Durig Capital seeks out quality high yielding global investments that offer both a high yield and a good probability of appreciation, while providing a unique hedge against inflation and/or a continued devaluation of the US dollar. As a result of our diversification research efforts, we have identified and selected Southern Cooper (SCCO), which holds some of the world’s biggest copper reserves, for our investments with income portfolio.
Wealth Preservation Concerns
With the equity and commodity markets continuing to thrashing about with no consistent or clear direction, preserving wealth is a top priority for many people seeking income from their investment portfolios. The current very low US Treasury rates remain significantly below inflation rates, putting American savers in the tenuous position of continuous wealth erosion.
Considering that this has been another year of declining equity and property prices, minimal pay raises, elevated inflation, ineffective politicians, potentially increased taxes, and the Fed’s constant printing of more money (not only backstop the US economy but also that of Europe) leaves one with the stark realization that all these have resulted in a widespread erosion of wealth that will likely continue, and perhaps even accelerate, until the aforementioned conditions begin to change.
The Copper Market
According to preliminary ICSG data and data projections that indicate a deficit of about 250,000 tons, global growth in copper demand for 2012 is expected to continue outpacing supply growth. “Demand will grow, but it’s not going to grow as fast as it did in 2009 and 2010,” said Walter de Wet, head of commodities research at Standard Bank Plc in London. He stated further that they see the supply side lagging substantially for copper. Barclays Capital’s estimate is forecasting copper shortages as mining companies fail to keep up with consumption.
Recycling old scrap and converting it to refined metal and alloys provided 140,000 tons of copper, equivalent to 6% of apparent consumption. Copper, like aluminum, is 100% recyclable without any loss of quality whether in a raw state or contained in a manufactured product. It is estimated that 80% of all the copper ever mined is still in use today. Copper is used more in developed countries (140–300 kg per capita) than in less developed countries (30–40 kg per capita), so as countries like China and India become more developed their use of copper is forecasted to greatly increase.
Copper is the benchmark standard for electrical conductivity. It conducts electrical current better than any other metal except silver. Being so highly conductive for electricity makes copper the most common choice for most light-gauge wires. Silver is more conductive, but due to its cost it is not practical in most cases. Aluminum is also used, but the metal can heat up, and also loses more power during transmission. Consequently, in most of the electrical devices used today, from cell phones to TVs to house wiring, copper is the preferred, if not the only, solution. With that said, perhaps it’s easier to understand the demand growth in copper by looking at the increase in electrical power equipment usage year over year.
Southern Copper Corporation
Southern Copper Corporation is one of the largest integrated copper producers in the world, and their operations make them one of the largest mining companies in Peru and in Mexico. Furthermore, our research has revealed that they may have the largest copper reserves in the world. Most of the reviews that we have read list it as a Peruvian exploration company. Based on last year’s book value, about 52% of its property value was based in Peru and roughly 48% in Mexico, splitting their book value nearly equally between the two countries. The corporate headquarters is in the United States, in Arizona.
We think that Southern Copper Corporation’s greatest strength may reside in its copper ore reserves, which at December 31, 2010 were estimated at 59.7 million ton, as it generates about 80% of its revenues from copper. The 2008 US Geological Survey estimate of 590 million tons of identified and undiscovered global copper reserves seems to indicate that Southern Copper Corporation has over 10 % of the world’s copper reserves. Using the estimate of nearly 60 million tons of proven and probable reserves and a copper price of $6,622 a ton (12/16/2011, 3 month futures) would give it over $395 billion in situ. It currently has a market capitalization of about $24.8 billion, and realize net profits after tax of about 24-30% of their $6.6 billion in revenues. Given a resource value of about $395 billion, it could conceivably generate over $106 billion in future profits using an average of the most recent returns.
Furthermore, it could theoretically mine its reserves at the current rate for about 60 years, which is well beyond the expectancy of most of the other mining companies that we have reviewed. Looking at Southern Copper’s baseline numbers, which are always subject to change, we can see a greater than 14% internal rate of return at its current price.
Southern Copper has paid $2.46 in dividends over the last 52 weeks, which works out to be a 8.38% yield at the current stock price. Though this dividend is high, it will fluctuate along with the underlying fundamentals. Their most recent quarter resulted in a $0.70 dividend, giving it an over 9.5% run rate yield. However, considering that copper is now priced on the lower end of where it has traded for the last two years, we expect there to be a lower dividend payout in future quarters.
- Copper fluctuations
- Union and labor issues
1. Copper Prices. Even though over longer time periods copper prices have seen strong growth, short-term, week-to-week and month-to-month fluctuations in the price of the metal could result in sharp movements in either direction. Since their dividend seems heavily based on current profits, there could also be significant variations in the dividend yield rates. Based on the last three years, forward sales accounted for about 80% of Southern Copper’s revenues. As a result, the fluctuations in copper prices will still affect the overall valuation of the company, but may have much less effect than what some investors might expect on the current quarter’s profit. Although the share prices of SCCO have fluctuated, they have roughly been flat for about the the last 5 years, their future forward sales should help protect profits, and therefore the dividend, if the metal remains weak for another quarter or two.
2. Labor Unions. Southern Copper Corporation utilizes a high level of unionized labor, and with many global issues akin to such things as the Occupy protests and the fairness of wages issues, there is a possibility of being affected by labor issues in the future. In recent years, their Buenavista mine experienced a severe labor stoppage that started in July 2007 and finished in June 2010. The Bunenavista mine is a very large open pit mine in Mexico that has since become fully operational, and seems to be positively affecting earnings and has raised output for the entire company.
3. Deflation. While we believe that generating unprecedented growth in the US dollar money supply in the efforts to forgo a US, European or even a more global systemic failure will continue to incubate an eventual wealth-devastating inflationary cycle, we also acknowledge that continued near term failures and a possible meltdown of the European banking system will likely emanate more deleveraging and disinflation. In an effort to shield the rest of the world from the grave deflationary whirlpool now stirring in Europe, the US has aggressively accelerated its increase of money supply and is expanding its global lending portal. Historically, over time this sort of action results in a significant inflationary cycle. However, this may not materialize any time soon, as it could be overshadowed by the deflationary effect of significant European failures for some number of years.
The US service industry is about 80% of the US economy and is still under pressure, showing signs of further contraction and deflation. This large sector’s decline has quite effectively thrown a wet blanket on the vast amounts of kindling that typically fuels inflation. Aside from the service industry, in hard goods like copper, we seem to already have alarming high levels of inflation. Given the uncertain outlook and possibility of ongoing European quasi fumbles, a torrid mixture of deflationary and inflationary pressures will continue to smolder.
Our interest and primary focus is to protect our clients wealth. While we continue to prepare for and be very wary of an inflationary cycle and believe the vast trillions of dollars of national debt will likely only be addressed with a greatly devalued fiat currency, we are aware that the gestation period prior to its arrival may be long and drawn out. In the short term, we also believe hard goods like cooper may continue to see prices increases, even without a significant rise in official inflation rates and in spite of possible negative growth in the service industry. Therefore, we believe that adding a high dividend yielding position in Southern Copper Corporation, which has significant world class copper reserves and is very closely correlated to copper prices, is an very intelligent diversification risk.
We think SCCO allows our clients to attain the strategic goals of a good current income stream, and provides for diversification away from the US economy and the US dollar. By owning hard assets in the ground that could result in an appreciating revenue stream, SCCO and its future dividends could possibly outlive most of our current clients. This portfolio position looks to provide a longer term hedge against commodities inflation while also generating a high level of income, and it is why we’ve selected it as a core position in our Investment Growth & Income Portfolio.
Southern Copper Corp
Per share values in USD, 12-16-2011:
Market value: $29.46
Dividend rate: 8.38 %
Disclosure: I am long SCCO. Durig Capital and some of its clients may have positions in SCCO.