Southern Copper Corporation

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 4/5

Southern Copper Corporation (SCC) is one of the world’s largest integrated copper producers with operations primarily in Peru and Mexico. It engages in mining, smelting, and refining copper, and also produces significant amounts of molybdenum, silver, and zinc.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Southern Copper Corporation is a major player in the copper mining and production industry, primarily operating in Peru and Mexico. Its operations span the entire value chain, from mining ore to producing refined copper and other by-products.

  • Geographic Presence: The company’s assets are concentrated in Peru, where it has the Toquepala and Cuajone mines, and Mexico, where it operates the Buenavista mine and other smaller operations. This geographic concentration exposes the company to the specific risks of these regions, including political and regulatory factors.
  • Revenue Distribution: SCCO’s revenue is significantly tied to copper prices, with sales of other metals like molybdenum, silver, and zinc contributing a smaller, albeit important, portion. Due to significant price volatility in commodities, a large portion of profitability varies based on this variable.
  • Industry Trends: The copper industry is characterized by supply and demand dynamics, with long-term demand growth driven by the global energy transition and increased infrastructure development. However, these opportunities are subject to the cyclical nature of commodity markets. This has been greatly seen in the last few years, with high inflation leading to supply chain issues and affecting market prices.
  • Margins: Profit margins for commodity-related businesses such as copper are dictated by the relationship between copper prices and input costs, including energy, labor, and materials. These margins can be volatile as they are strongly affected by market dynamics.
  • What makes SCCO unique: Compared to other copper producers, Southern Copper has a unique mix of high-grade copper mines with relatively low operating costs. It also has a long history of low debt levels, which have been increasingly used recently. However, a lack of diversification and the higher risks in its operating countries are not present in its competitors, and it should be taken into consideration.
  • Competitive Landscape: The copper industry is dominated by a handful of large, global players. The sector has a history of consolidation. Competition among these majors, including BHP Billiton, Codelco, and Glencore, is based on cost advantages, scale, and operational efficiency.

Financial Analysis

  • Recent Performance: In the most recent quarter ending June 30, 2023, Southern Copper posted total revenues of $2,398.8 million, down from $2,647.6 million in the same period in 2022. Net income for the same period was $623.7 million, compared to $578 million in the prior period. Net income for the six months ended June 30, 2023 was $1.362 billion compared to $1.299 billion a year ago.
  • These results indicate that revenues are directly tied to commodities prices, and as prices increase, revenues and margins go up as well.

  • Profitability Metrics: The company has had great net margins for the first half of the year. However, given the volatility of commodity prices, net profits can fluctuate drastically year over year.

    • The company’s operating cash cost per pound of copper produced in the first half of 2023 has been increasing to almost $2.36 per pound, compared to $2.07 in 2022. The management has cited increases in cost of power, natural gas, and labor in the Peruvian region to contribute to the higher expenses
  • Capital Structure:
    • SCC’s long term debt was $6.892 Billion at June 30th 2023. While the company was previously known for low debt, and the capital structure remains within a range that indicates a level of safety.
    • The Net debt was ($738.2) Million.
    • For a mining company with high capital expenditure demands, maintaining a strong financial structure is essential.
  • Cash Flows: SCCO has consistently generated strong cash flows from its operations, even when adjusted for the cyclicality of commodity prices. The cash flows should increase dramatically as the company has completed major capital expenditures.
  • Debt Management: The company has been reducing long-term debt. However, it is vital to pay attention to any changes in debt ratios with any new expansions or any drop in financial performance in the coming years.
  • For the first half of 2023, SCC generated approximately $1.779 billion in cash flow. This solidifies its financial position and allows it to pay down debt and improve the balance sheet.

Moat Rating: 2/5

Southern Copper’s economic moat is, at best, narrow. Here’s why:

  • Intangible Assets (Brand & Patents): SCC’s competitive advantages are not reliant on brands, patents, or other intellectual property, which makes it more vulnerable to competition from other large miners.
  • Cost Advantages: SCC’s cost advantage is mostly driven by operating in low-cost regions, with high-grade deposits and the benefits from these, like good infrastructure, should be weighed in, in determining the sustainability of this advantage. This could be a moat, but it’s not a wide one.
  • Switching Costs: There are virtually no switching costs in commodities. Buyers will generally choose whichever supplier offers them products at the lowest prices.
  • Network Effect: The company does not benefit from a network effect.
  • Pricing Power: It is very difficult for copper miners, in general, to establish a durable pricing power. Therefore, even if cost of operations is low, it will be difficult for a miner to command a premium above competitors.

Risks to Moat and Business Resilience

  • Commodity Price Volatility: Copper prices are volatile, and changes to supply or demand can impact profitability dramatically. Management has stated in its earnings calls, that the volatility of commodities creates a risk to financial performance.
  • Operational Risks: The company faces operational risks, including mining accidents, supply-chain disruptions, and operational costs, especially as it tries to implement long-term projects.
  • Political and Regulatory Risks: A significant portion of SCC’s operations is in Peru and Mexico, which are subject to political and regulatory instability. Government regulation, permitting delays and increased taxes, and social unrest can also affect production, operating margins, and, subsequently, financial results.
  • Environmental Risks: Regulations relating to environmental issues such as water management, emissions management, and land use, are significant for this company.
  • Labor Relations: The company has historically experienced labor problems. Any large strike could potentially put the company in a state of turmoil, as well as negatively impact operations.

Understandability: 2 / 5

Southern Copper’s business is relatively simple to understand at a high level, but its economic intricacies require considerable knowledge of the sector. The primary drivers of the company’s performance are copper prices, operating costs, and production volumes. It requires significant knowledge of accounting and finance to model its financial statements. This difficulty arises in many areas:

  • Complex Financial Statements: The company’s financial statements contain numerous specific line items, and due to being an international company, its reporting standards differ slightly from a typical U.S. based company. It requires in-depth understanding to analyze everything properly and derive meaningful calculations and analysis.
  • Commodity Economics: There are many variables involved in the pricing of metals, and it can get complex very quickly. Understanding these different aspects is essential to be able to predict the future economic performance of SCCO.
  • Regulatory Environment: The regulations around the mining industry, especially in developing nations can be hard to understand. An investor should have knowledge of the legal factors to predict possible hindrances to operations in foreign countries.

Balance Sheet Health: 4 / 5

SCCO generally has a strong balance sheet, even with increased debt.

  • Low Debt-to-Equity Ratio: Currently, the balance sheet does not look nearly as pristine as a few years ago, where the company operated with no debt. However, current debt levels are still reasonable for its business model, and there is no concern for excessive debt.
  • Positive Cash Flow: The company currently has a good, positive cash flow that allows it to support current business operations, and leaves it capable of taking further investments.
  • Net Cash Position: While net debt levels have dropped, there is still plenty of cash and liquid investments, adding to the financial flexibility of the company.

Recent Concerns

In the latest earnings call, the management was optimistic about future projections as China’s demand for copper picks up again.

  • Labor Concerns: Even though strikes have been contained, labor risks still remain. It is important to see how they will handle those risks if they appear again.
  • Operational Challenges: The company cited that it is having problems with operating costs. The current economic crisis and the prices of inputs is putting a strain on operations, and are raising the cash costs of producing copper. A solution to this problem is of utmost importance.
  • Price Volatility: Management is aware of the price volatility of copper and other metals, and believes it is impossible to predict the fluctuations accurately.

Summary

Southern Copper is a significant player in the global copper market with strong financial discipline and decent operational leverage, but its moat is limited by its commodity-based operations, geographic concentration, and lack of diversification. It may be best suited for investors who do not have an outsized opinion on the long term prices of commodities, and are comfortable with the risk profile of operating in developing countries. It requires some expertise to understand the nuances of this sector, and may be too hard for a beginner investor.