Southern Copper Corporation — Q3 2011 Form 10-Q
Business context and period: Copper producer with principal operations in Peru and Mexico; also produces molybdenum, silver, zinc and other metals. This unaudited quarterly filing covers the three and nine months ended September 30, 2011, compared with the same periods in 2010. Amounts below are U.S. dollars unless stated otherwise. The interim financial statements received an independent accountant’s review, not an audit.
Financial and operating performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net sales | $1.746 billion | $1.258 billion | $5.149 billion | $3.651 billion |
| Operating income | $962 million | $603 million | $2.724 billion | $1.752 billion |
| Operating margin | 55.1% | 47.9% | 52.9% | 48.0% |
| Net income attributable to SCC | $663 million | $365 million | $1.799 billion | $1.062 billion |
| EPS, basic and diluted | $0.79 | $0.43 | $2.12 | $1.25 |
| Operating cash flow | $868 million | $534 million | $1.586 billion | $1.369 billion |
- Growth drivers and costs: Q3 sales rose 38.8% and nine-month sales rose 41.1%. Management attributed higher earnings primarily to higher metal prices and restored production at Buenavista. Nine-month LME copper averaged $4.20/lb, up 29.2%; silver averaged $36.30/oz, up 100.8%. Higher production, energy, labor, materials and third-party concentrate costs partly offset revenue gains.
- Production: Q3 mined copper production increased 24.4% to 343.2 million lb; nine-month production was 939.4 million lb versus 767.1 million. Buenavista contributed 99.0 million lb in Q3 and was operating at full capacity. Nine-month molybdenum production decreased to 29.9 million lb from 33.7 million, zinc to 138.7 million lb from 169.2 million, while silver production was approximately unchanged at 9.4 million oz.
- Cash costs: Management’s non-GAAP operating cash cost was $0.484/lb for Q3 and $0.374/lb for the first nine months, compared with $0.308/lb and $0.152/lb, respectively, in 2010. Excluding by-product credits, the corresponding costs were $1.651/lb and $1.664/lb. These non-GAAP measures are company-defined and may not be comparable across issuers.
- Balance sheet and liquidity: September 30 cash and cash equivalents were $1.243 billion, with short-term investments of $536 million, together $1.779 billion versus $2.269 billion at year-end 2010. Current assets were $3.331 billion and current liabilities $796 million. Total debt was approximately $2.751 billion, with no significant near-term maturities stated. Cash plus short-term investments less debt was approximately negative $972 million.
- Capital allocation and investment: Nine-month capital expenditures were $337 million, compared with $281 million. The company paid $1.492 billion in dividends and spent $258 million repurchasing shares during the nine months. The board increased the repurchase authorization to $1.0 billion; cumulative program purchases were $715 million through September 30. A $0.70/share dividend was declared after quarter-end.
Material changes versus prior period
- Q3 net income attributable to SCC increased 81.5%; nine-month net income increased 69.5%. Restored Buenavista output materially increased Mexican open-pit sales and operating income; Peruvian operations had lower copper sales volumes and lower operating income.
- Operating cash flow increased $217 million for the nine months, but working-capital movements used $327 million of cash, a $450 million adverse swing versus the prior-year period.
- Cash declined by $950 million from year-end 2010. Financing used $1.764 billion, chiefly due to dividends and share repurchases; investing used $811 million, including $460 million net purchases of short-term investments.
- The effective tax rate for the first nine months fell to 30.5% from 34.3%, reflecting U.S. tax-return adjustments and a greater contribution from Mexican operations.
Outlook, risks and notable items
- Production and spending guidance: Management maintained 2011 copper production guidance of 630,000 tonnes, including 7% third-party copper, and molybdenum guidance of 17,500 tonnes. It expected 2012 copper production of 640,000 tonnes, including approximately 5% third-party copper. 2011 zinc and silver production estimates were 88,000 tonnes and 12.6 million oz. Estimated 2011 capital expenditures were approximately $600 million.
- Projects: Buenavista’s $3.7 billion expansion is planned in phases, with added annual copper capacity of 88,000 tonnes in 2013 and 188,000 tonnes in 2015. Tia Maria’s environmental approval process was halted in April 2011 amid protests; $434.3 million had been spent by quarter-end. Management said any impairment, if required, would not be material, but restart and approval remain uncertain. Toquepala expansion approval also faced local opposition and a public hearing was declared invalid; $142.4 million had been invested.
- Commodity and market exposure: Management cited global economic and European debt uncertainty, volatile metal prices, and possible supply constraints. Copper prices fell late in Q3; the company recorded a $77.6 million negative provisional-price adjustment for the quarter. Management expected copper market support from tight supply, while describing molybdenum as in surplus and anticipating a possible demand rebound in 2012. These are management expectations, not guarantees.
- Hedges and pricing: Copper swaps and collars covered portions of Q4 2011 and Q1 2012 sales. Nine-month realized hedge losses were $23.7 million, while Q3 realized gains were $20.7 million. Outstanding provisional sales remain subject to final metal pricing; management said final pricing was not expected to materially affect results.
- Taxes, labor and contingencies: Peru enacted a revised operating-margin-based mining royalty and a new special mining tax in September 2011. San Martin and Taxco mines remained on strike; Buenavista had returned to full operation. A large Peruvian former-employee labor-share lawsuit and related claims remain unresolved; the company recorded no provision because it believes it has defenses and cannot reasonably estimate the contingency. The Tia Maria project and other operations also face environmental, permitting, community and litigation risks.
- Legal and corporate developments: On October 14, 2011, a Delaware court found that SCC paid too much stock consideration in the 2005 Minera Mexico merger; AMC indicated it would appeal. On October 28, AMC withdrew its proposed combination with SCC. SCC also disclosed a remaining $2.6 million guarantee exposure relating to an affiliate’s loan.
- Management identified commodity prices, fuel and electricity costs, ore grades, water and geological conditions, permits, labor relations, environmental matters and foreign-country political and economic risks as factors that could cause actual results to differ from forward-looking statements.
Important facts for investors to verify
- Whether Buenavista’s restored production and expansion milestones proceed as planned, and whether 2011–2012 production guidance is achieved.
- Permitting, community engagement and potential impairment or delay risks for Tia Maria and the Toquepala expansion.
- Metal-price, provisional-pricing and hedge exposure, including the sensitivity estimates: annual net income changes of about $7.3 million per $0.01/lb copper move, $23 million per $1/lb molybdenum move, $1.2 million per $0.01/lb zinc move and $8 million per $1/oz silver move, assuming stated conditions.
- Progress and potential financial exposure in the labor-share litigation, the Delaware merger judgment and ongoing Mexican labor disputes.
- Liquidity and capital-allocation priorities given reduced cash, substantial dividends and repurchases, planned capital spending, and the company’s debt obligations.
- Effect of Peru’s new mining royalty and special mining tax on future operating costs and cash flows.