Southern Copper: Added To Watchlist (NYSE:SCCO)

Southern Copper Corporation (NYSE:SCCO) has demonstrated strong performance this year, marked by a more than 35% increase in its stock price year-to-date, fuelled in part by the recovery in copper prices. With the largest copper reserves among listed companies and a significant dependence on copper mining for earnings, Southern Copper is well-positioned to capitalize on rising copper prices. Despite concerns about China’s influence on copper demand, the company’s strategic focus on copper aligns with the global shift toward clean energy and electric vehicles, suggesting promising long-term growth potential.

Its robust fundamentals, including its distinction as a low-cost copper producer, contribute to the company’s financial resilience. Southern Copper’s ability to generate substantial cash flow even during periods of low copper prices, along with its controlled debt levels, underscores its financial strength. Ongoing capital investment projects, despite potential regional risks, enhance the company’s long-term viability and make it a good long-term addition to one’s portfolio. However, the valuation levels appear somewhat elevated at the moment.

The copper price and Southern Copper

While Southern Copper might not be the largest miner of copper, its copper reserves are the largest of any listed company. The company is also more dependent on copper mining to its overall earnings than most of its peers who often earn more than half of their sales through other minerals such as iron ore. In contrast, earnings from copper makes up more than 70 percent of Southern Copper’s sales. In the second quarter of 2023, copper sales amounted to around 77 percent of Southern Copper’s total sales.

This greater reliance on copper revenues makes Southern Copper a better pure copper play than most of its peers and positions it well to benefit from higher copper prices. However, it does also leave the company more exposed to earnings declines should the copper price decline. Therefore, the direction of the copper price is particularly important for the direction of the Southern Copper share price in the short term.

China and its economic prospects have long been key drivers of the copper price. According to Statista, China consumed around 55 percent of the world’s refined copper in 2022. Therefore, Southern Copper will not be immune from events in China notwithstanding the fact that its revenues are mainly “dependent on Asia-Pacific, Mexico, and the United States”, as noted by Seeking Alpha’s The Value Analyst.

More recently copper prices declined on the back of a contraction in Chinese Manufacturing data in July. Seeking Alpha News noted that “Analysts are expecting more stimulus ahead, especially for construction, but the measures may not go far enough to sustain a rally in prices.” In my view, there is likely to be a bit more volatility in copper prices as the Chinese story plays out in the near term. This potential for increased volatility may mean that cautious investors should consider a pause in further purchases of Southern Copper stock in the near term.

However, I believe the long-term growth story for copper remains firmly intact and should benefit well-managed copper mining companies like Southern Copper. Copper is viewed as an important metal to be used in the energy transition. Regardless of one’s personal view on the soundness of climate change policies, governments seem set to increasingly drive and incentivize the transitioning to renewable energy and electric vehicles. Willing has noted in this respect that –

The transition to clean energy requires larger quantities of copper, which is used for wiring in electric vehicles (EVs) and solar panels. Higher crude oil and gas prices are raising operational costs for copper producers, but also accelerating the energy transition and in turn increasing copper demand.

Therefore, the transition to increased usage of renewable energy and the growth in demand for EVs are likely to be key drivers of copper demand in future. While I do not foresee that this growth would replace the importance of China to the copper market in the near future, it will certainly bode well for less dependence on China for the copper market in the longer term.

Southern Copper’s solid fundamentals

Southern Copper is one of the lowest cost producers of copper, producing copper at around $2.01 per pound without factoring in any by-product credits. After factoring in by-product credits the company is effectively producing copper at around $0.78 per pound well above the current price of around $4.02 per pound. Importantly, the company’s ability to produce copper at a lower cost than its peers ensures that it can generate sufficient cash flow even when copper prices are low. Fitch notes that these cost advantages have also enabled the company to maintain relatively low levels of debt, despite having a sizable capital expenditure program. Southern Copper currently has a net debt to earnings before interest, taxation, depreciation and amortization (EBIDTA) ratio of around 0.91. While this ratio is the highest of the major mining houses included in the peer comp charts below, it remains well below the industry average of around 1.5.

This low net debt to EBIDTA ratio is particularly impressive in light of Southern Copper’s large capital expenditure program. The company’s capital investment program for this decade amounts to nearly $15 billion. It continues to invest in a number of new projects across South America. In the company’s first quarter 2023 earnings call, management discussed several of its upcoming capital investments in Peru. Management noted that:

the Tia Maria project … is a project that will […] produce 120,000 tons of refined copper cathodes per year. The estimated capital budget for the project is $1.4 billion… The Los Chancas project [in Peru] envisions an open pit mine with a combined operation of concentrator and SX-EW processes to produce 130,000 tons of copper and 7,500 tons of molybdenum annually. The estimated capital investment is $2.6 billion, and the project is expected to begin operating in 2030.

These projects all seem promising and add to the long-term viability of the company’s operations. However, some investors might remain wary of exposure to Peru given the recent history of social unrest and disruption to mining operations. Southern Copper itself has not been immune from these disruptions and faced substantial problems in its own mining operations and ability to export copper as a result of this unrest. The resumption of operations in Peru has likely also been one of the key drivers of the rise in the stock price this year.

The risk of longer-term disruptions in Peru seems to have dissipated somewhat with management noting that “coming back to operation and operating at full capacity now, Cuajone had much more mineral production and better ore grades and recoveries. That certainly helped this quarter’s production.” Nevertheless, potential political unrest in core markets such as Peru remains a risk that investors should be aware of.

Valuation

Southern Copper is currently trading at a forward price to earnings ratio of around 22.69 which is the highest of the major mining companies considered in the peer comp chart below. While this is not a particularly low forward P/E ratio it is not unusual for Southern Copper to trade at a somewhat elevated P/E ratio with its 5-year average forward P/E ratio around 18.07.

Nevertheless, it is clear that the stock valuation is currently quite high relative to the company’s peers and compared to its own historical average forward P/E ratio. It is this elevated valuation that causes me to be hesitant to initiate a position rather than any concern over the fundamentals of the company.

Conclusion

Southern Copper’s solid fundamentals, including its status as a low-cost producer of copper, makes it a valuable potential addition to an investor’s portfolio. The company’s ability to generate healthy cash flow even during periods of lower copper prices, coupled with its manageable debt levels, underscores its financial stability. The continued strong capital expenditure without incurring high debt levels further contributes to this positive view of the stock.

However, the current valuation of Southern Copper presents a point of caution. Trading at a relatively high forward P/E ratio compared to both its peers and its historical averages, the stock appears to be priced at a premium. Given this high premium I will be adding Southern Copper to my watchlist for a possible addition to my portfolio at a lower price. I would personally look at adding the stock if its trading between $70 – $75, which is in the region of its 5-year average forward P/E ratio.