Victor Lazarovici,
Nesbitt Burns

This year has not been kind to Corporacion Nacional del Cobre de Chile (Codelco), Chile’s state-owned mining company and the world’s number-one copper producer. The firm, which accounts for 15% of world copper supply and 45% of Chile’s export earnings, has had to deal with weak prices, sluggish demand, global oversupply and capital scarcity.

To make matters worse, in October, rival Grupo Mexico successfully bid to acquire US mining company Asarco for $2.2 billion-a deal that would turn the Mexican conglomerate into the world’s third largest copper producer, and an even bigger potential competitor. With that announcement, Latin America promises to become a hot spot in the race for global copper dominance and further consolidation.

Despite these developments, Codelco executives remain bullish about the company’s future. And many analysts are betting that the Chilean mining company, like a seasoned toreador, will be able to dust itself off after a close call with the bull and return to slay the beast.

Codelco’s fortunes took a sharp turn for the worse after so many Asian economies collapsed in 1998, sending global commodity prices into a tailspin. The company responded by implementing an emergency cost reduction plan that included wage cuts and dismissals at its five mines-Chuquicamata, El Teniente, Salvador, Andina, and Radomiro Tomic. It also sold off non-core assets and shifted production from higher- to lower-cost mines.

The combined measures have helped trim Codelco’s already low operating costs during each of the past two years. Still, Codelco’s pre-tax profits fell by a stunning 49% in the first half of 1999 to $122 million-one of the company’s worst financial performances in history.

Codelco’s financial outlook has improved in the second half of the year as copper prices have risen from 61 cents per pound in March to just under 80 cents in October. Many analysts expect prices to strengthen during the remainder of 1999, and that Codelco will generate more than $200 million in profits this year. “Considering the weak pricing environment, Codelco’s financial numbers this year are respectable,” says Victor Lazarovici, managing director and senior base metals analyst at Nesbitt Burns in New York.

And the outlook for 2000 is even better, as a global economic expansion, coupled with the closure of several competitor mines in North America, could mean rising demand for the company’s high-grade cathode. While few expect a return to the halcyon days of 1995, when copper prices exceeded $1.30 per pound, Jim Conklin, Lehman Brothers currency strategist thinks copper prices could rise to 90 cents a pound or even higher next year. Merrill Lynch First Vice President René Kleyweg is even more bullish; he expects prices to pierce the $1 per pound mark within the next two years, giving the company and the Chilean economy a shot in the arm.

Taking Stock
Despite its quasi-sovereign status, Codelco, like many other Latin American blue chip companies, saw its capital costs rise in the wake of Russia’s debt moratorium last August.

After a long absence from the international debt markets, Codelco issued $300 million worth of 10- and 20-year notes in April 1999, taking advantage of the favorable investment climate sparked by Chile’s first sovereign issue in ten years. Investors eagerly snapped up those bonds, which were rated as A- by Standard&Poor’s and Baa1 by Moody’s Investors Service and priced at 217 basis points over US Treasurys.

Codelco Vice President of Finance Mario Espinoza told LatinFinance that his company will be monitoring market developments closely in 2000 and is prepared to take advantage of “future opportunities that the market can offer,” including syndicated loans, Yankee bonds, and eurobonds. Nevertheless, he emphasized that Codelco has no plans to change its long-standing tradition of financing expansion activities primarily with its own resources.

Codelco has traditionally enjoyed tremendous economies of scale in copper production and distribution. Recent merger activity within the global sector, however, may force Codelco to go “pit to pit” with competitors of comparable resources and capabilities, such as Phelps Dodge and Grupo Mexico. The former boasts an annual copper production capacity of almost one million tons, following its purchase of Cyprus Amex Minerals. The latter, meanwhile, has an annual production capacity of almost 850,000 tons following its Asarco acquisition. “With the recent consolidation of North American producers, the days of market leadership seems to be ending,” says Alberto Arias, Goldman Sachs Latin American metals and mining analyst. “Codelco has to start to get used to the idea to being first among equals.”

Not all observers, however, feel that the trend toward fewer but larger, producers is necessarily bad news for Codelco. Lehman’s Conklin, for instance, believes that further consolidation within the global sector could lead to a situation where a small number of producers are able to regulate production in cartel-like fashion in order to stabilize prices. “This could mean windfall profits to low cost producers such as Codelco, whose cash costs are significantly below the global average,” he says. Codelco executives, meanwhile, insist the company isn’t concerned about the competitive threat posed by the new mega-miners. “For us, the real challenge is to develop new industrial applications for copper that will increase the size of the pie,” says Codelco Chairman Marcos Lima. This includes the development of a new copper alloy that is lighter yet more durable than aluminum, which could be used in the production of car radiators and other industrial machinery. “Our real competitors come from the plastics and aluminum industries,” adds Codelco’s Espinoza.

Working On Growth
Unlike many of its competitors who responded to the slumping global prices by closing mines and shelving expansion projects, Codelco has continued to look for ways to expand output.

Thanks in large measure to an expansion at its Andina mine, first-half production this year rose to 724,000 tons-a 5.6% increase over 1998’s figure.

And while company officials expect copper production to remain flat at 1.5 million metric tons in 2000, they anticipate significant output gains in 2001, once a major expansion at its Radomiro Tomic mine is complete. Codelco will pump more than $200 million into Radomiro Tomic, located near the northern town of Calama, over the next two years to purchase trucks, excavators, front-end loaders, and other machinery.

When the expansion is complete, Tomic will produce 250,000 tons of copper a year-an increase of 75,000 tons over present capacity. The company hopes that expansions and productivity increases throughout its five divisions will help it keep pace with global demand, which is rising by 2% to 3% annually.

In addition to expanding its output, the company has been forced to seek out new markets for its red metal since the sharp fall in Asian demand. Fortunately for Codelco, it hasn’t had to look far. Exports to the US have grown by 200% during the past two years and are expected to continue growing at a rapid, albeit slower, pace in the years ahead. “We are very bullish about the outlook for future export growth in the North American market,” says Lima.

Good Partners Wanted
Standard&Poor’s recently wrote that one of Codelco’s chief problems is its “limited geographic diversification compared with its global metal company peers, since its existing mines are all located in Chile.” The Company acknowledges this liability, but notes that it is actively seeking out mineral exploitation opportunities in other regions. Codelco also continues to strike joint ventures on the exploration side. In October, it signed an agreement with Mexico’s Penoles SA de CV, the world’s largest silver producer, to prospect for copper deposits in the Mexican state of Sonora. This adds to its existing exploration partnerships with firms such as Cyprus Amax, Asarco, Canada’s Cominco, South Africa’s Billiton, and Finland’s Outokumpu.

While such alliances are undoubtedly a good thing, analysts warn that Codelco must also further reduce costs and rationalize production in order to keep a leg up on the competition. “The focus in the sector has shifted from increasing supply to minimizing costs and maximizing productivity,” says Merrill’s Kleyweg. “While Codelco has done a decent job on the latter, it cannot take its eye off the ball for one moment, since its competitors are moving quickly to streamline and innovate.”

Will Codelco Be Privatized?
Many Wall Street analysts believe that the Chilean government should take Codelco private in order to provide the company with access to capital, technology and management expertise needed to maintain competitiveness. One of those is Mauricio Reveco, Latin America Mining and Steel Analyst at Salomon Smith Barney.

Reveco argues that privatization would give Codelco the agility it needs to seize opportunities in the highly dynamic global mining sector.

“A government-owned mining company simply cannot move from the exploration phase to the operation phase with the same speed and flexibility as a private company,” Reveco says. “In Codelco’s case, investment decisions must be approved by Congress and several committees before monies are allocated.

Private sector companies, by contrast, can move much quicker, and that’s a real advantage.”

And while Codelco has recently announced plans to sell its 82.5% stake in mining equipment manufacturer CMS TechnologÌa, few observers expect any of the company’s core mines to be auctioned in the near future. Even those such as Salvador with comparatively high operating costs and low profitability are seen as politically sacrosanct.

Ironically, the person most likely to push the privatization envelope the furthest is Socialist Ricardo Lagos, who as of this writing was the leading candidate for the December presidential elections. Lagos, who was ambassador-designate to the Soviet Union at the time former President Salvador Allende was assassinated, says he would invite joint ventures with private investors to prospect for new mines and exploit existing capacity in and outside of Chile. He would also aim to revise a law stating that 10% of Codelco’s revenues must go to the military and use these to pay for social programs.

Conservative candidate Joaquin LavÌn would also welcome additional private sector involvement in Codelco, but stop short of full-scale privatization unless there was a clear public mandate. “We think that privatization should be an issue of going ahead in order to improve efficency…(but) it has to be done in a way that you obtain the consensus of the people involved,” stated former finance minister and current LavÌn economic adviser Hernan B¸chi during a recent Council of the Americas meeting in New York. Many observers question, however, whether such a consensus could ever be reached in Chile given the political sensitivity on unemployment and the possibility of sweeping layoffs if Codelco were to be auctioned.

While the next Chilean president will undoubtedly tread carefully on the privatization issue, Wall Street analysts are upbeat about the prospects for positive, market-oriented changes at Codelco, no matter which candidate is elected. “Both candidates seem to understand the need to allow greater private sector involvement in Codelco in order to introduce agility, flexibility, and entrepreneurship,” says Arias of Goldman Sachs. “This understanding bodes well for both Chile and Codelco’s future.”