Southern Copper Corporation — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. The unaudited interim statements cover an integrated copper and other metals producer operating principally in Peru and Mexico. Grupo Mexico indirectly owned 88.9% of the company. The independent accountant performed an interim review, not an audit.
Financial and operating performance
- Q2 revenue and earnings: Net sales were $1.530 billion, up 14.6% year over year. Operating income was $525.9 million, up 36.6%; net income attributable to SCC was $299.7 million, up 35.1%; diluted EPS was $0.39 versus $0.29. Operating margin was approximately 34.4%, compared with 28.8% in Q2 2016.
- First-half results: Net sales were $3.114 billion, up 20.7%; operating income was $1.096 billion, up 49.9%; SCC-attributable net income was $614.1 million, up 50.9%; diluted EPS was $0.79 versus $0.53. Operating margin was approximately 35.2%, compared with 28.3%.
- Revenue drivers: First-half average LME copper price increased 22.5% to $2.61/lb. Higher metal prices and sales volumes lifted revenue; copper accounted for 81.6% of first-half sales. First-half copper sales volume rose 2.7% to 980.6 million pounds, while mined copper production fell 4.0% to 946.6 million pounds.
- Costs and taxes: First-half operating costs and expenses increased 9.1% to $2.017 billion. Cash cost per pound before by-product credits rose 6.3% to $1.51; net of by-product credits it declined 2.1% to $0.93. The effective tax rate increased to 35.7% from 32.7%, primarily reflecting higher expected dividends from Mexican subsidiaries.
- Cash flow and investment: First-half operating cash flow was $843.9 million, versus $328.8 million. Capital investment was $497.7 million, versus $564.9 million; operating cash flow less capital investment was approximately $346 million (a simple calculation, not a company-reported non-GAAP measure). Cash and equivalents ended at $688.7 million, up from $546.0 million at year-end.
- Liquidity and debt: Current assets were $2.645 billion and current liabilities $800.8 million, implying working capital of about $1.844 billion. Long-term debt was $5.956 billion, nearly unchanged from year-end; its estimated fair value was $6.633 billion. Cash plus short-term investments totaled $728.9 million.
- Dividends: The company paid $0.12 per share in May. After quarter-end, the board authorized $0.14 per share, payable August 23, 2017.
Material changes versus the prior comparable period
- Higher copper and other metal prices were the main contributors to higher revenue and earnings; copper sales volumes also increased, despite lower mined copper output.
- Q2 mined copper production declined 4.5%, principally due to lower grades and recoveries at Cuajone and lower leach production at Buenavista. First-half production also declined at Cuajone and in Buenavista SX-EW operations.
- First-half net cash from operations increased by $515.1 million year over year. Investing cash outflow rose to $485.4 million from $22.0 million, partly because prior-year investing cash flow included substantially larger proceeds from short-term investments.
- First-half dividends paid increased to $154.6 million from $61.9 million. No shares were repurchased in the first half of 2017; $53.7 million of repurchases occurred in the first half of 2016.
- A $10.2 million environmental remediation provision reversal reduced first-half operating costs after remediation actions for the 2014 Sonora River spill were declared complete, subject to continued biological monitoring.
Outlook, risks and notable items
- Production outlook: Management reduced its 2017 copper production forecast from 900,000 to 890,000 tons. It expects 986,000 tons in 2018 as the new Toquepala concentrator ramps up, and targets production of 1.5 million tons by 2023. Forecasts are subject to execution and operating risks.
- Projects and capital needs: Toquepala expansion was 70% complete, with $650.2 million invested against a $1.2 billion budget and completion expected in Q2 2018. Tia Maria, budgeted at about $1.4 billion, had $363.7 million invested but still required construction permits amid community opposition. The company reported approximately $1.983 billion of committed capital-project spending and expects to fund projects from cash, internally generated funds and, if needed, external financing.
- Commodity and operating risks: Results are highly exposed to volatile copper and by-product prices, ore grades and recoveries, energy and fuel costs, exchange rates, labor relations, equipment and permitting. Management estimated that a $0.10/lb copper-price change would affect second-half 2017 net income by about $57.5 million, assuming stated conditions and excluding potential hedging.
- Labor: A 12-day strike at two Peruvian unions ended in April; the company estimated approximately 1,400 tons of lost copper production. Strikes at Mexico’s San Martin and Taxco mines remained unresolved, and operations were expected to remain suspended.
- Legal and environmental contingencies: The company said formal remediation actions for the 2014 Sonora River spill were completed and the trust was closed, but related civil and other lawsuits remained pending; management considered them without merit and not expected to have a material financial effect. A possible Peruvian soil-remediation contingency could not yet be estimated. Tia Maria and other litigation matters also remained pending.
- Other notable exposure: Provisionally priced sales included 57.3 million pounds of copper and 11.5 million pounds of molybdenum scheduled for settlement from July through September 2017. Related price adjustments were +$5.6 million for copper and -$11.9 million for molybdenum at quarter-end. Related-party transactions are significant; purchases and sales with Grupo Mexico and affiliates totaled $243.2 million and $131.9 million, respectively, in the first half.
Most important facts for investors to verify
- Whether copper prices, sales volumes and by-product credits sustain earnings and cash flow, especially given first-half mined-copper production declines.
- Progress, cost and timing of the Toquepala expansion and the permits and community acceptance required for Tia Maria.
- How the $1.983 billion of committed project spending will be funded and its effect on debt and liquidity.
- Developments in unresolved labor matters, environmental claims and litigation, including any change in management’s assessment of potential losses.
- Exposure to commodity-price, foreign-exchange and provisionally priced sales movements, and the implications of the company’s substantial related-party activity.