Business Context and Reporting Period
Company: Southern Copper Corporation (SCC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2008
Business Overview: SCC is primarily engaged in the production and sale of copper, along with by-products including molybdenum, zinc, silver, lead, and gold. Operations are divided into three segments: Peruvian open-pit operations, Mexican open-pit operations, and Mexican underground operations (IMMSA unit). The company operates in a volatile global economic environment, facing significant labor disputes and declining metal prices in late 2008.
Key Financial Metrics
| Metric (in millions, except per share) | 3 Months Ended Sep 30, 2008 | 9 Months Ended Sep 30, 2008 |
|---|---|---|
| Net Sales | $1,440.1 | $4,401.1 |
| Operating Income | $675.9 | $2,333.1 |
| Net Earnings | $417.8 | $1,531.3 |
| Earnings Per Share (Basic & Diluted) | $0.47 | $1.73 |
| Operating Cash Flow | $696.9 | $1,606.9 |
| Cash and Cash Equivalents | $1,175.6 | $1,175.6 |
| Total Debt (Current + Long-term) | $1,294.9 | $1,294.9 |
| Capital Expenditures | $134.2 | $314.9 |
Margins: Operating margin for the nine months ended September 30, 2008, was approximately 53.0%. The effective tax rate for the nine-month period was 33.2%.
Material Changes vs. Prior Period
- Revenue Decline: Net sales decreased 10.4% in Q3 2008 and 8.1% in the first nine months of 2008 compared to 2007. This was driven by lower copper and zinc prices and reduced sales volumes due to strikes.
- Profitability Drop: Net earnings fell 33.5% in Q3 and 19.6% in the nine-month period year-over-year. The decline is attributed to the Cananea mine strike, lower production volumes, and falling metal prices, partially offset by higher molybdenum prices and volumes.
- Production Volumes: Mine copper production dropped 13.3% in Q3 2008 (261.6 million lbs vs. 301.7 million lbs in 2007). The decrease was primarily due to the Cananea strike (28.0 million lbs) and lower ore grades at Toquepala. Conversely, molybdenum production increased 3.5% in Q3.
- Cost Increases: Operating costs rose due to higher fuel and power costs (up 63.5% unit cost in Peru) and severance payments related to labor disputes. However, workers' participation costs decreased due to lower pre-tax earnings from strikes.
- Derivative Gains: The company recorded significant gains from copper derivative instruments ($54.2 million in Q3 and $62.9 million in the nine months), which helped offset lower metal prices.
Guidance, Outlook, Risks, and Unusual Items
Management Commentary and Outlook
Management emphasizes a strong cash position (over $1.1 billion) and low debt levels as key strengths to navigate the global economic downturn. The company expects to continue capital investment projects, including the Tia Maria greenfield project and expansions at Toquepala and Cuajone, which are projected to add 220,000 tons of annual copper production by 2011.
Risks and Contingencies
- Labor Disputes: The Cananea mine strike (ongoing since July 2007) and strikes at Taxco and San Martin mines significantly impact production. The company has offered severance packages to resolve the Cananea dispute, with a recorded liability of $48.4 million.
- Market Volatility: Copper prices dropped sharply from $3.98/lb in June 2008 to $1.81/lb by October 31, 2008. The company notes that further declines could adversely affect results.
- Legal Proceedings: Ongoing litigation includes "labor share" claims by former Peruvian employees (Garcia-Ataucuri case) and disputes regarding mining rights and environmental compliance. The company believes it has meritorious defenses but notes uncertainty in outcomes.
- Environmental Obligations: The company is in the process of finalizing a mine closure plan for Peruvian operations, with an estimated asset retirement obligation of $14.5 million.
Unusual Items
- Share Repurchases: In Q3 2008, the company repurchased 3.3 million shares for $68.5 million. In October 2008, the board increased the repurchase program authorization to $500 million.
- Stock Split: A three-for-one stock split was executed on July 10, 2008.
- Subsequent Events: As of October 31, 2008, provisional sales valuations declined by approximately $137.6 million due to falling copper prices, though copper derivative contracts appreciated by $60.1 million.
Investor Verification Checklist
- Strike Resolution: Verify the status of the Cananea, Taxco, and San Martin labor disputes and the timeline for production resumption.
- Price Sensitivity: Assess the impact of continued copper price volatility on future earnings, given the company's high exposure to LME prices.
- Derivative Exposure: Review the details of open copper collar contracts and exchange rate derivatives to understand potential future gains or losses.
- Capital Project Progress: Monitor the execution and cost management of the Tia Maria and Toquepala expansion projects amidst economic uncertainty.
- Legal Liabilities: Track developments in the Peruvian "labor share" litigation and the U.S. IRS tax examination for years 2005-2006.