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Southern Copper Cost-Cut & Expansion Plans Solid, Debt High

Zacks Equity Research

On May 20, we issued an updated research report on Southern Copper Corporation SCCO. Backed by its largest copper reserves in the industry, and constant endeavor to increase low-cost production and investment in capacity, the company remains well poised for growth. However, current weakness in metal prices and high-debt levels will affect near-term results.

Expansion Projects on Track

The Toquepala concentrator expansion was completed during the fourth quarter of 2018 for $1.3 billion. It reached 86% of capacity usage at the end of the first quarter of 2019 and is anticipated to achieve full capacity by the second quarter of 2019. This expansion project will increase Toquepala´s annual copper production to 258,000 tons in 2019, a production improvement of 52% for this operation compared with last year. It will raise the company’s copper production in 2019 to 986,700 tons, higher than 883,689 tons in 2018.

In Mexico, the company has a planned investment of $413 million in the Buenavista Zinc-Sonora project which includes development of a new concentrator to produce approximately 80,000 tons of zinc and 20,000 tons of additional copper annually. Once completed, this new zinc concentrator is likely to double the company's zinc production capacity.
 
An investment of $159 million is estimated for Pilares-Sonora project in Mexico which consists of an open pit mine operation with an annual production capacity of 35,000 tons of copper in concentrates. It will significantly improve the overall mineral ore grade. Additionally, the company has number of other projects that it may develop in the future. Notably, the company expects to reach 1.5 million tons of copper production by 2025.

Low Cost & Largest Reserves: A Winning Combination

The company continues to witness the benefits of cost-reduction programs and expansion actions. During 2018, it obtained a cash cost reduction of 5.3% to 87 cents per pound, despite an increase of 16.5% in fuel cost and other materials. Considering last year´s average prices for its main products, Southern Copper expects cash cost to average 80 cents per copper pound in 2019, an additional reduction of 8%, fortifying its leadership as a low-cost producer.

Southern Copper boasts of the largest copper reserves in the industry, and operates high-quality and world-class assets in investment grade countries, such as Mexico and Peru. Backed by a positive market outlook, constant commitment to increasing low-cost production, largest copper reserves and growth investments, the company is well poised to continue delivering improved performance.

Betting on Peru’s Growth Prospects
 
Peru is currently the second largest producer of copper and its national output is expected to hit 4.8 million ton per year by 2021 — double the output of 2017. In June 2018, Southern Copper completed the acquisition of Michiquillay project in Cajamarca, Peru, which boasts mineral resources of 1,150 million tons and copper grade of 0.63%. It will produce 225,000 tons of copper annually and by-products such as molybdenum, gold and silver, at a very competitive cash-cost. Michiquillay offers immense growth opportunities for the company and fits into the company’s portfolio of mining projects in the Americas, especially in Peru. It is likely to become one of the largest copper mines in Peru.
 
Taking the Michiquillay ($2.5 billion) and Los Chancas ($2.8 billion) projects into consideration, the company’s total investment program in Peru runs to $8.1 billion.
 
Low Metal Prices, High Debt: Near-term Concerns
 

During first-quarter 2019, the LME per pound copper price decreased 11% to $2.82 reflecting the market uncertainty owing to trade war between the United States and China, and Brexit concerns. Average molybdenum and zinc prices in the first quarter of 2019 also decreased 3.6% and 20.6%, respectively on a year-over-year basis. Average silver prices also decreased 7.0% in the first quarter of 2019 from the prior-year quarter.

Further, the company’s debt-to-equity ratio stood at 89% at first-quarter 2019 end, which is also a cause of concern.

Metal Prices to Pick Up in the Long Term

Notwithstanding the current low copper prices, the impending demand-supply imbalance will eventually drive copper prices. Copper production has recently been affected by persistent decline in investments. Notably, this issue has been plaguing several companies in recent years. On top of this, labor unrest, excess government taxation and technical difficulties are impacting production. Further, during the first quarter of 2019, heavy rains led to production losses in Chile and Peru. This will also lead to a deficit this year.  On the contrary, demand is on the rise for the metal given its requirement across a gamut of industries.
 
Molybdenum prices are set to increase on the back of healthy demand from the oil and gas industry, and decline in supply and recovery of the U.S. economy and developed countries. Long-term fundamentals for zinc remain strong due to its significant industrial consumption and expected mine production shutdowns. Further, silver prices are likely to gain driven by its industrial use and impending demand-supply imbalance.

Share Price Performance

Shares of Southern Copper have plunged 33.5% in the last year, compared with the industry’s decline of 30.8%.
   
Zacks Rank and Stocks to Consider

Southern Copper currently carries a Zacks Rank #1 (Strong Buy).

A few top-ranked stocks in the Basic Materials space are Israel Chemicals Ltd. ICL, Arconic Inc. ARNC and Arch Coal Inc. ARCH, each carrying a Zacks Rank #2 (Buy), at present. You can see the complete list of today’s Zacks #1 Rank stocks here.

Israel Chemicals has an expected earnings growth rate of 13.51% for 2019. The company’s shares have gained 12.7% in the past year.

Arconic has an estimated earnings growth rate of 31.62% for the current year. The stock has appreciated 19.4% in a year’s time.

Arch Coal has a projected earnings growth rate of 16.7% for the ongoing year. Its shares have rallied 12% over the past year.

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