Southern Copper Corporation — Q2 2010 Form 10-Q
Reporting period: Three and six months ended June 30, 2010. The unaudited interim statements were reviewed by the independent accountant, not audited. Southern Copper operates mines and processing facilities in Peru and Mexico and is 80% owned by Grupo Mexico.
Financial performance and position
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Net sales | $1,173.2 million | $824.5 million | $2,392.6 million | $1,446.5 million |
| Operating income | $540.4 million | $303.2 million | $1,149.2 million | $447.3 million |
| Net income attributable to SCC | $313.4 million | $175.0 million | $696.6 million | $253.7 million |
| EPS, basic and diluted | $0.37 | $0.21 | $0.82 | $0.30 |
| Operating margin | 46.1% | 36.8% | 48.0% | 30.9% |
Revenue rose 42.3% in Q2 and 65.4% for the half, chiefly reflecting higher metal prices and increased molybdenum sales, partly offset by lower sales volumes of copper, silver and zinc. Average LME copper prices were $3.19/lb in Q2 and $3.23/lb for the half, versus $2.12 and $1.84, respectively. SCC reported net income growth of 79.1% in Q2 and 174.6% for the half.
- Production and cost: Q2 mined copper was 250.3 million lb, down 4.8%; copper sold was 255.8 million lb, down 5.6%. Molybdenum mined production rose 25.5% to a record 12.1 million lb. Management’s non-GAAP operating cash cost was $0.265/lb in Q2 and $0.064/lb for the half, including by-product credits; excluding those credits, the figures were $1.565/lb and $1.535/lb.
- Cash flow: First-half operating cash flow was $835.0 million, compared with cash use of $83.9 million a year earlier. Investing used $189.7 million, including $168.3 million of capital expenditures. Financing provided $725.5 million, including $1.5 billion of new debt; dividends paid were $748.0 million.
- Liquidity and debt: At June 30, cash and equivalents were $2.145 billion and short-term investments $50.1 million; current assets were $3.122 billion against current liabilities of $549.7 million. Long-term debt was $2.755 billion and current debt $10.0 million, versus total debt of $1.280 billion at year-end 2009. Debt to total capitalization increased to 48.7% from 24.7%.
- Margins and costs: Operating costs increased 21.4% in Q2 and 24.4% for the half. Management cited higher fuel and power, labor and repair costs, third-party metal purchases, and workers’ participation tied to higher pretax earnings. Interest expense also increased after the April debt issuance.
Material changes, outlook and management commentary
- On April 16, SCC issued $1.5 billion of senior unsecured notes: $400 million due 2020 at 5.375% and $1.1 billion due 2040 at 6.75%. Proceeds are for general corporate purposes, including capital spending. Ratings agencies assigned investment-grade ratings; Moody’s upgraded the senior unsecured rating to Baa2.
- SCC regained control of the Cananea mine on June 6 after nearly three years of stoppage. Repairs are estimated at $114 million; management’s target was to restore normal capacity by February 2011. The company said estimated fixed-asset losses, net of insurance recoveries, were not material.
- Management described commodity markets as volatile amid concerns about U.S. recovery, European debt and Chinese growth, but saw potential support from recovering U.S. industrial production, falling LME inventories and a possible 2011 copper-market deficit. Metal prices and production remain significant uncertainties.
- Capital plans include a previously described $2.8 billion 2010–2012 program and a Board-approved, post-quarter five-year Sonora program of approximately $3.8 billion. The latter includes a Cananea expansion targeting 450,000 tons of annual copper capacity, plus a smelter, refinery, power plant and Pilares development. These are plans and estimates, not assured outcomes.
- For Tia Maria in Peru, management expected approval to begin construction in Q4 2010 and anticipated production in 2012, subject to environmental review and resolution of local water-supply concerns. Social unrest had prevented a scheduled public hearing.
- On July 22, the Board authorized a 37-cent quarterly dividend, payable August 25. Also on July 22, parent affiliate AMC made a non-binding proposal for an all-stock combination in which SCC public shareholders would receive AMC shares. SCC said an independent-director special committee would evaluate the proposal.
- Other notable items: SCC recovered $7.7 million from Asarco on a previously written-off receivable, recorded across cost of sales, other income and interest income. No derivatives were held in the first half of 2010. The company recorded a $59.2 million asset retirement obligation, including $7.9 million from estimate changes in the first half.
Risks and contingencies
- Metal-price volatility is a major earnings risk; management estimated that a $0.01/lb copper-price change would affect annual SCC net income by about $5.8 million, assuming production, sales and tax rates remain as estimated. Foreign-exchange exposure, energy and input costs, ore grades, and operating interruptions also matter.
- Labor disruption remains a risk: San Martin and Taxco mines had been on strike since July 2007. Peruvian union agreements for the majority unions expired in February 2010 and were under negotiation.
- Peruvian former employees’ labor-share litigation seeks shares and dividends. SCC made no provision, citing defenses and inability to reasonably estimate the exposure. Other disclosed matters include a U.S. lawsuit relating to the 2006 Pasta de Conchos accident, a Delaware shareholder derivative action, and an Excomet acquisition suit; SCC disputed the claims.
- The San Luis Potosi smelter was closed in March 2010; remediation costs could not be reasonably estimated. The company also cautioned that stricter environmental rules or community opposition could affect projects. Management reported material compliance with applicable environmental requirements, while acknowledging future regulatory risks.
- Related-party activity includes purchases from Grupo Mexico affiliates and other connected entities. SCC subsidiaries also guaranteed MexTransport loans; the remaining guaranteed balance was $4.8 million at June 30, with SCC exposed if the borrower defaults.
Important facts for investors to verify
- Whether copper and by-product prices, production volumes and by-product credits sustain the reported earnings and unusually low cash costs.
- Cananea’s repair spending, insurance recovery, restart timing and progress toward the stated production targets.
- Funding, timing, permitting and expected returns for the large Sonora and Peru capital projects, particularly Tia Maria and the Cananea expansion.
- The terms, independent review and potential consequences of AMC’s non-binding combination proposal for SCC’s public shareholders.
- Debt service, future dividend levels, and the company’s ability to fund capital plans while maintaining liquidity.
- Developments in labor, environmental and legal contingencies, including the unprovided Peruvian labor-share claims and unestimated San Luis Potosi remediation.