Streetwise

Lauren Rudd

Sunday, March 31, 2013

Copper Will Play an Expanding Role

Before you decide to become a card carrying member of the Chicken Little league as a result of listening to the soothsayers of doom, consider that a funny thing happens on the way to Wall Street. Stocks over time outperform other investments...period.

The key reason is that businesses retain earnings, which are reinvested to generate additional earnings and higher dividends. Driving it all is the basic theory of compounded return. This was pointed out as far back as 1924 with the publication of a slim little book titled “Common Stock as Long Term Investments,” written by Edgar Lawrence Smith.

Legendary economist John Maynard Keynes, in reviewing the book, was quick to delineate that most important point. Keynes wrote, “Well-managed companies generally do not distribute to shareholders the whole of their earned profits. In good years, if not in all years, they retain a part of their profits and put them back in the business. Thus, there is an element of compound interest operating in favor of a sound industrial investment.”

Nonetheless, it is no secret that the Wall Street playing field is not level and that the financial markets have always been driven by greed and a liberal interpretation as to what denotes fair play. However, the Street’s antics should never be an impediment to your investment policy or program.

So where and how do you start? One good way would be to search for companies that show a symbiotic relationship with an expanding economy. One possible example might be Southern Copper (SCCO). The Company is an integrated copper producer with the industry’s largest copper reserves. It operates mining and exploration facilities in Mexico and Peru, with additional exploration undertakings in Argentina, Chile, and Ecuador.

The Company’s strengths include mining, milling, and flotation of copper ore; smelting of copper concentrates to produce anode copper; and refining of anode copper to produce copper cathodes.

A year ago when I wrote about Southern Copper my 2012 earnings estimate was $2.55 per share, with a 12-month target price on the shares of $35.50, for a capital gain of 12 percent. In addition, there was an indicated dividend, consisting of both cash and stock, of 6.6 percent. Earnings came in at $2.28 per share; yet the shares recently closed at $36.45.

Looking at Southern Copper’s financial results for 2012, net sales were $6,669.3 million, only about 2.2 percent lower than 2011’s historical record, despite a 10 percent lower copper price. This result was made possible by an overall increase in sales volume, specifically copper sales up 7.1 percent, silver up 14.6 percent and zinc sales up 3 percent, thereby enabling the Company to pay a stock/cash dividend in 2012 of $4.06.

Net income for 2012, excluding a court ordered one-time legal fee of $316 million, was $2.25 billion for a 33.7 percent profit margin. If you include the payment, income falls to $1.93 billion, yielding a profit margin of 29.0 percent.

Capital expenditures were a record $1.05 billion, reflecting a strong commitment to expansion programs designed to develop the Company’s full potential.

A slowdown in the Chinese economy, combined with the Eurozone debt crisis, weighed heavily on copper prices in 2012. However, the Chinese economy is again expanding, while our domestic housing market is also improving. These factors should result in higher copper prices in 2013, auguring well for copper producers.

A discounted earnings model yields an intrinsic value of $47 per share utilizing a 12 percent discount rate combined with a consensus 5-year earnings growth rate of 9.4 percent. The more conservative free cash flow to the firm model suggests an intrinsic value of $77 per share, using a discount rate of 9.43 percent, which is the Company’s weighted average cost of capital. The shares recently closed at $36.45.

My earnings estimate for FY 2013 is $2.70 with a projected share price of $43 yielding a capital gain of 18 percent. There is currently an indicated cash dividend of $0.96 or 2.70 percent.