The Copper Stock to Watch

03/15/2012 8:15 am EST

Focus: GLOBAL

Rudy Martin

Editor, Investing Insight

An improving economy means there will be an increase in global demand and production, which means industrial commodities like base metals will be in growing demand soon...so it's time to find some good mining stocks, writes Rudy Martin of Latin Stock Investing.

People watch copper because it’s thought to be a good gauge on where the global economy is going, thanks to its myriad of economic uses. And the signals affecting copper prices are increasingly positive ones.

Copper futures pushed higher last week, erasing much of the week's earlier losses, as a better-than-expected reading on the US labor market and hopes for looser monetary policy in China propped up the demand outlook for the industrial metal.

In addition, the world's top copper producer, Chile's Codelco, said last week it will invest over $4.3 billion this year, and expects output to dip to 1.7 million tonnes in what it forecasts will remain a tight market, with demand from No. 1 consumer China remaining firm.

Finally, with the late-week near term cease fire between Greece and its creditors, now may be a great time to reconsider copper, as investors refocus on productive assets.

A major beneficiary of higher copper prices should be the stock of Southern Copper (SCCO), whose headquarters is in Phoenix, Arizona, but whose mining and smelting operations are in Mexico and Peru. Here are 3 reasons why I like US-domiciled SCCO:

  1. World class assets and integrated, low-cost operations drive top-tier margins. 

SCCO is the world’s sixth largest copper mining company. It has the world’s largest copper reserves and longest mine life in the industry.

The company holds 60 million metric tons of copper reserves. Its reserves provide an estimated mine life of over 80 years, more than double the 34 years of the next longest firm. SCCO’s fully integrated operations make it one of the lowest-cost producers of copper.

The operating cash cost per pound of copper is roughly $1.70 and stands at only 40 cents net of by-products. These factors result in healthy EBITDA margins for SCCO, which stand at the top end of the industry (SCCO at 56% vs. about 50% average for its leading competitors).

  1. High-teen production growth led by an attractive pipeline of projects.

SCCO has very strong growth prospects, with mined copper production expected to grow from 587,500 tons in 2011 to 1.1 million tons by around 2015, for a robust annualized growth rate of 17%.

The company has approved a capital expenditure program of $4.8 billion through fiscal year 2015 that will drive significant production increases. The key projects are:

  • Cuajone expansion, expected to be complete by the third quarter of 2012, resulting in an increase in the copper production there of 22,000 tons per year.

  • Buenavista SXEW III plant scheduled to be operational by the second half of 2013, with an increased capacity of 120,000 tons per year.

  • Angangueo project, planned for production in the second half of 2014 with an annual capacity of 36,000 tons of copper, 41,000 tons of zinc, 4.5 million ounces of silver and 6,600 tons of lead

  • Toquepala project scheduled to be complete by the first quarter of 2014 with an annual copper production of 100,000 tons per year.

  1. Sound copper-market fundamentals, underpinned by Asia growth.

The long-term demand fundamentals for copper remain sound, driven by growth in Asian economies (Asia accounts for 60% of the total world demand, with China consuming 37% of total copper output).

The prevailing economic uncertainty is weighing on copper prices. However, the supply situation for fiscal 2012 is expected to remain tight, given little incremental production and falling grades. Copper demand is geared to electrical, construction, and industrial applications, and will pick up as global economic growth rebounds.

Naturally, there are other types of risks associated with higher copper prices. For example, the benefit from high copper prices could be mitigated if manufacturers choose to substitute aluminum for copper to cut costs.

If you agree with a higher copper price scenario, there are other stocks you could also consider if you like this idea. For example, Freeport McMoran Copper & Gold (FCX) has seen a sharp rise in revenues due to steady escalation in the price of copper. Other competitors of Southern Copper include Codelco and Newmont Mining (NEM).

In addition, if you want something a bit off the beaten path, you could also buy Grupo Mexico (GMBXF). It’s the $24 billion market value pink sheet-listed company that owns 80.9% of SCCO. Last fall, it called off a poorly executed offer to merge SCCO into Asarco, which Grupo Mexico also owns.

For now, my pick is stick with SCCO, which has the trading liquidity and strong institutional investor support. I like this idea of a stock with a solid franchise, improving market fundamentals, and growing operations.

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