Grupo Mexico weathers the storm (October 16, 2006)

Lima, Peru — The Atlantic hurricane season has been mercifully light this year, but Mexican copper, coal and zinc miner Grupo Mexico (GMBXF-O, GMEXICOB-M) still got its share of storms. From a coal mining disaster that killed 65 miners and crippling strikes in Mexico, to two failed expansion attempts in Peru, things might have seemed exceptionally difficult if not for the saving grace of high metals prices and the record profits they have brought the Mexico City-based company.

Grupo Mexico, which controls its mining assets via its Lima-based subsidiary Southern Copper Corp., appears to be through the worst of its torments, however, and production and labour relations are quickly recovering. Grupo Mexico’s bankrupt U.S. division, Asarco, is also off its books and is being handled by a creditors’ committee.

“Hopefully, with all these things, we should be pretty much running all of our mines normally by the fourth quarter of this year,” said Southern Copper’s chief financial officer, Eduardo Gonzalez.

Copper output is expected to reach full capacity at the company’s La Caridad mine in northern Mexico, one of the world’s biggest copper pits, by mid-November, as output recovers following a tumultuous internal union battle that began in March, prompting a 4-month-long walkout and a production loss of around 45,000 tonnes of copper-in-concentrate and around 9,000 tonnes of copper cathode production. Grupo Mexico was forced to fire all its 2,000 workers at La Caridad in July after the Labor Ministry approved the cancellation of a collective contract to break the strike.

The walkout was an attempt to pressure the government to reinstate the head of the country’s mining union, Napoleon Gomez, who is accused of stealing from a US$55 million worker fund. Workers at Grupo Mexico’s other big Mexican copper mine, Cananea, went on strike for six weeks in June in support of Gomez, costing the company losses of 16,500 tonnes of copper-in-concentrate and 7,500 tonnes of copper cathode production. Gomez, who denies any wrongdoing, is in hiding in Canada after officials with the United Steelworkers of America gave him asylum in Arizona in March. The mining union’s new, government-backed leader, Elias Morales, says he hopes Mexico will arrest Gomez, 60, before the end of the year.

“I want him to pay by going to jail for robbing from the workers’ fund, whether he pays the money back or not,” Morales says.

But a hard-line faction of the Mexican Mineworker union still supports Gomez, meaning Grupo Mexico is careful about whom it rehires at La Caridad. Gomez, who took over from his father as the head of the union in 2001, remains popular because he has led dozens of strikes, winning substantial increases in wages and benefits. But Grupo Mexico and the government can ill-afford more walkouts at Cananea, the world’s fourth-largest copper mine in terms of reserves, or La Caridad, which has an 80-year life, because they are an important source for China’s and India’s surging demand for metals. Peru is the world’s third-largest copper producer, while Mexico ranks tenth, according to the U.S. Geological Survey.

Grupo Mexico, via Southern Copper, aims to push ahead with a US$120-million expansion plan at Cananea, building a third solvent extraction-electrowinning (SX-EW) facility to provide an additional 33,000 tonnes of copper cathodes a year from 2008. The project is part of a drive to increase production by 40% at the mine. The company is spending US$90 million on expanding Cananea’s concentrator capacity by 33,000 tonnes of copper-in-concentrate a year, and adding a US$25-million molybdenum circuit to produce 4,000 tonnes of the metal annually.

Overall, Grupo Mexico’s copper production could rise by 60% over the next four years to around 1.2 million tonnes of copper, as new Peruvian projects Tia Maria and Los Chancas, and Mexican project El Arco come on-stream. El Arco, in Mexico’s Baja California peninsula and with around 1 billion tonnes in resources, is expected to require around US$1.4 billion in investment, including road links and power and water supplies, according to a 1996 prefeasibility study.

Southern Copper is also considering expanding its Ilo copper smelter on Peru’s southern coast, to take capacity to 1.8 million tonnes a year, up from the current 1.2-million-tonne level.

“The (US$400 million) modernization project at the Ilo smelter continues on schedule and should be finished by the end of 2006,” says SCC’s chief executive, Oscar Gonzalez.

The drive for internal growth comes as Grupo Mexico has struggled to expand via acquisitions so far this year. Swiss-based Xstrata (xsraf-o, xta-l) beat the company to the Tintaya copper mine in the central Andes after BHP Billiton (BHP-N, BLT-L) decided to sell off the pit, making a higher US$750-million bid. Grupo Mexico also lost out in its bid for Peru’s promising Toromocho copper deposit, after the deposit’s owner, Canada’s Peru Copper (PCR-T, PCU-N), described Southern Copper’s bid as “frivolous.” Company officials have declined to comment and analysts say the episode remains a mystery given the potential of Toromocho, which could be one of Peru’s biggest copper pits once it is developed.

Merger scenarios

Southern Copper’s longer-term position has also thrown up some confusion after Grupo Mexico has openly talked about different merger and acquisition scenarios.

“We see options such as associating ourselves with other global companies such as Phelps Dodge, Xstrata, Anglo American and Rio Tinto,” Oscar Gonzalez told reporters on the sidelines of a Peru gold conference in May. Eduardo Gonzalez said in April that Grupo Mexico would consider reducing its 75% stake in Southern Copper to a minority position for the right price.

A possible merger between Phelps Dodge (PD-N) and Southern Copper has been the subject of much media speculation and something analysts say could work.

“Our analysis suggests that the (possible) transaction makes a lot of strategic and financial sense,” says Deutsche Bank analyst David Martin.

A Southern Copper purchase could drive earnings per share up by nearly 60% and up to almost 50% if Phelps Dodge took over Southern Copper, analysts suggest. The merger would create the world’s second-largest copper miner, second only to Chile’s Codelco and give Phelps Dodge access to Grupo Mexico’s huge reserves. Grupo Mexico and Southern Copper have declined to comment.

“Studies are always being done about what is out there, but no company is a target right now,” said Juan Rebolledo, Grupo Mexico’s head of international affairs.

— The author is a freelance writer based in Lima, Peru.