By Cagdas Ozcan
Southern Copper (SCCO), is one of the world's largest mining corporations. The company deals with mining and processing mineral resources such as copper, molybdenum, zinc, lead, coal and silver. It was formerly known as Southern Peru Copper Corporation. The company was incorporated in Delaware, in 1952. However, it settled its modern size and structure with the acquisition of Minera Mexico and its subsidiaries in April 2005. After this acquisition, Southern Copper became the largest mining company in Mexico and Peru.
SCCO announced its first quarter 2012 financial results with a press release on April 26, 2013. According to this press release, net income in the first quarter of 2013 was $495.4 million, representing a decrease of 6.8, compared to the previous quarter. In the same quarter, SCCO's copper mine production decreased by 2.2% to 3,421 tons. However, capital expenditures increased by 78.6% to $316.8 million. SCCO's closest competitor's, Freeport-McMoRan's (FCX) net income for the same term was $648 million.
As of the time of writing, SCCO was trading at $33.84 with a 52-week range of $27.72-$42.03. Trailing twelve month [ttm] P/E ratio is 15.81, and forward P/E ratio is 14.6. P/B, P/S and P/CF ratios stand at 5.7, 4.4 and 15.3, respectively. The company seems to have some debt issues. It has a debt/equity ratio of 0.8, compared to the industry average of 0.3. It should also be considered that the industry average covers all related companies. Southern Copper has a market cap of $29 billion, which is slightly lower than the market cap of Freeport-McMoRan. Southern Copper's operating margin is 44.8%, and net profit margin is 27.9%.
SCCO has a 2-star rating from Morningstar. What is the fair value of SCCO given the forecast estimates? We can estimate the fair value using a discounted earnings plus equity model as follows.
Discounted Earnings Plus Equity Model
This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5 + Disposal Value
V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r
While this formula might look scary for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my growth estimates. You can set these parameters as you wish, according to your own diligence.
Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate. In order to smooth the results, I will also take the average of ttm EPS along with the mean EPS estimate for the next year.
E0 = EPS = ($2.14 + $2.45) / 2 = $2.30
Wall Street holds diversified opinions on the company's future. The company has one hold and one underperform ratings from Wall Street analysts. Average five-year growth forecast is 8.7%. Book value per share is $5.98. The rest is as follows:
Fair Value Estimator
Fair Value Range
(You can download FED+ Fair Value Estimator here.)
I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for SCCO is between $32 and $38 per share. At a price of $33.83, SCCO seems fairly valued.
(click to enlarge)
Copper is a good transmitter of heat and electricity. Several industries such as the automobile industry use copper in large quantities. Copper is also widely used in circuit boards. SCCO has the largest copper reserves in the world, but there are actual macroeconomic situations that affect copper concerns. China's destocking policy and warehouses' stockpiling are heart of the matter, actually.
SCCO is an indirect subsidiary of Grupo Mexico. As of December 2012, Grupo Mexico owns 81% of SCCO's valuable shares. SCCO stock was trading for as high as $41.96 on January 23, 2013. Since then, it is going down, and reached the bottom of $31.34 on April 17.
Based on my FED+ valuation, SCCO is now trading at its fair value range. I rate SCCO as a buy for long-term investors. The demand for copper might rise after China abandons its destocking policy. The global economic recovery is likely to increase the demand for copper. I think copper stocks can form another way to invest in global economic growth.