Southern Copper Corporation

News & Events

2024-01-12 05:30:27 ET

Summary

• Southern Copper is the best copper miner with extensive reserves, low cash costs, and long mine life.
• The company maintains excellent liquidity and solvency. Its profit margins and returns exceed its competitor's performance. SCCO distributes dividends with adequate yield at 4.2%.
• SCCO is fairly valued by the market; despite how I like the company, I prefer to stay on the sidelines. There are other great companies at better prices.

Introduction

Copper is one of the foundational commodities of our world. It is used everywhere. In the coming years, the demand for copper is expected to grow significantly. The primary reason is the energy transition. Supply, however, is declining. Now is the perfect time to seek exposure to copper.

The best miner to bet on a copper deficit is Southern Copper ( SCCO ). The company owns the largest copper reserves, has a low cash cost, and has a long mine life. Its mines are in Peru and Mexico. 44% of its revenue comes from the USA and Mexico. SCCO tops its competitors with superior margins and returns. Besides that, the company has a robust balance sheet and pays dividends with attractive yields. The red flag is the valuation. It is too high for my preferences. A viable investment means a great company at a reasonable price. Here is missing the second part. I give a hold rating.

SCCO overview

SCCO has a few distinct advantages compared to its peers: lowest cash cost, extended mine life, and most extensive copper reserve base in listed miners. The chart below from the last presentation shows SCCO's strengths.

SCCO has 44.8 mmt copper reserves, surpassing Freeport-McMoRan ( FCX ) with their Grasberg mine. The latter is probably the SCCO mines in Peru and Mexico. 55.8% of the revenue and 66% of the EBITDA comes from the Mexican assets, Buenavista and La Caridad. 40% Revenue/34% EBITDA originates from Cuajone and Toquepala, SCCO Peruvian mines. Those four mines are the primary revenue generators. Nevertheless, SCCO operates five smaller underground projects in Mexico.

The company cost profile is the most competitive in the industry, as shown below.

SCCO, along with Vale and Glencore ( GLNCY ), falls in the best part of the cost curve. In the long term, being a low-cost producer may save the company in steep commodity bear markets.

Copper production represents 70-75% of the company's revenue. The remaining percentage comes from molybdenum (15%), silver (3%), and zinc. Peru and Mexico are in the top five molybdenum-producing countries globally. SCCO is one of the significant producers outside China and Chile. Geographically, the revenue (figures for 2022) is well diversified: 24% Mexico, 19% the US, 14.7% Switzerland, 6% Japan, and 5.7% China.

Mexico leads as a revenue source. In my opinion, it puts SCCO in an advantageous position. Adding US sales, 44% of SCCO`s revenue comes from North America. It's a bet on Mexico's economic revival and US infrastructure renewal. Besides that, the company is not dependent on the second-largest economy in the world, China. The latter may bring benefits, too, depending on what you think about the Chinese economy. I am bullish on China in 2024. It's the Year of the Dragon, and I expect the Chinese government to boost its economy via fiscal and economic stimulus. This is one of the reasons they belong to Vale. However, SCCO is the top player for copper investors who want to avoid China.

3Q23 results

Let's make a quick review of the 3Q23 production figures:

Copper production in 3Q23 decreased by 1.9%. Copper represented 75% of sales in 3Q23. The quarterly result reflects a 2.1% decrease in production in Peru. Production at the Cuajone mine was down due to lower ore grades. Declines were also recorded at Buenavista and IMMSA operations. Those above were partially balanced by higher production at Toquepala (+12.6%) and La Caridad (+0.8%) mines QoQ due to higher ore grades.

Production at Mexican operations decreased by 1.8% QoQ, mainly due to lower production at the Buenavista mine. Compared to 2Q23, copper production decreased by 0.6%, primarily due to a lower output at the Cuajone and Buenavista mines.

In 3Q23 molybdenum prices averaged $23.59/lb compared to $16 in 3Q22. 3Q23 molybdenum production increased 12.6% YoY. La Caridad (+37.8%) and Toquepala (+14.7%) mines were the main drivers with improved ore grades and recoveries. Cuajone (-28.8%) mine brought disappointing results, caused by a drop in ore grades and recoveries. For 2023, the company expects to produce 25,900 tons of molybdenum.

Silver represented 4% of sales value in 3Q223, with an average price of $23.60/oz. 3Q23 silver mine production dropped by 10.0% YoY. All mines realized lower production figures: Cuajone (-23.5%), Buenavista (-18.3%), IMMSA (-7.5%), and La Caridad (-4.0%). Toquepala (+13.0%) mine improved output offset slightly the decline. 3Q23 zinc production increased by 9.4% YoY. The major reason is improved output at the Charcas and Santa Barbara.

3Q23 SCCO's total operating cost and expenses increased by $67 million YoY due to higher labor costs, depreciation, and sales expenses. Declining energy costs and lower inventory consumption partially compensated for these costs. 3Q232 EBITDA is $1,291 million, representing 27% YoY growth over 3Q22 ($1,018 million). The adjusted EBITDA margin improved in 3Q23 at 52% versus 47% in 3Q22.

SCCO's cash cost, including the benefit of by-product credits, was $0.98 per pound in 3Q23 or $0.14 lower than the cash cost of $1.12 in 3Q22. OPEX cost before by-product credits were $2.24 per pound in 3Q23, $0.05 higher than 2Q23. Higher cash costs and increased administrative expenses caused this 3% growth in OPEX costs. Lower treatment and refining charges and higher premiums partially reduced compensated cash costs and G&A increase.

SCCO's goal is 946,700 kt annual copper production for 2024. Over three years, SCCO will invest $7.7 billion in capital expenditure. The plan for 2024 is to allocate $1.3 billion in CAPEX.

SCCO balance sheet

To assess how strong a company is, I first look at its balance sheet. The last few years have been great for commodity producers, and mining majors have significantly improved their balance sheets. The chart below compares SCCO, FCX, and GLNCY's capital structure.

SCCO has the highest total debt-to-equity and total debt-to-capital ratio. Those figures do portend SCCO is over-leveraged. It is the opposite. Its management team has made significant progress in reducing the company`s debt. Knowing the company has a healthy capital structure is not enough. The next step is to check how liquid the company is. I use multiples to estimate the company`s liquidity position: EBITDA/Interest expense, Net debt/EBITDA, and quick ratio.

SCCO scored the highest point in that round. The company has 17.1 EBITDA/Interest expenses, 0.9 Net debt/EBITDA, and 2.7 Quick Ratio. To reiterate, SCCO, FCX, and GLNCY are all excellent enterprises. The exercise aims to estimate who is the best among the best. The last chart in that section shows the debt amortization schedule, total debt to EBITDA, and EBITDA margin.

SCCO has $2.1 billion in cash. Besides that, the company realized $4.69 billion in operating income and $4.1 billion in operating cash flow. In the current decade, the company must repay $551 million in debt: $500 million in 2025 and $80 million in 2028. A significant portion of the company`s debt is due after 2034. The annual amortization in 2035 is $1 billion. Given the company's strong liquidity position, I do not see any issues repaying its debts in 2025. I am bullish on copper in the long term. With its low cash cost profile, SCCO will reap enormous profits in a bull cycle, and I expect to cover its debts before 2035.

Profits and dividends

The chart above shows the EBITDA margins of the copper majors. SCCO holds a pole position in the list. Let's see how profit margins developed over the past three years.

SCCO tops the list with 56% Gross and 53% EBITDA margin. Profits have declined over the last three years following the lower copper prices. The latter recovered in the previous few months, expecting a Chinese recovery and soft landing. The time will show if Dr. Copper`s forecast is correct. SCCO ranks at the top based on ROE and ROTC. Having the best cost profile in the industry pays out.

SCCO distributes dividends with adequate yield at 4.2%. The company ranks second between GLNCY and FCX. I am not keen on the highest payout ratio of SCCO, 94%. I prefer a lower payout ratio (35-50%) for capital-intensive businesses. The remaining free cash could be used for additional CAPEX and buyback shares. In a commodity bull market, cutting the outstanding shares count via buybacks is one of the best ways to create shareholder value. All three companies have increased their dividends since 2019. I expect that with rising copper, the dividends CAGR will continue growing.

Valuation

SCCO's best cash cost profile, most extensive reserves base, and top margins come at a steep price. The chart below compares major miners (not only copper) with a market cap above $30 billion.

SCCO is in the top right corner of the graph with 12.3 EV/EBITDA and 6.7 EV/Sales. FCX and GLNCY trade at much lower multiples. In particular, the latter has 0.4 EV/Sales, lower than Vale, which has 1.8.

The graph below compares SCCO, FCX, and GLNCY ten-year multiples.

It is worth mentioning that it has always been the most expensive in the group. Glencore has been involved in some questions and activities that adversely impact its image. Besides that, GLNCY, over the years, moved its focus to coal. The deal with Teck was another step in that direction. In 2021, FCX surpassed SCCO EV/EBITDA for a while. In conclusion, SCCO is fairly valued by the market; despite how I like the company, I prefer to stay on the sidelines. There are other great companies at better prices.

Risks

All commodity producers depend on China to various degrees. SCCO fairs better than most of its major competitors, with 6% of revenue coming from China. Of course, a deep recession in China will ripple globally, causing copper demand to stagnate. However, the soft "hard" landing in China will not have such a profound effect globally. It will impact companies like Fortescue, with 90% of its revenue dependent on China. SCCO is perfectly positioned to weather any storm caused by Chinese economic troubles. Financially, SCCO is sound. The company is flush with cash, generating excessive operation profits and cash flow. Most of its debt matures in the next decade.

Investors Takeaway

SCCO is the best copper miner with the most extensive reserve base, lowest cash cost, and most extended mine life. However, all nice perks come at a steep price. The company maintains excellent liquidity and solvency. Its profit margins and returns exceed their competitor's performance. SCCO distributes dividends with adequate yield at 4.2%. The company ranks second between GLNCY and FCX. I like SCCO, but I prefer to buy on correction. Investing is not picking the right stock or paying the best price. We need both ingredients. For now, I am on the fence. My verdict is a hold rating.

For further details see:

Southern Copper Is An Ideal Copper Miner, And Mr. Market Knows It