2023-11-21 22:18:52 ET
Summary
- Southern Copper Corporation, with the world's largest reserves of the red metal, is well-positioned to exploit the expected boom in critical minerals amid the global green energy race.
- The company has industry leading operating margins of 45%, a solid dividend yielding over 5%, and expects to grow output 80% by 2032.
- The price of copper meanwhile has bounced back on good news out of China, and is out-performing other critical minerals, including battery metals like nickel, lithium, and cobalt.
- I rated the stock a hold a year ago over fears of declining commodity prices. Since then the stock is up 60%, which is great for current investors, but the price might be too high at the moment for folks just coming to the table.
I covered Southern Copper Corporation ( SCCO ) just over a year ago, when I rated the stock a hold - citing concerns with falling commodity prices and potential to miss earnings targets. The stock is up about 60% since then. I am again rating the stock a hold - but for different reasons this time around.
One of the most profitable and resource-rich mining companies in the world, SCCO is up almost 30% in the past year, offers a strong dividend, and is well-positioned long-term with demand for the red metal projected to significantly outstrip supply amid the global green transition. The stock also looks attractive in the near-term with copper prices in bounce-back mode while a significant amount of supply could be taken offline if First Quantum, which accounts for more than 1% of global copper supply, is forced to stall or halt production at its flagship mine in Panama.
Southern Copper is a tempting stock to jump on but it just isn't at an ideal price for new investors. The price of copper would have to average about $4.50/lb for most of the next decade to justify the current stock price. Hence, I rate it a hold.
Well-Positioned Profit Machine
Southern Copper currently leads the world in copper reserves, is number 2 in resources, and comes in fifth in terms of annual production, which is split between Mexico (60%) and Peru (40%).
SCCO Company Resources (SCCO Investor Presentation)
The company is also efficient, with the lowest cash costs in the industry, allowing it to deliver substantial operating profits and cash flows over the past decade. EBIT margin currently sits at 45% and levered cash flow at 22%. As a result it has garnered an A+ profitability grade, blowing away the sector median. Not to mention it has delivered strong dividends consistently with a yield that now sits at over 5% while growing at a CAGR of over 30%.
SCCO Factor and Dividend Grades (Seeking Alpha)
Southern Copper's profit margins by every measure are anywhere from 100% to over 500% above the sector median. in the trailing twelve months the company saw an EBIT margin of 45% and EBITDA a jaw-dropping 53 percent, while levered free cash flow is at 27% and ROTC 20%.
SCCO Profitability Grade (Seeking Alpha)
Southern Copper's profitability marks also blow away its peers, as the table shows below. Notice that its stock price performance leads the pack of top pure play copper rivals as well, although its P/E and EV/EBITDA valuation ratios are of concern, which we shall dig into.
SCCO Performance vs. Peers (Seeking Alpha)
SCCO plans to boost production by 80% to reach 1.6mln tons in 2023. This will require some heavy capex investment along the way at an average of almost $2 billion per year (assuming Cu price of $3.85/lb).
SCCO Production and Investment Projections (SCOO Investor Presentation)
The Copper Clean Energy Boom Cometh
According to the IEA's mid-range forecast , annual copper demand could reach 34mln tons by 2035, about 35% above 2022 levels. Electricity networks will account for nearly 50% of this 8.8mln ton rise in demand, with EV batteries accounting for 25%. Clean energy tech requirements as a % of total demand will shift from 22% in 2022 to 40% by 2035.
Copper Demand by Source (IEA Critical Minerals Data Explorer - Updated July 2023)
Perhaps more critical when it comes to future prices, is that copper shortages could reach as high as 10mln tons/year by 2035, per an S&P report last year. The shortage forecasts have so far failed to spark the level of investment that will be needed to come close to closing the gap. However, S&P projected that the expected significant deficits may not begin hitting until 2027. Annual surpluses ranging from 200mln to 300mln tons are expected in 2024, 2025, and 2026.
S&P Refined Copper Balance Forecast (S&P Global Commodity Insights)
The International Copper Study Group (ICSG) , meanwhile, is projecting an even higher surplus for 2024 - of 400mln tons - although it expects demand to rise 2.7%.
Despite the projected surpluses, consensus price forecasts - as of the end of September - have copper rising every year until it reaches $4.32/lb in 2027, about 12% above the YTD price of $3.85/lb.
Copper Price Forecast (Data: S&P Global Consensus Estimates)
Copper prices have recently rebounded, now up 5% in the past 12 months, and are outperforming other key green minerals - including battery metals such as lithium, nickel and cobalt. This is partly being driven by optimism over an end to Fed rate hikes and news signaling a potential uptick in near-term demand. China’s central bank this week vowed to ensure financing for the property sector, a major consumer of the red metal.
Copper Price vs. Nickel, Lithium, Cobalt (Seeking Alpha)
Most of the other pure-play copper stocks got a bigger immediate bounce from this news, although SCCO is crushing its rivals in terms of momentum in the past year, which was boosted by a solid Q3 earnings report , beating the EPS consensus target by 5% and the revenue target by 60%.
SCCO Price Performance vs. Peers (Seeking Alpha)
The problem with SCCO, despite the stellar momentum and profitability metrics, is that the stock price looks expensive both relative to the sector, its peers and intrinsically.
SCCO Relative & Intrinsic Valuation
By nearly every valuation multiple available, SCCO looks significantly overvalued relative to the sector, although its dividend yield of 5.35% is solidly above its material sector peers. SCCO is trading at more than 20x earnings, 7x book value, and 15x cash flow. Southern Copper's EV/EBITDA TTM ratio, a critical multiple for valuating mining companies, is more than 32% higher than the sector median while EV/EBITDA FWD is over 50% higher.
SCCO Valuation Grade (Seeking Alpha)
SCCO's dividend has strong grades across the board in terms of safety, growth, yield, and consistency. The dividend has grown at a CAGR of over 38% over the past three years. The annual payout in 2023 was $4.00/share, but consensus estimates are projecting it to fall to $3.21/share next year before bouncing back to $3.90/share.
SCCO Dividend Grades (Seeking Alpha)
A dividend of $3.21/share, at a perpetual growth rate of 5%, and cost of equity of 9.5%, implies a stock price of $71.33, about 5% under the current price. However, based on a perpetual growth rate of 6%, the stock would be worth $91.71, implying its undervalue by over 20%.
When putting together the intrinsic valuation I relied on consensus estimates for the top line for the first three years of the DCF model then based years 4-10 on Southern Copper's production projections using a copper price of $3.85/lb. In the end it translated into an annualized sales growth rate of over 6 percent. I used an EBIT margin of 45% and a tax rate of 35%. The capex/sales ratio averaged out to 16% and levered free cash flow a healthy 23% over the ten years. Sales are projected to grow from $10.2mln in year 1 to $18.2mln by year 10, according to the model.
SCCO 10Y Sales / Profit Projections (MH Analytics / Company Data)
According to the discounted cash flow analysis, using 9.5% as the cost of equity, the stock's fair price is projected to be $57.20, suggesting that the stock is about 30% overvalued. I include a sensitivity table below that shows the stock would be fairly valued if we assumed a copper price of $4.50/lb for years 3-10.
SCCO DCF Analysis (MH Analytics)
Risks
A couple risks worth mentioning have to do with the company's ownership structure, float %, short interest and to a lesser degree, debt. Almost 90% of outstanding shares of Southern Copper are owned by Grupo México, S.A.B. de C.V. (GMBXF). And GMBXF is 60% owned by Empresarios Industriales de México and its CEO German Larrea Mota-Velasco. This is quite a consolidation in the hands of a few. More surprising is the fact the float is only 11% of shares, significantly lower than its top pure-play peers.
SCCO Ownership Breakdown (Seeking Alpha)
The short interest of over 6% is also quite high compared to most stocks. In fact, only about 25 other material sector stocks have higher short interests.
SCCO's debt to equity ratio of 90% is a bit high as well as its interest payment/sales ratio of over 3%, although the latter looks well-covered by operating profits. Southern Copper's Altman-Z score of nearly 6 is encouraging along with the fact it received BBB+ credit ratings from S&P and Fitch.
Conclusion
No other pure play copper miner is better-positioned than Southern Copper to take advantage of the expected boom in demand for critical minerals required for clean energy technologies amid the global race to net-zero emissions. The company has the world's largest copper reserves, monster operating margins of 45%, and plans to grow output 80% by 2032. Not to mention it has a strong dividend at $4.00/share, which represents a yield of over 5%. Despite these strengths the stock is still a bit expensive for new investors. However, the stock is certainty worth holding onto given the company's strategic position, strong fundamentals, high-quality dividend, and solid momentum.
For further details see:
Southern Copper: Global Leader Poised To Exploit Clean Energy Boom