nearly flat and silver rose 1.4%.
Management’s 2015 production estimates were 757,300 tonnes of copper, 23,100 tonnes of molybdenum, 13.0 million ounces of silver and 64,400 tonnes of zinc. Copper and molybdenum estimates were raised; zinc guidance was reduced due to temporary mine disruptions. These are forward-looking estimates, not guaranteed results.
Management cited weaker Chinese-demand concerns and commodity-price volatility, while expressing longer-term confidence in copper demand and anticipating a tighter copper supply market if announced production cuts and project delays persist. SCC said cost reductions, higher production, exchange-rate depreciation and lower fuel costs were supporting operations.
The Buenavista concentrator was ramping up, with full capacity expected by Q1 2016. The Toquepala expansion, budgeted at $1.2 billion, was expected to add annual capacity of 100,000 tonnes of copper and 3,100 tonnes of molybdenum, with completion targeted for Q4 2017. El Pilar was acquired for $100.4 million; the company forecast commercial operations by 2018, subject to a preliminary purchase-price allocation that remained unfinished.
Tia Maria’s environmental impact assessment was approved, but its construction permit remained delayed amid community opposition and dialogue efforts. The project budget is approximately $1.4 billion; SCC had invested $360.2 million through September 30. Management said any impairment, if required, was expected not to be material.

Risks, contingencies and unusual matters

Buenavista spill: The August 2014 spill of approximately 40,000 cubic meters of copper sulfate solution led to administrative proceedings, a criminal complaint and multiple civil and collective-action lawsuits. Two collective actions had been dismissed; other claims remained pending. BVC estimated a contingent liability of $114.8 million; $39.9 million had been paid from company funds and approximately $74.9 million was deposited in a trust and classified as restricted cash and operating expense. SCC said it considered the legal proceedings not likely to have a material effect, while continuing to defend them.
Other legal exposure: Peruvian former employees’ labor-share claims remain unresolved and management said the amount cannot reasonably be estimated; the company recorded no provision. In September 2015 a lower court seized 10.5 million investment shares owned by SCC and another company in connection with one case; SCC challenged the seizure. Tia Maria concession disputes and a Peruvian tailings-dam property lawsuit also remained pending.
Environmental uncertainty in Peru: Potential remediation costs under new soil standards could not yet be estimated; SCC said a meaningful range was not available pending further studies and regulatory action. The company also continued work toward meeting sulfur-dioxide air-quality requirements near Ilo.
Labor: San Martin and Taxco mines in Mexico remained suspended amid strikes and litigation. SCC reported a non-material impairment of assets at those mines. Peruvian collective bargaining negotiations began in Q3 2015.
Controls: Management concluded disclosure controls were not effective at September 30, 2015 because of a previously reported material weakness involving access controls and segregation of duties in the Mexican operations’ former ERP system. SAP and remediation controls had been implemented, but testing was ongoing; management targeted completion of remediation in 2015. Management nevertheless stated the interim financial statements fairly presented the company’s position and results. The independent accountant performed a review, not an audit.
Principal risks include volatile metal prices, foreign currency movements, operating and geological conditions, permits, water availability, labor relations, environmental obligations, litigation and political and economic risks in foreign operations. Provisional sales exposed the company to further pricing changes; reported October price movements were expected to reduce sales by $1.9 million on settlements and a further $5.4 million on later-settling open sales.

Important facts for investors to verify

Whether copper and by-product prices, sales volumes and production track management’s 2015 estimates, and the sensitivity of earnings to commodity prices.
Debt terms and interest burden following the April 2015 bond issue, alongside cash generation, capital spending and continued share repurchases.
Progress, costs and expected timing for Buenavista, Toquepala, El Pilar and Tia Maria, including Tia Maria permitting and community acceptance.
Updates to the Buenavista spill trust, remediation program, lawsuits and liability estimate, and developments in the Peruvian labor-share claims and seized shares.
Whether the Mexican ERP access-control material weakness is remediated and controls are demonstrated to operate effectively.