Southern Copper Corporation: Q2 2006 10-Q Summary
Business Context and Reporting Period
This Form 10-Q covers the three and six months ended June 30, 2006. Southern Copper Corporation (SCC) operates primarily in the mining and production of copper, with significant by-product sales of molybdenum, zinc, silver, and gold. Operations are segmented into Peruvian open-pit mines, Mexican open-pit mines, and Mexican underground operations (IMMSA unit). The company is a large accelerated filer with 147.2 million shares of common stock outstanding as of the period end.
Key Financial Metrics
| Metric (in millions, except per share) | 3 Months Ended June 30, 2006 | 6 Months Ended June 30, 2006 |
|---|---|---|
| Total Net Sales | $1,276.7 | $2,398.0 |
| Operating Income | $649.0 | $1,281.7 |
| Net Earnings | $439.3 | $860.9 |
| Earnings Per Share (Basic & Diluted) | $2.98 | $5.85 |
| Operating Cash Flow | $132.8 | $570.5 |
| Cash and Cash Equivalents | $801.0 (Balance Sheet) | $801.0 (Balance Sheet) |
| Long-Term Debt | $1,529.9 | $1,529.9 |
| Capital Expenditures | $87.6 | $230.7 |
Margins: Operating margin for the six months ended June 30, 2006, was approximately 53.4%. The effective tax rate for the six-month period was 32.0%.
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 33.7% for the quarter and 26.7% for the six-month period compared to 2005. This was driven primarily by significantly higher copper, zinc, and silver prices, partially offset by lower molybdenum prices and volumes.
- Production Decline: Mine copper production decreased 26.4% in Q2 2006 (273.9 million lbs) compared to Q2 2005. This was due to illegal work stoppages at the La Caridad and Cananea mines in Mexico and the San Martin mine. Peruvian production increased 14.7 million lbs due to higher ore grades.
- Derivative Losses: The company recorded a loss of $257.9 million on copper derivative instruments in both Q2 and the first six months of 2006, which is now included in net sales (previously non-operating). This significantly impacted reported sales figures.
- Cost Increases: Cost of sales increased due to the purchase of copper concentrates to offset production losses from strikes, a new accounting policy charging all mine stripping costs to production (previously capitalized), and higher workers' participation payments.
- Debt Issuance: In May 2006, the company issued an additional $400 million of 7.5% notes due 2035, increasing long-term debt to fund expansion programs.
Outlook, Risks, and Contingencies
- Labor Disputes: Significant risk remains from labor unrest in Mexico. Illegal work stoppages at La Caridad, Cananea, and San Martin caused production losses and forced the declaration of "force majeure" on certain contracts. The La Caridad mine was closed in June and returned to the company in late July 2006 after workers were fired.
- Political Risk: The filing highlights risks associated with the 2006 presidential elections in both Peru (Alan Garcia elected) and Mexico (Felipe Calderon elected by a slim margin with challenges filed), which could impact market conditions and operations.
- Environmental & Regulatory: The company is subject to a new Peruvian royalty charge (1-3% of sales) and is in the process of finalizing a mine closure plan required by Peruvian law. The Ilo smelter modernization project ($500 million estimated cost) is 91.5% complete and expected to finish by January 2007 to meet environmental compliance (PAMA).
- Litigation: Ongoing litigation includes claims by former Peruvian employees regarding "labor shares" and a shareholder derivative suit regarding the acquisition of Minera Mexico. The company believes these claims are meritless.
- Capital Projects: Future investments include the Los Chancas and Tia Maria projects in Peru, estimated at $800 million to $1 billion, with production expected to begin in 2009 and 2011.
Investor Verification Checklist
- Strike Resolution: Verify the operational status and production ramp-up at the La Caridad and Cananea mines following the resolution of illegal work stoppages in July 2006.
- Derivative Exposure: Review the specific terms and settlement dates of the copper swap contracts (296.8 million lbs hedged for July-November 2006) to understand future earnings volatility.
- Peruvian Royalty: Monitor the outcome of the company's protest regarding the application of the new Peruvian royalty charge to SX/EW production, which could impact future tax liabilities.
- Capital Expenditure Progress: Track the completion of the Ilo smelter modernization project and the budget adherence for the $600 million expansion program.
- By-Product Pricing: Assess the impact of fluctuating molybdenum prices on the "operating cash cost" metric, as by-product credits significantly offset production costs.