Southern Copper – 2024E Update Calls For A Rating Change (Downgrade) (NYSE:SCCO)

Dear readers/followers,

If you’ve followed my work to any extent over the past few years, you know that I’m a big investor in many areas that other investors shun – one of them is cyclical commodities, including metals – both precious and semi-precious. Copper is one of them. I invest both In European copper businesses and recyclers and when it comes to the NA/SA-based copper industry, my choice goes to Southern Copper (NYSE:SCCO).

Why does the choice go to Southern Copper? That’s what I’ll update you on in this article, and show you why this company has outperformed since I invested in it.

The positives about this company include being in a market-leading position in the copper space. I would also say that this company has great fundamentals and provided you invest at the right or cheap enough price, a very solid fundamental upside.

However, SCCO has recently spiked – and the valuation is now far above where I would consider the company attractive.

In this article, we’ll go through the company’s latest results and I’ll show you why I’m moving to “HOLD”.

Southern Copper – The company is qualitative

As I said, Southern Copper is an NA/SA-based company, and as the name suggests, the company can be traced back to South America rather than North, with original roots in Mexico through Minera Mexico, acquiring SA copper business interests. The company’s status as a majority-owned business with 89% by a Mexican Mining Conglomerate called Grupo Mexico is the first thing that you need to know here.

The main business interests lie in the area of copper mining and smelting, and unlike other businesses that I invest in with a multi-metal focus, this company focuses solely on copper. The appeal of copper is similar to that of the appeal I see in aluminum – it’s a metal that “enables” our modern world. It’s found in everything from electrical/electronics to things like consumer products and machinery.

With the decline of China, I expected the global copper demand to drop – and for some time it has. To understand just how significant China’s copper demand was, all you really need to do is realize that at times over the past few years, the country has been responsible for 40-50% of global copper demand.

Why is SCCO so relevant here?

Because it maintains the largest copper reserves of any company in the industry, with full vertical integration and very experienced management. Those are always excellent qualities to begin a company overview with. In this case, we’re talking about gross, operating, and net margins, where SCCO is above average in almost every respect (Source: GuruFocus/Tikr.com). The company also manages very compelling ROIC/ROE and other profitability metrics, to where I can easily call this one of the most financially successful companies in the copper sector on the entire market.

The company’s main risk is, without a doubt, its massive exposure to Asia and Mexico as markets is over 50% here, with an expectation for a market surplus for the year and a global demand increase of 1% for 2023. Due to the significant demand decline from China, there is an overall uncertainty as to how the demand increase from clean energy technologies can weigh up this. Copper is used as follows, and you’ll understand here why the price shifts so much with macro, due to construction exposure and the like.

However, the company has the size and the operations to work through cycles. It has one of the lowest production costs out there aside from what I consider to be an above-average dividend history. Here are the company’s operations and some of the working estimates.

The company’s main competitors in Copper are the businesses Freeport McMoRan (FCX), BHP Billiton, Glencore, Anglo American, Rio Tinto, and First Quantum. None of the European companies I invest income very close to this, and SCCO’s four open pit mines at a very large scale.

That is not to say that the company only generates revenue from copper. Very few companies only handle “one” metal, given that when you mine Copper, you’re also likely to find other things in the same pits/deposits – things like Zinc, Silver, and Molybdenum as well as byproducts of the process.

The company’s results for 4Q were good – as explained by the rocketing valuation that we’ve seen for the business. There was an expected, increasing market deficit in 2024, along with lower copper inventories, in fact, higher than expected (Source: SCCO IR). On the other hand, the Chinese economy is, as the company says, recovering more slowly than normal. I would go so far as to say it’s not recovering that much at all. In addition, Europe or much of Europe has entered a recession, with a potential so-called “soft landing” in the US, or a small potential recession here as well.

So in short, the company’s main KPI, the LME copper price, is up around 8 cents on the dollar – but there are still things to watch out for.

Looking at the company’s results you might expect this business to generate significant sales increases and EBITDA increases, The reality for 4Q on a YoY comparison is the exact opposite. EBITDA is down 35%, cash costs are up, and net income is down more than 50% for the quarter – but is also down 8% for the full year.

The company’s pipeline is one of the positives to consider here – plenty of things are coming in the next few years.

As things currently stand, the company yields around 3%, which is okay, but nothing to write home about given that you’re getting 4-5% from a savings account on an MMF today.

The company has been called by other investors, including analysts here on Seeking Alpha, as the “ideal copper miner”, and I would agree with that assessment. The company’s ability to work through downcycles and really see long-term upside at the right price is superb – and the company’s current upside is okay – it’s only valuation that turns this company somewhat “sour” in terms of total potential returns.

And valuation, if you follow my work, you know that’s what I am really all about – let’s see why SCCO isn’t all that impressive from this perspective any longer.

Southern Copper – The valuation is prohibitive at this point

Back when I last wrote about this article over a year ago, in a piece you can find here, I was very positive about the company. SCCO was cheap, under $65/share, and I gave the company just that $65/share because the company’s growth outlook was fairly bad – so I didn’t think that it warranted much above that $65/share.

Moving forward until today, the company’s forecasts in fact materialized worse than expected, but the valuation has climbed significantly since I made my last investment, defying gravity in a way and currently at over $104/share.

I will be increasing my price for SCCO here, given the 2024E and 2025E estimates, which I do consider to be not completely unlikely. These estimates include an increase in EPS of 15% in 2024 and another double-digit increase in 2025E (Source: FactSet/Seeking Alpha). The price increase I am applying is based in part on this increase in earnings. At the same time, you need to remember that this company is not really accurately forecastable, so the increase doesn’t represent the earnings increase amount/percentage. The company manages to miss most of the time, over 60% of the time on a 1-year basis with a 10% margin of error, which are negative misses (meaning below stated/forecasted EPS).

Even, in fact, if you were to forecast the company at something of a 5-year average at 20.5x, the returns that you’d get here would be negative in terms of TSR.

And, in fact, most who follow this company in terms of analysts have long since “left the boat”, with the average price target for the company coming no higher than $74/share (Source: S&P Global). The range is wide – a low end of $47 and a high end of $130, making it almost 3x from the low-end price target. Currently, only one out of 17 analysts following SCCO has the company at a buy rating, and given the current valuation, I would say that this analyst is something of a “copper bull”. The company meanwhile earns a total of 12 underperform/SELL ratings from analysts here, making it more than 50% of all analysts viewing the company likely to underperform (Source: S&P Global).

As I see it, while this company is incredibly qualitative, there is absolutely no argument for the company trading at these multiples. We’re currently at over 32x P/E for a 3%-yielding copper business, albeit at a BBB+ rating – but still not justified, as I see things here.

I believe the most likely outcome if you were to “BUY” the company today would be a negative rate of return – unless the company continues to defy as I said, gravity. That is not something I am willing to wager on.

The ratings from other SA analysts as well as Wall Street and also the SA Quant system confirm this, all of which have a “HOLD” or a “SELL” rating. I don’t use “SELL” ratings except in companies that I believe are in distress – and SCCO is certainly not in distress.

Based on what I currently expect SCCO to generate in terms of returns, I would not estimate the company above a 20x P/E on a 2024E basis, and that increases my share price target to $73/share. But beyond that, I am unwilling to consider the business at what the market “demands” for the company today, and because of that, I say that this is now a “HOLD”.

Why 20x? SCCO has seen some success over the past few decades as a commodity business because of through-cyclical stability. It has never really seen a negative earnings or fundamentals, not even during the worst times or the GFC. Because of this, I view the longer-perspective historical multiples as perhaps the best indication for a long-term fair value estimate – and when we go out to the 20-year average, we find an around 20-21x P/E, where I go to the lower end to stay conservative. It also represents a double-digit discount to the company’s assets – and beyond that, why I consider the company higher than other mining business, is because this company is the largest on the planet with a very solid IG rating at BBB+. That is the reason I say that 20x P/E is “fair” here for the long term.

My thesis for the company is updated for the 2024E period and now reflects this as follows.

Thesis

• This company is an excellent play on Copper mining, and one of the most interesting copper companies out there based on its assets and the company forecasts and growth. The company’s profitability KPIs are some of the absolute best in the entire copper business on a global scale, and I would buy this company any day at a more conservative valuation.
• Fundamentals are solid – and the company’s history provides us with a relatively forecastable sort of high and low target, allowing us to determine when to buy and sell with relative accuracy (going by historical numbers, at least) – even if this is influenced by the typical volatility of a commodity company in the copper space, where SCCO “plays”.
• For now, I consider the company to be clearly overvalued – I would give the company a “HOLD” rating here but with a clear downside to a PT of $73/share, and plenty of potential for negative RoR.
• Because of this, I have rotated my modest position in the company and would stay away from here, all things considered.

Remember, I’m all about:

• Buying undervalued – even if that undervaluation is slight and not mind-numbingly massive – companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
• If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
• If the company doesn’t go into overvaluation but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
• I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.

Here are my criteria and how the company fulfills them (italicized).

• This company is overall qualitative.
• This company is fundamentally safe/conservative & well-run.
• This company pays a well-covered dividend.
• This company is currently cheap.
• This company has a realistic upside based on earnings growth or multiple expansion/reversion.

I neither believe the company to be cheap, nor it to have a realistic upside at this valuation. To me, the company is very clearly a “HOLD” here.