Don't Ignore Southern Copper Corp's Q1 2014 Results

Southern Copper's net income took a big year-over-year hit, and it is not the only company facing significant volatility in the short term.

May 6, 2014 at 12:15PM

Southern Copper's (NYSE:SCCO) first-quarter 2014 results are in, and the numbers are not too pretty. Year over year, its earnings before interest, taxes, depreciation, and amortization fell 22.7%, and its net income fell 34.7%. Now is the time to take a step back, look at the situation, and understand where Southern Copper is and where the industry is going. A bad quarter is only one data point, but the fundamental forces at play are not transient.

What happened?
In simple terms Southern Copper's production increased and prices have fallen. The problem is that prices have fallen much further than Southern Copper's production increased. From Q1 2013 to Q1 2014, COMEX copper prices fell 10%, molybdenum by 12%, silver by 31.9%, and gold by 20.6%. In the same time frame, Southern Copper's total production grew 8.8%. The simple reality is that the company's production did not increase enough to compensate for the fall in prices.

It gets worse
If Southern Copper was the only company raising production, there would not be a big problem -- but it is not the exception. To hit profit targets, miners are encouraged to increase profitable production, but this only adds to the market's supply issues. According to the International Copper Study Group, from January 2013 to January 2014 world copper production increased from 1.47 million metric tonnes to 1.54 million metric tonnes. The only encouraging news is that after making a number of adjustments, January 2014 world refined usage of copper of 1.87 million tonnes was 0.023 million tonnes greater than production.

Some miners have cut their copper production but only by small amounts. From Q1 2013 to Q1 2014, Freeport-McMoRan Copper & Gold (NYSE:FCX) cut its copper production from 980 million pounds to 948 million pounds. The big gold miner Barrick Gold (NYSE:ABX) cut its copper production from 127 million pounds to 104 million pounds in the same time period. Newmont Mining (NYSE:NEM), on the other hand, increased production from 65 million pounds to 77 million pounds in the same time period.

What does the future hold?
When the times are good, it is easy to forget that markets are inherently unstable. Beyond the fact that production does not automatically change to prop up prices, there is another element of instability specific to copper. 

Copper is commonly used as collateral for Chinese loans. Goldman Sachs estimates that up to 1 million metric tonnes, or 2,205 million pounds, of copper could be released onto the copper market during the next couple years if yuan volatility continues.

Falling copper prices can force highly indebted borrowers to put up more collateral or unwind their positions, making a situation where falling copper prices create falling copper prices. In simple terms volatility begets volatility.

The big gold miners Barrick and Newmont are in a rough spot after calling off their proposed merger. Barrick's Q1 2014 adjusted net earnings fell to $238 million from $923 million a year earlier. In the same time frame, Newmont Mining's adjusted net income fell to $108 million from $353 million. Copper helps to supplement their gold production and stabilize their income. Copper volatility means that they have one less tool to help counteract low and volatile gold prices

Southern Copper and Freeport-McMoRan can expect significant volatility in their copper earnings in 2014. Like Southern Copper, Freeport-McMoRan's Q1 2014 net income attributable to common shareholders fell to $1.1 billion from approximately $1.3 billion in Q1 2013. These numbers are not encouraging, but they are expected given the unstable macro environment. 

Where does this leave investors?
The slow response of production to declines in copper prices and Chinese copper loans paints a volatile picture of the immediate future. In the short term, expect more earnings cuts. It is not exactly a secret that volatility comes and goes periodically, so such periods of instability are to be expected. Southern Copper and Freeport-McMoRan have short-term challenges, but they are still promising long-term investments as demand for copper is not going to disappear anytime soon.

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Joshua Bondy has no position in any stocks mentioned. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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