Southern Copper Corporation — FY2017 Form 10-K
Reporting period: Year ended December 31, 2017; audited consolidated financial statements prepared under U.S. GAAP. The filing also reports fourth-quarter results. Southern Copper is an integrated copper producer operating mines, smelters and refineries in Peru and Mexico. Grupo Mexico indirectly owned 88.9% of the company.
Financial and operating performance
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Net sales | $6,654.5 million | $5,379.8 million | +23.7% |
| Operating income | $2,618.9 million | $1,564.2 million | +67.4% |
| Operating margin | 39.4% | 29.1% | +10.3 percentage points |
| Net income attributable to SCC | $728.5 million | $776.5 million | -6.2% |
| Basic and diluted EPS | $0.94 | $1.00 | -$0.06 |
| Cash from operating activities | $1,976.6 million | $923.1 million | +$1,053.5 million |
| Capital investments | $1,023.5 million | $1,118.5 million | -8.5% |
- Higher metal prices drove much of the revenue increase: average copper price was $2.80/lb, up about 27%; zinc and molybdenum prices rose 37.9% and 26.6%. Copper represented 82.3% of 2017 sales.
- Net income fell despite stronger operating results, primarily because of a provisional, non-cash $785.9 million U.S. tax-reform charge. The effective tax rate rose to 69.2% from 39.9%.
- Fourth-quarter net income attributable to SCC was a loss of $287.4 million, or a loss of $0.38 per share; the filing attributes the annual earnings decline principally to the tax-reform charge.
- Gross margin was 41.0% versus 31.6%; net margin was 10.9% versus 14.4%.
- Copper mine production declined 2.6% to 1,933.4 million pounds. Lower grades and recoveries at Cuajone and lower Buenavista SX-EW output more than offset higher Toquepala production. Zinc production fell 7.2%; silver and molybdenum production decreased 1.5% and 1.9%.
- Non-GAAP operating cash cost was $1.49/lb before by-product credits and $0.92/lb after credits, versus $1.44 and $0.95, respectively, in 2016. By-product credits increased with higher prices and zinc sales.
Liquidity, debt and capital allocation
- At year-end, cash and cash equivalents were $1,004.8 million, short-term investments $50.5 million, and current assets $3,170.1 million against current liabilities of $1,168.3 million; the current ratio was 2.71.
- Total debt was $5,957.1 million, substantially unchanged year over year; debt was dollar-denominated at fixed rates, with a weighted average rate of 5.89%. Net debt was $4,901.8 million. Net debt to net capitalization improved to 44.4% from 47.7%.
- Operating cash flow exceeded capital investment by about $953 million. Dividends paid were $456.1 million, or $0.59 per share, versus $139.3 million and $0.18 per share in 2016. A further $0.30-per-share dividend was authorized in January 2018.
- Management said it expected 2018 cash requirements to be met through cash on hand and internally generated funds, with external financing available if needed. The board approved a 2018 capital investment program of $1,748.2 million.
Material changes, outlook and management commentary
- Management forecast 2018 copper production of 931,000 metric tons, silver of 17.5 million ounces, zinc of 84,600 tons and molybdenum of 21,700 tons. The copper forecast assumes the Toquepala expansion begins production; the filing gives differing completion/start timing in separate passages (June versus third quarter 2018).
- The Toquepala expansion was 87% complete at year-end, with $892.9 million invested against a $1.2 billion budget; it is expected to add 100,000 tons of annual copper capacity. Management described a longer-term goal of 1.5 million tons of annual copper production by 2025.
- Major planned projects include the $413 million Buenavista zinc project, expected to begin operations in 2020, and the $159 million Pilares project, expected in 2019. Tia Maria remains dependent on construction permits and resolution of community concerns; management expected a license in the first half of 2018. Project estimates and schedules are forward-looking and not assured.
- Management anticipated a supportive copper market in 2018, citing expected demand growth and constrained supply. Results remain highly sensitive to market prices: the company estimated that a $0.10/lb copper-price change could alter annual net income by about $143.9 million, assuming stated production and other assumptions.
- In February 2018, SCC won the Michiquillay project bidding with a $400 million proposed price and 3% net-sales royalty; estimated investment is about $2.5 billion, with production targeted for 2025. This is a subsequent event, not a 2017 operating result.
Risks, contingencies and unusual items
- Commodity-price volatility is the central earnings risk; other material exposures include ore grades and reserves, operating costs, energy and water supply, foreign exchange, labor, political and regulatory conditions in Peru and Mexico, environmental obligations, mine-slope stability and project execution.
- The 2014 Buenavista copper-sulfate spill resulted in recorded charges of $126.2 million through 2017 (the financial-statement note reports total 2014–2015 expense of $136.4 million). Regulators closed their remediation proceedings, but multiple civil, collective and constitutional lawsuits remained pending. The company said damages could not be determined and considered the suits without merit.
- Peruvian soil-contamination characterization and remediation planning remained unresolved; the company said it could not yet estimate the potential loss. Tia Maria-related suits and a dispute concerning the Pasto Grande tailings-dam area also remained pending, with contingencies not reasonably estimable.
- Tax accounting for the 2017 U.S. Tax Cuts and Jobs Act was provisional under SAB 118 and expected to be finalized during 2018; the ultimate impact could differ. The company also reported $214.5 million of unrecognized tax benefits and an IRS examination of 2011–2013 tax years.
- Taxco and San Martin mines in Mexico had been on strike since 2007 and remained suspended. Three strikes occurred at Peruvian operations in 2017; SCC said lost production was not significant and sales contracts were unaffected. A February 2018 San Martin union vote could enable negotiations to end that strike, subject to formal recognition.
- Fuel, gas and power represented approximately 31% of 2017 production costs. The filing also reports two employee fatalities in 2017, compared with six in 2016 and one in 2015.
- Management reported effective disclosure controls and internal control over financial reporting. The auditor issued unqualified opinions on the financial statements and internal controls.
Most important facts for investors to verify
- Whether the $785.9 million provisional tax charge, deferred-tax valuation allowances and transition-tax calculations were finalized or revised in 2018.
- Whether Toquepala expansion commissioning and the 2018 production forecast were achieved, given the filing’s different stated timing.
- Progress on Tia Maria permitting and community acceptance, and the resulting capital commitments and schedule.
- Subsequent developments, potential exposure and any cash costs from the Buenavista spill litigation, Peruvian environmental matters and other pending disputes.
- Whether San Martin resumed operations and whether labor disruptions affected production, costs or customer commitments.
- Execution and funding of the $1.748 billion 2018 capital program, including project economics, related-party procurement and the company’s ability to sustain dividends while investing.