SCCO

Business Context and Reporting Period

Company: Southern Copper Corporation (SCC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 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 operations, Mexican open-pit operations, and Mexican underground operations (IMMSA). The company is a large accelerated filer.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 10.4% to $1,499.2 million, driven by higher metal prices (copper up 31.6%, molybdenum up 27.9%) and increased molybdenum sales volume, despite a significant drop in copper production.
• Production Decline: Mine copper production fell 25.3% to 281.9 million pounds. The decrease was primarily due to a strike at the Cananea mine in Mexico, which operated at approximately 27% capacity in Q1 2008 compared to full capacity in Q1 2007.
• Cost Increases: Operating costs rose to $634.5 million (from $571.0 million). Increases were attributed to higher production costs (power, fuel, materials), currency translation losses, and higher depreciation due to the modernized Ilo smelter.
• Derivative Gains: The company recorded a $2.9 million gain on derivative instruments in Q1 2008, compared to a $21.2 million loss in Q1 2007.
• Tax Rate Shift: The effective tax rate increased to 33.5% from 29.4%, largely due to a shift in earnings mix from Mexico to the higher-tax jurisdiction of Peru following the Cananea strike.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• Capital Expansion: SCC is executing a $2.1 billion investment program in Peru (Tia Maria, Toquepala, Cuajone, Ilo smelter/refinery) expected to increase copper production by 39% by 2011. Additionally, a $1.2 billion investment in the Los Chancas project is planned pending permits.
• Dividends: The Board approved a quarterly dividend of $1.70 per share ($500.6 million total) to be paid on June 3, 2008, an increase from the $1.40 per share paid in Q1 2008.
• Debt Repayment: On April 1, 2008, the company fully repaid its Series A Yankee bonds ($150 million).

Risks and Contingencies

• Labor Disputes: The Cananea mine strike resumed in April 2008 after a brief resumption of operations. The Board has offered severance packages to employees, and production is expected to remain suspended until resolved. Strikes at Taxco and San Martin mines also continue.
• Legal Proceedings: Ongoing litigation includes claims by former Peruvian employees regarding "labor shares" and disputes over mining rights and royalties in Mexico. The company believes these claims are without merit but notes potential financial exposure.
• Commodity Price Volatility: Earnings are highly sensitive to copper, molybdenum, and zinc prices. A $0.01 change in copper price impacts annual net earnings by approximately $6.6 million.

Investor Verification Checklist

• Cananea Strike Resolution: Verify the status of labor negotiations and the timeline for resuming full production at the Cananea mine, which represents ~23% of aggregate copper production.
• Peruvian Expansion Timeline: Confirm progress on the $2.1 billion Peruvian investment program and the feasibility study for the Los Chancas project.
• By-Product Revenue Impact: Assess the sustainability of high molybdenum prices, which significantly offset operating costs (resulting in a negative cash cost per pound when by-products are credited).
• Legal Exposure: Monitor developments in the Peruvian "labor shares" litigation and Mexican royalty disputes.
• Currency Hedging: Review the effectiveness of exchange rate derivatives given the volatility of the Mexican Peso and Peruvian Nuevo Sol.