An Opportunity to Capture High Yields From This Copper Company

southern-copper-companySouthern Copper Corporation is an integrated copper producer with mining, smelting, and refining operations in Mexico and Peru, and exploration projects in Mexico, Peru, and Chile. In addition to being the world’s number five producer of copper, Southern Copper also produces molybdenum, zinc, lead, coal, and silver. The company was incorporated in 1952 in Delaware and conducts its operations through its “Peruvian Branch” and its Mexican subsidiary, Minera Mexico. Minera Mexico is a holding company with operations conducted through various subsidiaries. Additionally, it is important to note that Southern Copper is 81.3% owned by Grupo Mexico, a Mexican company with subsidiaries engaged in mining, transportation, and infrastructure. The following chart shows the organizational structure under which Southern Copper finds itself.

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SCCO Corporate Structure

Source: http://www.southernperu.com/ENG/about/Pages/PGStructure.aspx

In terms of its revenue by product, copper is the dominant driver of revenues at 77% in Q1 2013. Despite Asia’s representing 65% of the world’s copper consumption, it represents just 17% of Southern Copper’s revenue. In the table below, from Southern Copper’s May 14, 2013 presentation at the 2013 Bank of America – Merrill Lynch Global Metals, Mining and Steel Conference, you will find a more complete breakdown of the company’s revenues by product and by market.

SCCO Geographic Footprint & Product Diversification

Given its status as the world’s number one company by copper reserves, and with the price of copper trending lower in recent months, you may be wondering how much it costs Southern Copper to produce all that copper. There are two ways in which copper producers report their cash costs per pound of copper production: net of by-products and all-in cost. Net of by-products, Southern Copper has a cash cost of $0.91 per pound. All-in, the cost is $1.99 per pound. Both figures are through Q1 2013. Copper prices at the CME have recently been fluctuating in the $3.00 to $3.20 per pound range.

In the first quarter of 2013, Southern Copper had capital expenditures of $316.8 million, free cash flow of $278 million, cash and cash equivalents totaling $2.462 billion, and debt totaling $4.214 billion (short- and long-term debt). If you would like long-term exposure to Southern Copper through the company’s debt, CUSIPs 84265VAG0 and 84265VAE5 may be of interest.

CUSIP 84265VAG0 is Southern Copper’s Baa2/BBB rated 5.25% coupon, November 8, 2042 maturing notes. At the recent offer price of 80.34, the notes have a 6.806% yield-to-worst.

CUSIP 84265VAE5 is Southern Copper’s Baa2/BBB rated 6.75% coupon, April 16, 2040 maturing notes. At the recent offer price of 96.856, the notes have a 7.011% yield-to-worst.

Both series of notes are senior unsecured obligations of Southern Copper and have make whole calls. The 2040 maturing notes have a make whole call at the Treasury Rate plus 35 basis points, and the 2042 maturing notes have a make whole call at the Treasury Rate plus 37.5 basis points. The 2040 and 2042 series also each have a conditional put for a change of control at 101 cents-on-the-dollar. Additionally, there is one thing in particular concerning subsidiaries and guarantees that I would like to point out.

In both prospectus supplements you will find the following:

“Risks Related to this Offering

We partially depend upon our subsidiaries to service our debt, and the notes are structurally subordinated to the payment of the indebtedness of our subsidiaries.

We are the sole obligor on the notes. We derive a substantial portion of our revenue and cash flow from our subsidiaries and our ability to service our debt, including the notes, is substantially dependent upon the earnings of our subsidiaries. None of our subsidiaries will guarantee these notes. Our subsidiaries are separate and distinct legal entities and have no obligation, contingent or otherwise, to pay any amounts due under the notes, or to make any funds available therefore, whether by dividend, distribution, loan or other payments, and the consequent rights of holders of notes to realize proceeds from the sale of any of those subsidiaries’ assets will be structurally subordinated to the claims of any subsidiary’s creditors, including trade creditors or holders of debt of those subsidiaries. As a result, the notes are structurally subordinated to the prior payment of all of the debts (including trade payables) of our subsidiaries and effectively subordinated to all of our existing and future senior secured indebtedness to the extent of the value of the collateral securing such indebtedness.”

Neither the 2040 nor the 2042 maturing notes are guaranteed by subsidiaries of Southern Copper. When looking at the organizational structure under which Southern Copper find itself (presented earlier in this article), it appears as if Southern Copper has two main subsidiaries, one in Peru and one in Mexico. But notice in the previous paragraph the words “Our subsidiaries are separate and distinct legal entities.” On its website, Southern Copper describes its “Peruvian Branch” as not being “a corporation separate from [Southern Copper].” Therefore, it is reasonable to assume that the prospectus supplement is not referring to the company’s Peruvian operations when discussing subsidiaries. In the prospectus supplement for the 2042 maturing notes, it says that “as of September 30, 2012, the indebtedness of our subsidiaries that is structurally senior to the notes was U.S. $51.2 million.” In the context of Southern Copper’s total debt, $51.2 million of structurally senior debt (to the 2042 and presumably 2040 notes) is not that much.

Prior to purchasing either series of notes, I would encourage investors to read the prospectus supplement and the prospectus. They can be found here and here. Also, please keep in mind that this article is for informational purposes only and not a recommendation to buy or sell any securities. Only you can decide if taking the counterparty risk of investing in individual bonds is right for you.

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Comments

  1. aziz says

    why would anyone buy an individual bond? you get no diversification and transaction costs are enormous.

    • David Waring says

      Hi Aziz,

      Thanks for the comment. I think the reason why people buy individual bonds instead of bond funds is because they want the greater certainty of income that an individual bond can provide vs. a bond fund. While transaction costs can be enourmous if you go through an online broker that does not mark up prices and are buying liquid bonds this brings down the transaction costs substantially. You can also buy multiple individual bonds for diversification but this of course assumes that you have the capital. More on the topic here:

      http://www.learnbonds.com/bonds-vs-bond-funds/

      Best Regards,
      Dave

  2. DKB says

    This is likely the result of one or both of the following: on-the-run versus off-the-run dynamics, and technical set up.

    The most recently issued bond of a credit or company are called “on-the-run”. They are generally more sought after by index funds and therefore considered more liquid than previous issues. This creates a spread premium for the on-the-run issues, which could explain why the 42s (which were issued in 2012) are more expensive than the 40s (issued in 2010).

    Unfortunately most bond investors aren’t privy to technical landscapes, but the set-up here could be as subtle as a certain trader at a broker/dealer is short the 42s and needs to cover at a reasonable spread. This would raise the bid and therefore raise the offer of this particular issue, creating a divergence between this particular bond and the other bonds that SO has issued.

    Bond market dynamics are different from equities, and the differences in pricing of bond issues among the same issuing entity is a prime example.

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