Codelco Financial Results Indicate Potential Weakness Ahead
BMI View: The announcement by Chilean state-owned Codelco of both weaker earnings and lower mined output reflect both company-specific and industry-wide challenges facing the firm. In the quarters ahead, we expect Codelco will face upward cost pressures,at the same timeaswe forecast continued moderation in copper prices. Looking towards the longer term, we believe tensions may increase between the firm, which is seeking capital for significant investment projects, and the Chilean government, which underPresidentMichelle Bachelet is likely to increase social spending.
State-owned Chilean mining firm Codelco's final 2013 financial results indicate year-on-year (y-o-y) deterioration in the company's operational performance and weakening global prices for copper. Total 2013 production came in at 1.62mnt of copper, allowing the firm to maintain its status as the world's top copper producer, but marking the lowest level of production since 2008. Compared to 2012 in particular, lower ore grades forced the firm to dig deeper at various deposits, leading to production falling 1.5% on a y-o-y basis. Indeed, production fell at all of Codelco's mines, except for an 8% increase at the firm's El Teniente mine. While Codelco claimed it lowered cash costs by 0.3%, we believe cost risks remain to the upside given continued water access issues and the multi-year trend of declining ore grades.
|Copper Prices To Head Lower|
|Historic & Forecasted Three-Month LME Copper Prices|
Crucially for the firm's bottom line, production declines occurred at the same time as copper prices moderated, averaging 7% lower over the course of 2013 at US$7,349/tonne compared to 2012, when prices averaged US$7,955/tonne. Furthermore we forecast copper will average US$6,800/tonne in 2014 and US$6,750/tonne in 2015 on the back of slowing Chinese demand growth and ample supply. Lower average prices led Codelco's copper sales to drop to US$12.02bn in 2013, compared to US$12.79bn in 2012. Hence, the firm cited pre-tax profits of US$3.89bn in 2013, a decrease from US$4.01bn in 2012. When including Codelco's acquisition of a stake in Anglo American Sur S.A in 2012, which added US$3.79bn to 2012 profits for a total of US$7.81bn, the firm's pre-tax profit dropped by slightly over 50%.
Potential Tension Between Codelco And Government
Given Codelco is state-owned, its profits are sent to the country's treasury, giving the government final say on how much cash the company can retrain. Thus, Codelco must negotiate with the government to secure the nearly US$23bn through 2017 it is seeking for investment projects to compensate for declining ore grades and mined output. While we believe it is likely that the government of the new administration of President Michelle Bachelet will fully fund Codelco to maintain the country's competitiveness in the copper space, at this point the situation remains ambiguous enough that we cannot rule out potential funding disagreements ahead. Particularly given that the country's fiscal surplus is likely to continue narrowing, from 2.9% of GDP in 2013 to 1.8% and 1.6% of GDP in 2014 and 2015 respectively, we expect further tensions between Codelco's financial needs and the Bachelet administration's proposed social spending plans.
|Nominal Surplus To Continue Narrowing|
|Chile - Central Government Budget Balance|
Should Codelco ultimately face lower-than-expected funding commitments from the Chilean government, we believe it is likely to modify its financing policies rather than scale back investment plans and cede market share to other firms (see '2014 To Prove Crucial Year For Codelco's Strategy,' January 24, 2014). Under such a scenario, the firm could tap capital markets as it did in August 2013 when it issued US$750mn of new debt and issue bonds with greater regularity. The company's net debt-to-EBITDA ratio of slightly over 10, while higher compared with the previous several years, does not appear unsustainable and is lower than levels seen in the previous decade. Thus, we believe the firm has leeway to issue new bonds and thereby raise private money.
Chilean Copper Sector's Fate Tied With Codelco's
Given that Codelco accounted for approximately 30% of total mined copper output in Chile in 2013, we expect the firm's ultimate investment plan to have a significant impact on the Chilean copper sector's relative position within the Americas. While we still expect Chile to remain the world's top copper producer through 2018, further production declines by Codelco could lead to its relative share being slightly eroded. In particular, the tension between Codelco and the Chilean government is one factor underlying our view that Peru's copper sector, which has a strong investment pipeline and as of yet has not faced the same level of upward cost pressures seen in Chile, should see faster growth than Chile. Indeed, we forecast Peruvian mined copper output will grow an average of 3.8% per year through 2018, compared to Chile's average annual growth of 2.0%.