Southern Copper Corp.: Production Growth Overshadowed By Demand Headwinds
Southern Copper Corp. (NYSE:SCCO) with operations in Mexico and Peru is recognized for controlling the second-largest copper reserves in the world. The company has benefited from steady production growth in recent years and maintains a large pipeline of new projects set to come online over the next decade. It’s an extremely challenging period for the copper market which faces significant demand headwinds given the economic disruptions from the global coronavirus pandemic. While we like SCCO’s world-class assets and solid operating profile as a pure play on copper, we take an overall cautious view on the stock with an expectation for more downside in the price of copper.
SCCO 2019 Recap
2019 was a record year for the company that reached a milestone of 1.02 million tonnes of copper production and up 12.5% year over year. The result was supported by ramping up of output at its Toquepala mine which featured a new concentrator. Output at the Buenavista mine was up 5.8% which balanced softer production at other mines related to some lower ore grades. Favorably, mined production of the company’s by-products, including molybdenum, zinc, and silver, all increased in 2019.
(Source: Company IR)
Total net sales of $7.3 billion was also a company record and up 2.7% compared to 2018 but pressured by lower copper prices on average in 2019. The impact here led to a lower operating income which fell 4.4% y/y, and a 0.8% decline in the adjusted EBITDA to $3.5 billion. EPS of $1.92 in 2019 was down 4% compared to $2.00 in 2018.
(Source: Company IR)
One of the positive themes for 2020 is the expectation of a lower overall cash cost which supports higher margins. In the earnings conference call, management explains that the expectation of higher output of by-product credits (revenues from zinc/lead/silver) will drive a lower implicit cash cost for copper to around $0.81 per pound.
“Our current expectation for the next year is to have a cash cost even lower than what we have in full for 2019. Currently, our view is to have a cash cost for next year of $0.81 per pound that will be formed as follows. The cost before any credits will be $1.52. That’s pretty much in line with what we had in 2019, but we will have much more credits than what we had last year, of about $0.71 per pound. That will, when you do the subtraction, leave you with $0.81 per pound of copper.”
The company continues to expand in Peru with a total investment pipeline in the country at $8.1 billion through 2026. This includes $2.5 billion for the “Michiquillay” project and $2.8 billion for “Los Chancas”. One of the issues in Peru is a greater concern for social-economic impacts on local communities. Southern Copper faced years of delays attempting to get its “Tia Maria” project construction permit. In 2019, the company finally received a permit for this $1.4 billion copper Greenfield project expected to produce 120k tons annually in SX-EW copper.
In Mexico, Southern Copper has a few smaller projects including “Buenavista Zinc” which will double the company’s output for zinc. Altogether, the company thinks it can reach copper production of 1.8 million metric tonnes by 2026, an increase of 80% from the 2019 level.
(Source: Company IR)
Analysis and Forward-Looking Commentary
The International Copper Study Group (“ICSG”) which is an industry think-tank just published 2019 data on global copper usage and supply trends. World mining production at 20.43 million metric tonnes was down 0.7% compared to 2018. This considers a lower mine capacity utilization at 84.3% compared to 85.3% in 2018. World refined copper production was down by 0.6% y/y. The trend in production was balanced by a similar decline of 0.6% in world refined copper usage. 2019 ended with a marginal refined copper deficit of 341k metric tonnes which narrowed slightly compared 391k in 2018.
(Source: International Copper Study Group)
The concern here comes down to global macro weakness. While some of the softer trends in demand in 2019 were blamed on the U.S.-China trade war, the situation now is the risk of a major global recession. While it’s recognized that China represents 49% of copper consumption annually, the unique challenges in 2020 highlight headwinds for all other regions including Europe. We think that in 2020, “the other 51%” outside China will be even more important.
At the sector level, construction demand and the use of copper in general & consumer products are likely to face pressures from weak economic activities this year. These trends are bearish for the price of copper. The copper balance deficit should narrow this year based on weaker demand and possibly reverse into a surplus of copper for the year.
(Source: Company IR)
As it relates to SCCO, the company remains exposed to the volatility in the price of copper. Considering the reported case level cash cost of $1.52 per pound for copper and $0.81 including the byproduct credits, the company can remain profitable even with some further downside in copper from current levels. Still, we expect the stock to face more bearish sentiment should copper prices trend lower. Keep in mind SCCO traded under $30 per share in 2019 or less than 10% higher from the current level.
SCCO is going to need some positive momentum in copper which we believe would require an improvement in the global growth outlook. Some talk has arisen regarding a potential infrastructure stimulus bill as the next phase of the U.S. government response to support the economy. This could also be a positive catalyst to support the price of copper, but we would need more details on what type of construction would actually be implemented.
To the downside, the risk is that the global outlook deteriorates possibly through a longer than expected period to contain the coronavirus or weaker than expected recovery. Economic and copper market data over the next couple of months from China and Europe will be important to gauge the underlying demand environment. We think the $2.00 per pound level in copper or approximately 10% lower from the current price represents an important support level for the commodity price. A break lower could signal a deeper correction.
Consistent with the stock trading down to a 4-year low, valuation multiples for SCCO are also at the lower end of historical ranges. Given the extreme volatility in copper prices currently, it’s difficult to gauge what full-year earnings will be for 2020. The risk is simply that copper prices fall lower driving more downside in earnings and valuation.
We like Southern Copper with its world-class assets and positive trends in production growth. Still, given the poor outlook for the global economy and trends in copper demand, it’s hard to turn bullish on the stock even following the recent declines. In some ways, copper prices have held up relatively well amid the enormous global economic disruptions from the coronavirus pandemic. We think the hard data points and indicators coming out over the next couple of months will be important to reprice the price of copper accordingly. Among commodities and metals, we prefer precious metals and energy which we believe offer better reward-to-risk setups. We take a cautious view on SCCO with a hold rating at the current level but will keep this one on our watch list.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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