SOUTHERN COPPER CORP annual report, FY2012

Business context and reporting period

Southern Copper Corporation (SCC) filed this Form 10-K for the fiscal year ended December 31, 2012; it is an annual report, not a standalone quarterly filing. SCC is an integrated copper producer operating mines, smelters and refineries in Peru and Mexico, with copper as its principal product and molybdenum, silver, zinc and other by-products. It reports three segments: Peru, Mexican open-pit operations and Mexican underground operations (IMMSA). Grupo Mexico indirectly owned 81.3% of SCC at year-end.

Financial and operating results

Gross margin was 53.6% (55.3% in 2011); operating margin was 46.6% (53.2%); net margin was 29.0% (34.3%). The current-assets-to-current-liabilities ratio was 5.00. Net debt was $1.754 billion and net debt to net capitalization was 26.8%; debt to total capitalization was 46.8%.

Annual mined copper rose 8.5% to 1.406 billion pounds, while copper sales increased to 1.415 billion pounds. Mined zinc and silver also increased; molybdenum production declined slightly. Average copper prices fell about 10% year over year, and average molybdenum, zinc and silver prices fell about 18%, 11% and 11%, respectively. SCC’s reported operating cash cost was $0.713 per pound after by-product credits, versus $0.517 in 2011; before those credits, it was $1.796 versus $1.759. This is a company-defined non-GAAP measure.

For Q4 2012, sales were $1.651 billion, operating income $813 million, net income $533 million and net income attributable to SCC $532 million. Q4 2011 comparatives were $1.669 billion, $902 million, $539 million and $537 million, respectively.

Material changes and unusual items

• Sales declined 2.2% year over year as lower metal prices more than offset higher sales volumes. SCC attributed the 17.2% fall in attributable net income to lower prices and a one-time $316.2 million legal-fee expense.
• A Delaware court judgment resulted in SCC receiving $2.108 billion from majority shareholder AMC in October 2012, recorded as additional paid-in capital. SCC paid $316.2 million to plaintiff attorneys, recorded as operating expense. The court had found that SCC paid an excessive price in the 2005 Minera Mexico merger.
• SCC issued $1.5 billion of fixed-rate unsecured notes in November 2012: $300 million due 2022 at 3.5% and $1.2 billion due 2042 at 5.25%. Debt rose, but the increase in cash left net debt lower than in 2011.
• Capital spending rose 71.6%, principally for Buenavista expansion. Buenavista achieved record copper production; its Mexican open-pit segment operating income was flat year over year despite higher sales.
• The company paid $3.140 billion in cash dividends and repurchased $147 million of shares in 2012. Reported dividends per share were $4.06, including a $0.35 stock dividend; Q4 dividends per share were $2.75.

Outlook, commentary and risks

Management expected 2013 copper production of approximately 650,000 tonnes, including about 10,000 tonnes sourced from third parties; molybdenum production of approximately 19,800 tonnes; silver production and sales of 16.3 million ounces; and zinc production of 99,100 tonnes. SCC budgeted $1.8 billion of 2013 capital spending, with a stated goal of increasing copper production capacity from about 640,000 tonnes to 1.2 million tonnes by 2017. These are management estimates, not guarantees.

Key projects are subject to execution and approval risks. Buenavista’s multiyear expansion was underway, with major project start-ups scheduled for 2013–2015. Toquepala expansion approvals were delayed amid community concerns; SCC agreed in February 2013 to fund approximately $98 million of Candarave community projects, contingent on project approval. Tia Maria remained suspended after protests and was rescheduled for a 2016 start, subject to approvals and a new environmental impact study. Management’s expectations for copper demand and prices were cautiously positive, citing anticipated demand growth, particularly in China, while acknowledging macroeconomic uncertainty.

Other material risks include volatile metal prices, energy costs, foreign exchange and inflation, water availability, environmental regulation, mine-slope stability, reserve estimation, and community or permitting delays. Taxco and San Martin mines in Mexico remained suspended due to strikes dating from 2007; labor disputes and legal proceedings continued. SCC reported no production from either mine in 2012. Peruvian former-worker labor-share lawsuits were not accrued because management asserted defenses and said the exposure could not be reasonably estimated. SCC also disclosed a lawsuit concerning the Quebrada Honda tailings dam and other pending concession-related litigation in Peru. In 2012 SCC recognized a $25.1 million Mexican asset-retirement obligation despite no specific enacted closure requirement, citing a constructive obligation. The filing reports three employee and three contractor fatalities across Mexico and Peru in 2012.

Management said cash on hand and internally generated funds were expected to meet near-term cash needs, with external financing available if required. The filing reports audited financial statements with an unqualified opinion and effective internal control over financial reporting.

Most important facts for investors to verify

• Whether lower metal prices, costs and the $316.2 million legal-fee charge explain the earnings decline, and how much of the fee is nonrecurring.
• Whether the $2.108 billion judgment receipt, dividend outflow and 2012 cash balance are correctly understood as distinct equity, financing and liquidity items.
• Progress, spending, timing and required approvals for Buenavista, Toquepala and Tia Maria; confirm the assumptions underlying the 2017 capacity target.
• Current status and potential financial impact of the San Martin and Taxco strikes, Peruvian labor-share claims, and the Quebrada Honda and Tia Maria-related proceedings.
• Debt maturities, covenant compliance, related-party exposures and the sustainability of dividends alongside the capital program.
• Reconcile annual and Q4 dividend disclosures, including the large Q4 per-share amount, and confirm which distributions were cash versus stock.