Dividend, Molybdenum Business Make Southern Copper a Buy

by Jeff Reeves | August 9, 2012 11:59 am

Southern Copper (NYSE:SCCO[1]) is perhaps one of the strongest of the large-cap materials stocks in 2012.

Aluminum stocks like Alcoa (NYSE:AA[2]) and the Aluminum Corp of China (NYSE:ACH[3]) remain flat, steel stocks like AK Steel (NYSE:AKS[4]) and U.S. Steel (NYSE:X[5]) are in the red significantly and even other copper stocks like Freeport-McMoRan Copper & Gold (NYSE:FCX[6]) are lagging.

So what makes Southern Copper so hot, fueling a 10% gain year-to-date that tracks the S&P and beats the Dow Jones Industrial Average?

And more importantly, can SCCO stock keep this up?

I think it can. Copper is, of course, the lifeblood of this pick. But a well-run business, a strong dividend history and an interesting angle on the element molybdenum make this materials stock an interesting opportunity right now.

SCCO Needs Firm Copper Pricing

For starters, let’s admit that the underlying base-metal prices are half the battle; these companies have limited control over how much they can charge for their products.

Sure, if metal prices are soft, they can curtail production and limit supply … but in an environment like this where an economic downturn has gutted demand from housing, manufacturing and other sectors, there’s only so much a supplier can do. After all, they can’t shut off the plant completely or they will go broke.

Click to Enlarge A look at this chart tells you the history of copper prices in the wake of the financial crisis.

Oddly enough, you’ll notice that in 2011, copper prices actually crested pre-recession highs!

There were two main reasons for this. The first is simple: The demand side recovered from 2009 lows and outstripped mining supply. The second is more tricky, because it’s all about speculation.

Hedge funds started piling into copper starting in 2010 as hard commodities became a favored asset amid stock market volatility, sovereign debt woes and ultra-low U.S. interest rates. Stockpiling from China also pushed up the metal as the nation looked to diversify its treasury holdings and perhaps hoard the metal for future use.

Now copper prices have reached somewhat of an equilibrium after drawing back from their highs. So has Southern Copper stock, which is down more than 30% from its early 2011 peak.

This encapsulates your investing thesis for SCCO. In short, copper prices need to move up for SCCO stock to move up. The miner lays claim to the world’s largest copper reserves at 146 billion pounds, so it lives and dies with the movement of this metal.

If you’ve read my previous columns on materials stocks, I remain convinced that baseline demand will put a floor under these picks. In May[7], I pointed to Alcoa and ArcelorMittal (NYSE:MT[8]) as stocks that might be worth checking out. AA has lagged the market slightly, but MT stock is up over 13% since my column, doubling the S&P 500. And just this week, I made the long-term bullish case for commodity stocks[9] as cyclical plays and a hedge against a weaker dollar in 2013.

Commodity stocks always are volatile, but a look at the charts shows that in the short term, there seems to be limited downside thanks to strong baseline demand. And considering glimmers of hope in housing and tech — big drivers of copper demand — I think it would be wise to stake out a position in SCCO in the coming months.

Beyond Copper

As I mentioned in the introduction, however, there are other important reasons to like SCCO stock beyond just its copper business.

A Secondary Play: Southern Copper owns molybdenum and zinc reserves as well as copper. If you’re not familiar with the mouthful that is molybdenum, it is a chemical element that can withstand ultra-high temperatures and thus is used in a wide variety of high-tech industries — from solar cell production to high-temperature lubricants to biological applications. Rare earths are an exciting but unproven part of the market. Rather than speculate in a volatile pure-play like Molycorp (NYSE:MCP[10]), which mines for molybdenum as well as rare earths, and which is off more than 45% year-to-date in 2012, SCCO is a milder way to get into this industry.

A Well-Run Operation: Compared with other base-metals companies, SCCO is a well-oiled machine. The company sports net margins approaching 35% and operating margins above 50%! That dwarfs the single-digit margins in companies like Alcoa and U.S. Steel that are producers and not miners. But even compared with mining peers like Freeport-McMoRan, Southern Copper is way in the lead on a margins basis. With a cool $2 billion in operating cash flow and a five-year growth rate of 8% annually for its earnings, SCCO clearly is a stable company that knows what it’s doing.

Big Dividends: I’ll admit, the dividend is volatile. But even if you take the last payment of 24 cents — the lowest in more than two years — and annualize it, you get a yield of 2.8% (24 cents x 4 quarters = 96 cents a year / a share price just south of $34). Not bad. And if you take the past four dividend payments that total $2.09, you get a yield of 6.2%! Granted, SCCO is pushing it by paying more than 80% of its profits to shareholders in the form of dividends. But it stands to reason that as profits rise, dividends will too.

Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.”[11] Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he was long AA.

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