A Basic Materials Dividend Titan: Southern Copper Corp.

Sep. 5.11 | About: Southern Copper (SCCO)
Southern Copper Corporation (NYSE: SCCO) is a leading mining company based in Phoenix, Arizona, but operates properties in Peru, Mexico, and Chile. SCCO had about $5.1 billion in revenue in 2010. The company has a market capitalization of $27.4 billion and an enterprise value of $28.5 billion, suggesting very limited leverage. SCCO has a strong track record of paying dividends making pretty regular quarterly payments; however, the amounts have varied over time based on the performance of SCCO.

SCCO's performance is heavily driven by copper prices. Increasing copper prices are a boon to the business, while decreasing prices can create disappointment. The following graph shows the historical prices:

Source: Indexmundi, for COMEX pricing for Sep 2011-Feb 2012. The copper futures prices are the flat bit of the curve at the far right.

The above chart also clearly shows a significant ramp up in copper pricing beginning around 2003 when prices went from perhaps $0.75 per pound to $3.50 per pound within a 2-3 year period. Since that time, prices have largely been in the $3 to $4 range with the exception of during the Great Recession, when all commodity prices plummeted. Since then, prices have recovered and pushed even higher, crossing the $4 per pound mark. As noted above, higher copper prices result in larger profits and dividends for SCCO. The following graph illustrates a relationship.

Source: Indexmundi, Yahoo!Finance

SCCO dividends have even outstripped copper price increases over time, but the same shape of the copper prices are reflected in the dividend curve. This shows the dividend behavior lagging the copper prices most notably during the Great Recession. It should be noted that SCCO does hedge a portion of its production throughout the year; however, there is a larger portion that is left unhedged.
SCCO's estimated forward dividend yield is 8.0% based upon a closing price of $32.42 and the author's projected annual dividend of $2.58. The following table shows the estimated forward quarterly dividends as well as the recent historical quarterly dividends. The forward dividend largely assumes continued overall growth in the global economy and reasonable strength in copper pricing. Forward COMEX copper prices suggest that the $4 per pound value should hold.
Historical and Projected Dividends
Type Ex-Dividend Date Quarterly Dividend ($ per share) Change on prior year
Projected 8/15/2012 0.660 6.5%
Projected 5/2/2012 0.650 16.1%
Projected 2/11/2012 0.640 10.3%
Projected 11/12/2011 0.630 46.5%
Historical 8/15/2011 0.620 67.6%
Historical 5/2/2011 0.560 24.4%
Historical 2/11/2011 0.580 34.9%
Historical 11/12/2010 0.430 138.9%
Historical 8/10/2010 0.370 270.0%
Historical 5/10/2010 0.450 900.0%
Historical 2/17/2010 0.430 267.5%
Historical 11/3/2009 0.180 -47.1%
Historical 8/4/2009 0.100 -82.5%
Historical 5/11/2009 0.045 -92.1%
Historical 3/9/2009 0.117 -74.9%
Historical 11/14/2008 0.340 -49.0%
Historical 8/18/2008 0.570 6.9%
Historical 5/12/2008 0.567 13.3%
Historical 2/8/2008 0.467 -17.6%
Historical 11/5/2007 0.667 45.5%
Historical 8/10/2007 0.533 60.0%
Click to enlarge
Source: Author estimates, Yahoo!Finance
The above table also highlights the variability in SCCO's dividend, which goes through booms and busts. The following graph shows the historical trailing twelve month yield and spread to the 10-year Treasury bond.

Created from data from Yahoo!Finance

The previous graph demonstrates that SCCO has a pretty volatile dividend yield that, as noted before, is clearly reflective of the volatility in copper prices. The next graph shows the normalized performance of the stock price, the dividend, and the trailing dividend yield.

Created from data from Yahoo!Finance

The above chart shows that SCCO has significantly outperformed its dividend increases, suggesting that its future growth opportunities are improving and investors are rewarding SCCO. It also shows some interesting aspects that the dividend yield can spike with rising prices when the dividends really shoot up. This occurred back when copper prices began their first upward surge. However, one can also see during the Great Recession that the yield climbed with a falling stock price and also that future dividends were subsequently disappointing, but stock price optimism returned. Right now, the stock is off from its very recent highs suggesting some uncertainty about the future.
Dividend Discount Model suggests a slight overvaluation
The first step to using the dividend discount model is to calculate an equity hurdle rate with the Capital Asset Pricing Model. SCCO has a beta of 1.58 and with the risk free rate at a very low 2% this gives the discount rate to be 13.1%. As noted above, the forward dividend is approximately $2.58. Applying a long term growth rate of 4% gives an estimated price of $28.49 for SCCO, about a 12% discount to the current price. The rationale behind the 4% long term growth is inflation, and some consistent growth from developing markets building out their infrastructure. However, as with any dividend discount model, the result is highly sensitive to growth rate and equity hurdle rate assumptions. Furthermore, in this case, future copper prices will also play an important role.

DDM Sensitivities
Sensitivity Equity Hurdle Rate
Growth Rate 12.1% 13.1% 14.1% 15.1%
0.0% 21.40 19.76 18.36 17.14
1.0% 23.34 21.40 19.76 18.36
2.0% 25.66 23.34 21.40 19.76
4.0% 32.03 28.49 25.66 23.34
6.0% 42.60 36.56 32.03 28.49
Click to enlarge
Source: Author calculations
SCCO appears to be slightly overvalued based on a dividend discount model. However, it is difficult to forecast its forward dividends which could be higher than I assumed. Furthermore, the high discount rate is driven by copper price volatility. One can see that even a 10% discount rate would already create an undervalued situation. For an investor with a strong view of longer term copper prices (staying the same or increasing), SCCO could be a great way to make that play. Still, a downturn in the economy that limits copper demand could easily drive the price lower; however, longer term prospects for global growth should be a benefit to copper prices.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.