/ 2000 First Quarter Results
GMEXICO
LONG TERM BUY
During the quarter, GMexico generated some savings at the recently acquired operations of Asarco. However, the duration of certain purchase agreements have not allowed for higher integration among GMM and Asarco, and led to a higher accumulation of inventories as compared to 4Q99. Standing out was Asarco’s EBITDA of US$ 15 million, as compared to 4Q99 losses. Nonetheless, as Asarco is still less profitable than GMM, gross margin fell during the quarter. Depreciation rose 80.3%, but negative goodwill of Ps 719.8 million made it seem as though non-cash charges (depreciation and amortization) fell 77.4%. Higher leverage due to Asarco’s acquisition led to a strong increase in interest expense and higher monetary gains despite lower inflation.
GMexico signed an agreement with CSR Ltd., for the sale of Asarco’s aggregates division for US$ 211 million. These proceeds will be used to pay down debt. Following this transaction, GMexico’s EV/EBITDA multiple should drop from 10.4x to 10.0x, and a large part of the loan taken on to finance Asarco’s acquisition will be repaid. On the other hand, the company, jointly with other large worldwide producers, could become one of the founding members of an electronic procurement page. GMexico will keep 70 million shares or 11.11% of current shares outstanding in its treasury, which will be used to negotiate mergers, acquisitions or strategic alliances. Our 2000E estimates have the EV/EBITDA multiple dropping from current levels of 10.4x to 7.4x. It is important to note that Phelps Dodge’s current T12 multiple is 10.7x. As from their peak level, LME copper inventories have dropped 27.1%, while GMexico’s share price has declined 29.2%, something that could represent a good point of entry for investors seeking good long-term alternatives.
Operating Results
GMM: Following the normalization of operations at Cananea, mining production even exceeded the company’s own expectations (copper production rose 29.1% as compared to 1Q99) and inventories accumulated (copper in process rose by 13,000 tons, or the equivalent to US$ 25 million) as the pace of purchases from third parties remained constant. Lower availability of refined metal for sale led to a drop in sales volumes (12.6% in the case of copper). In contrast, as a result of the coming on line of a precious metal refinery at La Caridad, silver sales volumes rose 18.3%. GMM’s EBITDA totaled US$ 62.3 million and cash costs for the elaboration of one pound of copper were US$ 0.506. The increase vs. 1999 was due to the strengthening of the peso and higher purchases.
Asarco: Production dropped during the quarter, due to the onset of studies aimed at optimizing future production, lower extracted mineral content and increased material cutting. Higher integration among GMM and Asarco could still not be achieved, as many contracts with third parties had not expired yet. A large part of expected significant savings will come from reducing purchases from third parties. Nonetheless, Asarco saved US$ 30.6 million in mining operation costs and expenses (excluding operations in chemicals and aggregates in order to make a valid comparison). The copper wire and cake plants in Amarillo, TX, are already operating at full capacity. Another effect that led to a 12.1% reduction in copper production was the shutdown of the El Paso foundry (which was operating in 1H99). During the quarter, Asarco contributed with US$ 15.2 million to overall EBITDA, representing a substantial improvement vs. negative EBITDA of US$ 18 million in 4Q99. As regards SPCC, EBITDA totaled US$ 24.6 million on a consolidated basis. It is important to note that Asarco’s and SPCC’s cash costs for the elaboration of one pound of copper were US$ 0.782 and US$ 0.541, respectively.
GFM: Tons-kilometers rose 9.6% vs. 1Q99. Gross margin contracted 3.1 pp, due mainly to diesel price increases, which were partially offset by a better sales mix. In addition, expenses compared unfavorably against 1Q99 levels, as the railway’s modernization program was postponed in 1Q99. EBITDA margin (as a percentage of consolidated sales) ended at 28.1%, down 2.7 pp vs. 1Q99. During 1Q00, GFM invested a total of US$ 27.8 million, mainly in railway reconstruction, station and yard modernization, workshop expansions and traffic control system purchases.
As the goodwill derived from Asarco’s acquisition was reclassified from properties, plants and equipment to deferred charges in GMexico’s 1999 audited financial statements, the amortization performed in 1999 was reversed, and will now be amortized over a two-year term as from 2000, as this is how long GMexico expects it to take for Asarco to become fully integrated into the Group’s operation (our 4Q99 quarterly included the company’s non-audited financial statements).
Financing Activities
Asarco’s Enthone-OMI chemicals division was sold for US$ 512 million and explained the drop in the company’s net debt as compared to 4Q99. Still, the strong increase in leverage vs. 1Q99 led to 124.7% growth in interest expense. Higher liabilities also explained the increase in monetary gains during the quarter. The above increase, which more than offset a low inflation rate in Mexico, but could not offset higher interest expense, and led to a lower financial income vs. 1Q99. In addition to Asarco’s acquisition, the implementation of Bulletin D-4 caused equity to drop and deferred liabilities to increase by Ps 5.69 billion each, both of which translated into higher leverage.
Outlook
As from peak levels reached in March, LME copper inventories have declined 27.1% to 604,600 tons, representing the first decline in two years as compared to the last 12 months, something that should boost prices in the short-term. As a result, company margins should not come under pressure, as GMM’s and Asarco’s synergies are still not too evident. At US$ 0.848 per pound and including GFM, we expect EBITDA of US$ 853.9 million and copper revenues to account for 75.5% of total revenues in 2000. Zinc, which should represent 10.3% of revenues, has a better outlook, as zinc inventories are at historical lows. However, this favorable scenario for these metals holds only if the US is headed towards a soft landing of its economy. If hard landing occurs, we might expect reductions in metal prices.
GMexico will have 70 million additional shares (11.1% of shares outstanding) in its treasury, to be used for mergers, acquisitions or strategic alliances. Investments in railway-related business are a possibility. On the other hand, GMexico could become one of the founding members of an electronic mining procurement page, with partners such as Phelps Dodge, BHP, and CODELCO, among others. In addition, CODELCO and GMexico are analyzing the possibility of jointly exploring projects in Peru.
As the US economy’s soft landing is highly likely, the metals produced by GMexico should have favorable prospects. The company’s visibility will increase with the ADR program and the possible listing of its mining businesses on international markets in the medium term. We continue to believe that GMexico is an excellent long-term investment alternative.
Francisco Suárez
The information contained herein has been obtained from sources that we believe to be reliable, but we make no representation as to its accuracy or completeness. Neither CASA DE BOLSA BANORTE, S.A. DE C.V. nor AFIN SECURITIES INTERNATIONAL accepts any liability for any losses arising from any use of this report or its contents.
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