Seeking Alpha
Long/short equity, special situations, event-driven, growth
Profile| Send Message|
( followers)  

Copper: What does the future hold?

Copper prices have fallen by around 10% since the beginning of 2013, negatively impacting the revenue of copper companies. Southern Copper (NYSE:SCCO), the world's largest company in terms of copper reserves, has remained under pressure due to declining copper prices this year. In the first nine months of this year, the company derived 78% of its revenue from copper production. However, during this period, the company's net sales declined 12%, primarily due to the 7.2% decline in the average copper price on the London Metal Exchange, or LME. As seen below, the Economist Intelligence Unit, or EIU's, forecast for copper prices also doesn't look favorable for copper producers. Copper prices are expected to remain almost flat over the next five years.

Year

2014

2015

2016

2017

2018

Copper price ($/pound)

3.47

3.32

3.20

3.28

3.32

Source: EIU

The future growth of Southern Copper will be highly dependent on the overall global demand for copper. China is the world's largest consumer of copper, consuming about 41% of the global copper production. In November, China's copper imports were 435,613 tons and increased 19.2% year over year, reflecting growing demand. Further, infrastructure projects under the country's urbanization plan offer a great opportunity for copper producing companies.

The Chinese government plans to have at least 900 million people living in urban areas by the year 2025. This would increase the urban population as a percent of the total population from 52% at the end of 2012 to 70% by 2025. The government funded urbanization program involves annual expenditure of $107 billion in order to transition 25 million people every year from rural to urban areas. This will certainly increase the construction of new homes, power projects, and transportation networks, thus increasing the overall copper demand.

Will the company grab this opportunity?

Southern Copper expects the Chinese copper consumption to increase from the current 41% of global consumption to 45% by the year 2018. The company is focusing on increasing its production capacity by 87%, from the current 640,000 tons to 1.2 million tons, by 2017. It is expanding its capacity by investing in various plants such as Bueunavista, Cuajone, Toquepala, and Tia Maria. Out of the planned $1.6 billion capital expenditure, or capex, for 2013, the company has already incurred $1.19 billion in the first nine months of this year. Further, the company plans to incur capex of $2.3 billion and $1.4 billion in the next two years. I believe the company's expansion plan will certainly help it generate better production volumes, thus providing an upside to its revenue in the future.

What are the other players doing?

The Chinese demand for copper is being fulfilled by exports from Chile, which is the world's number one copper producer and has 28% of the world's copper reserves. The Escondida mine, located in the Atacama Desert in Chile, is the world's largest copper mine and produces 20% of Chile's copper output. Rio Tinto (NYSE:RIO) and BHP Billiton (NYSE:BHP) are the major stakeholders in this mine project; BHP Billiton has 57.5% stake and Rio Tinto has 30%. Both companies are focusing on expanding the production at the Escondida mine from 1.1 million tons in 2012 to 1.3 million tons in 2015, which will enable both miners to meet China's copper demand in the future.

However, I believe Southern Copper is in a good position to capitalize on the Chinese copper demand considering its copper reserves and mine life. The company's copper reserves of 67.1 million tons are the highest among all copper producers. Moreover, its mine life of 105 years is the best in the industry, with the second positioned, Codelco, having a mine life of 34 years.

Efficiency is the key

With copper prices expected to remain gloomy, it becomes extremely important for copper companies to perform efficiently. Net cash cost, an important metric to determine the efficiency of copper producing companies, refers to the operating cash cost of producing copper, net of any by-product credits received. In the third quarter, Southern Copper reported net cash cost of $0.98/lb of copper, as compared to $1.09/lb in the second quarter. On the other hand, Freeport-McMoRan (NYSE:FCX) reported net cash cost of $1.46/lb of copper in the third quarter of this year. Even though it was a sharp reduction compared to the second quarter's net cash cost of $1.85, Freeport's cost of producing copper is much higher than that of Southern Copper. I believe this to be a major reason behind Freeport's lower profit margins compared to that of Southern Copper, as both these companies derive a major part of their revenue from copper production. For Freeport, copper sales accounted for 64.8% of the total sales in the first nine months of this year. As seen in the table below, Southern Copper has consistently posted better profit margins than Freeport.

Net profit margin

2009

2010

2011

2012

9M 2013

Freeport-McMoRan

18.3%

22.8%

21.8%

16.9%

12.9%

Southern Copper

24.8%

30.2%

34.2%

29.0%

27.4%

Moreover, Freeport raised an additional debt of $10.5 billion this year. The company also assumed almost $7.1 billion of total debt after acquiring two oil and gas companies. As a result, the company's debt increased from $3.52 billion at year-end 2012 to $21.1 billion at the end of the third quarter. I expect Freeport's profit margins to remain under pressure in the coming quarters with the burden of higher interest expense.

Conclusion

Southern Copper's expansion plan will help it capitalize on the Chinese copper demand. Moreover, it has been able to perform more efficiently than its counterpart, Freeport. Considering Freeport's level of debt and Southern Copper's pure plays copper business, I recommend investors buy this stock.

Source: Southern Copper Is Cheap At These Levels