More Growth Ahead at an Attractive Valuation: Raising Target Price

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1 Latin American Equity Research New York, November 22, 2010 Company Report Mexico Mining GRUPO MEXICO More Growth Ahead at an Attractive Valuation: Raising Target Price Victoria Santaella BUY Sergio Matsumoto New York: Santander Investment Securities Inc. New York: Santander Investment Securities, Inc (11/16/10) CURRENT PRICE: M$41.15/US$3.31 TARGET PRICE: M$52.00/US$4.10 What s Changed Rating Maintaining Buy Price Target (M$) to from EBITDA Estimates (US$ Mn) 10 to 4,094 from 4, to 6,783 from 5, to 7,623 from 6,806 Company Statistics Bloomberg GMEXICOB 52-Week Range (US$) E P/E Rel to the IPC (x) E P/E Rel to Mining(x) 0.6 IPC (US$) 2,869 3-Yr EPS CAGR (09-12E) 69.7% Market Capitalization (US$ Mn) 25,768 Float (%) Mth Avg Daily Vol (US$ Mn) 41.2 Shares Outst - Mn 7,785 Net Debt/Equity (x) 0.2 Book Value per Share 0.75 Estimates and Valuation Ratios 2009A 2010E 2011E 2012E Net Earn (US$ Mn) 887 1,872 3,659 4,336 Current EPS P/E (x) P/Sales (x) P/CE (x) FV/EBITDA (x) FV/Sales (x) FCF Yield (%) (1.9) Div per share (US$) Div Yield (%) Sources: Bloomberg, company reports, and Santander estimates. Investment Thesis: We are increasing our YE2011 target price to US$4.10 (M$52.00) from US$3.40 (M$44.80), which implies total upside potential of 29.0% in U.S. dollar terms, including a 5.1% dividend yield; thus, we are maintaining our Buy rating on the stock. The main drivers behind our recommendation include: Higher copper prices. We have revised our copper price estimates to US$4.00/lb. for 2011 and 2012 from our previous estimate of US$3.65 for both years, largely owing to stronger-than-anticipated demand, including the soon-to-be launched copper ETFs. However, we see a strong ceiling in copper prices at US$4.00/lb. Higher copper prices led to higher valuations for Southern Copper (YE2011 target price of US$47.40) and Asarco, than we previously estimated. Railroad division reaching record profits, driven by exports from Mexico to the U.S. We now expect a higher long-term load volume growth rate for this business (4.9% annual growth rate versus our previous conservative assumption of 3.5%). This plus a lower WACC assumption translate into a higher valuation of this division of US$4.0 billion. Further value may be unlocked with the potential IPO of this division sometime in 2011; the stock is currently trading at a 32% discount on a P/E basis compared with the industry average in the Americas. Company total EBITDA expected to grow by 66% in 2011 and 12% in 2012, largely driven by the re-start of the Cananea mine in Mexico, strong copper prices, and solid growth from the railroad division. For 2010, we expect EBITDA to grow by 93%, largely explaining the strong performance of the stock, up 46.6% YTD. Attractive discount versus it NAV at 30%. According to our estimates Grupo Mexico is trading at a 30% discount to its NAV, which is significantly higher than the 20% discount that we believe it deserves. Reasons for change to price target/estimates: Higher copper prices, updated assumptions for SCCO (including the recently announced expansion of Cananea in 2015), Asarco, and transportation divisions. Valuation and Risks: Our target price is based on a sum-of-the-parts DCF valuation analysis. Our target suggests 29.0% total-return potential, including a 5.1% dividend yield. Main risks include the high correlation with copper prices, ongoing strikes mainly in Mexico, delays in the start of projects, higher-than-expected royalties and taxes in Mexico and Peru, and a slowdown in economic activity, mainly in China. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212) * Employed by a non-us affiliate of Santander Investment Securities Inc. and is not registered/qualified as a research analyst under FINRA rules.

2 Grupo Mexico: More Growth Ahead at an Attractive Valuation: Raising Target Price Grupo Mexico (Gmexico) is a Mexican holding company with interests in mining, smelting, and refining of copper, molybdenum, and other metals; in freight railroad; and in infrastructure engineering. GMexico s mining assets, which are expected to account for 87.2% of 2011E company total revenues and 93.5% of EBITDA, are represented by an 80% stake in Southern Copper Corp., which has operations in Peru and Mexico, and full ownership of Asarco, with operations in the U.S. Grupo Mexico currently owns the largest copper reserves in the world, with over 64 million metric tons. The transportation division comprises two independent operating subsidiaries, Ferromex and Ferrosur, of which GMexico owns 55.5% and 75%, respectively; together they represent the largest railroad network in Mexico, covering over 9,924 miles of tracks and enjoying a 55% market share. GMexico is 35.5% owned by Empresarios Industriales de México (a Larrea family trust) and 15.0% by Mr. German Larrea. The company is listed in the Mexican Bolsa. Raising our YE2011 target price for Grupo Mexico. 2 WHAT HAS CHANGED? We are updating certain operating and structural assumptions, leading us to raise our 2011 target price to M$52.00 (US$4.10). As such, we believe there is 29% total-return potential for Grupo Mexico s stock, despite the strong YTD performance, up 46.6%. The following are the main changes affecting our valuation of Grupo Mexico s. In the following sections, we elaborate on these topics. Higher copper prices. We have revised our copper price estimates to US$4.00/lb. for 2011 and 2012 from our previous estimate of US$3.65, largely due to stronger thananticipated demand, including the soon-to-be launched ETFs. Expansion of Cananea now factored into our assumptions. We expect Southern Copper to double production from 500,000 metric tons in 2010 to 1.0 million metric tons in 2014, which includes the restart of the Cananea mine s operations in 2011, the start-up of Tia Maria and the expansion at Toquepala, both in Asarco and SCCO s asset combination under American Mining Corporation (AMC) should be positive for Grupo Mexico. The transaction implies a firm value for Asarco of US$6.812 billion, or value per ton of installed capacity of US$34,058 which compares positively with SCCO s discount of only 7%, thus benefiting Grupo Mexico s stockholders, in our opinion. Along with the combination of assets, we expect the company to disclose current reserve levels, potential synergies with SCCO operations and updated expansion plans, which provide further upside to our implied valuation. Transportation division (ITM), posting stronger growth than previously expected. This has led us to assume higher load volumes growth in the long term. ITM is expected to consolidate the results of its two main operating subsidiaries, Ferrosur and Ferromex, on the approval from the relevant Mexican authorities. Delaying the payment of royalties until 2012 for both Mexico and Peru. New royalties proposal is still being revised by the Mexican congress (lower house) so we are not expecting anything to be approved soon. In Peru, any risk to new royalties will likely occur after a new administration takes office in July 2011 (presidential elections are in April 2011). GAP position is a source of concern. Grupo Mexico currently holds an 18% stake in GAP and recently announced that it is partnering with GAP to bid for the Riviera Maya airport project. This raises questions about Grupo Mexico s overall long-term strategy, as we do not see much synergy in the Riviera Maya airport project with Grupo Mexico s core mining and railroad businesses, nor is perceived as a profitable business. Attractive discount to its NAV of 30%. In the past eight months, the discount has widened given SCCO outperformance. Moreover, the current NAV discount is significantly higher than the 20% fair discount that we believe the company deserves. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212)

3 COPPER PRICES HIGHER, BUT REACHING A CEILING Estimated copper prices are at US$4.00/lb. on average for 2011E and 2012E, and should start to decline in 2013E as a significant amount of capacity enters the market. Copper prices are 48% above the annual average of 2009 and but only 11.2% up YTD at US$3.70/lb., largely due to the low comparison base. For 2011 and 2012, we recently increased our copper price estimate from US$3.65/lb. to US$4.00, or some 9.6%. Our model shows copper prices declining by 7% starting 2013, when we expect over 1.8 million metric tons of new copper mine capacity to enter the market, breaking another record. For further details, please refer to our latest copper market report, Copper Prices Reaching a Ceiling; Significant Capacity Entering in 2011, published November 22, We expect global copper demand to increase by 7.2% in 2011 and 4.0% in 2012, largely driven by China, which we expect to experience demand growth rates of 10% and 9%, respectively. The estimated annual growth rates are optimistic if we consider that the CAGR in global copper demand for the past six years ( ) was only 2.0%. The expected increase in demand represents an additional 1.26 million metric tons in 2011 and 890,000 metric tons in 2012, which we expect to be satisfied largely with new capacity entering the market and an increase in scrap availability given our higher copper prices outlook. In 2011, we expect some 1.3 million metric tons of additional capacity to enter the market, a record high. The year 2011 marks the eighth anniversary of the commodity boom, and also the beginning of a period were many copper project will start up after years of investments in the sector. A new copper project takes 8-12 years to develop, which largely explains why 2011 marks the entrance of many copper projects into the market. Of the new capacity entering the market, 85% will come from Latin America, we believe, where Chile will lead the way with a capacity increase of 518,000 metric tons largely related to the opening of Los Bronces (AngloAmerican) and Esperanza (Antofagasta). The new ETFs that are physically backed by copper appear to be relatively small at launching. JPMorgan and BlackRock plan to raise a combined US$1.5 billion for their copper ETFs, according to their SEC filings. This implies that 183,000 metric tons of copper could be warehoused at their facilities, which is equivalent to 50% of the current inventory at the LME, or 0.9% of 2011E global copper demand (less than 4 days of global consumption). The dates for the ETF launchings have not been announced. Even though we understand that the size of the copper ETFs may grow over time, we believe their initial impact will not be as great as some industry observers have anticipated. Scrap has been and will continue alleviating the copper deficit, in our opinion. For the past seven years, copper scrap has satisfied the demand that copper concentrates (from the mines) were not able to supply to the market. Copper scrap is expensive to collect, so copper prices have to be relatively high in order to attract scrap into the market. However, whenever copper prices have surpassed the US$4.00/lb. level in the past seven years, massive amounts of scrap appear in the market, thus capping copper prices. In 2010, with copper demand increasing by an estimated 3.7%, mining production growing by only 1.6%, and the copper deficit widening, scrap production increased by 20%, to a record high of 3.5 million metric tons. The significant scrap production increase occurred, in our opinion, because copper prices are expected to reach an annual average of US$3.42/lb. for the year, or an increase of some 45.7% from the 2009 annual average. For 2011, we expect that scrap supply requires an increase by only 5% to satisfy any tightness in the market while all the new mining capacity enters the market. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

4 Grupo Mexico: More Growth Ahead at an Attractive Valuation: Raising Target Price SOUTHERN COPPER CORP: A CASCADE OF CAPACITY EXPANSIONS We continue to expect the company to increase capacity by 40% in We expect the new mine Tia Maria (120,000 metric tons of copper per year), the expansion of the Toquepala mine (100,000 metric tons of copper per year), and Phase I of Cananea s expansion (32,000 metric tons of copper per year) to be completed in 2012, followed by other smaller scale projects. In total, we are assuming SCCO will increase capacity by 274,000 metric tons by year-end 2012, which represents a 40% capacity increase to 959,000 metric tons per year from the current nominal capacity of 680,000 metric tons/year. Production increase should be higher at 60%, as we are starting from a low base in 2010, mainly because production at the Cananea mine was preempted for most of the year due to reconstruction works following the more than three-year strike, which ended in June Incorporated the recently announced expansion of Cananea after the end of the three-year strike. With additional 270,000 metric tons of copper capacity and some US$3.0 billion to be invested in this expansion, Southern Copper is expected to reach a total nominal capacity of 1.3 million metric tons in This new capacity is expected to enter in two phases; phase I in 2012 with 32,000 metric tons and phase II with 238,000 metric tons in Moreover, Cananea should contribute an extra 2 million pounds of molybdenum. Figure 1. SCCO Expansion Plans by Project, 2010E-2015E (Metric Tons) Sources: Company reports and Santander estimates. 2010E 2011E 2012E 2013E 2014E 2015E Cananea 32, ,000 Tia Maria 120,000 Toquepala Concentrator Expansion 100,000 Cuajone Concentrator and SX/EW 22,000 50,000 Pilares 50,000 Total New Capacity 0 22, , , ,000 Total Capacity 685, , ,000 1,059,000 1,059,000 1,297,000 % Increase 0% 3% 36% 10% 0% 22% 4 U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212)

5 AMC combination with SCCO should be positive for Grupo Mexico shareholders. Independent special committee to conclude due diligence in 1H11. ASARCO: WAITING FOR THE SYNERGIES WITH SCCO In July, Grupo Mexico announced its plan to combine the operations of SCCO and Asarco under AMC (American Mining Corporation) creating a champion of copper. We believe the transaction is positive for Grupo Mexico shareholders as it implies a firm value of Asarco of US$6.812 billion (equity at US$5.940 billion), which implies a value per ton of installed capacity of US$34,058. We believe Asarco warrants a discount to SCCO considering that SCCO has higher EBITDA margins (57.6% in 2010 vs. 45.6% of Asarco s), aggressive expansion plans, and significantly higher reserves. We note that Grupo Mexico just regained control of Asarco in December 2009 for less than US$1 billion after a four-and a-half year legal battle and bankruptcy status. Our updated Asarco fair value estimate is US$4.5 billion, which is higher than our prior valuation of US$3.5 billion because it incorporates higher copper prices discussed previously, and assumes cash cost improvements achieved in recent quarters. Our new fair value increased on management s indication that cost containment is currently Asarco s priority. We are not assuming any capacity increase going forward as the company has not announced any concrete expansion plans. However, the production at the Silver Bell Mining (the JV with Mitsui) has the potential to add some 22,000 metric tons per year of copper of additional capacity to the company (10% increase for Asarco total production), according management, providing some upside risk to our estimates. We note that our new Asarco valuation estimate is still 24% below Asarco s transaction value. We believe this reflects certain expansion and cost-reduction plans at Asarco that have yet to be announced by the company and not incorporated into our valuation model. We believe Asarco has the potential for upside once the company discloses its updated reserves, exploration strategy and possible synergies with SCCO. As of now, we are only considering a minimum capex program of US$150 million planned between 2010 and 2012, primarily focused on implementing modernization of metallurgic plants and an increase in molybdenum recovery, after many years of underinvestment during the period when Grupo Mexico did not control the company. In addition, Asarco s reserve base is based on exploration and drilling results conducted more than 10 years ago and needs to be updated, most likely with higher reserves levels given the current scenario of higher copper prices. In addition, the company may present some cost synergies once Asarco combines its assets with SCCO s, such as lower inter-company transportation and refinery costs, given the proximity of Asarco s assets in Arizona and SCCO s assets in northern Mexico, in our view. However, we have not taken into consideration any of these potential synergies in our valuation scenario, thus they represent additional upside potential, as mentioned previously. What are the next steps and timeframe? Following the merger announcement, Grupo Mexico formed a special committee of independent directors to evaluate the merger proposal. This is in accordance with common legal strategies to establish fairness in parent-subsidiary merger cases in the state of Delaware, in order to make challenges by minority shareholders less likely. The members of the special committee are Gilberto Perezalonso (ex-ceo of Geo and Aeromexico), Luis Miguel Palomino (managing partner of the financial consultants RMG Consultores and former chief economist for Latin America for Merrill Lynch), and Enrique Castillo (CEO of investment bank Ixe Grupo Financiero and former president of the Mexican Banking Association). All three members currently serve on Southern Copper s board of directors. The independent special committee has retained financial and legal advisors for the transaction. Another common method to establish fairness in the state of Delaware is to seek approval by the majority of the minority shareholders. If Southern Copper pursues this as well, a proxy vote would occur prior to the final approval. Grupo Mexico s management believes that the independent special committee s due diligence can be completed in 1H11. Then, the special committee is expected to negotiate at arm's length on behalf of the minority shareholders on the proposal prior to a general shareholder vote. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

6 Grupo Mexico: More Growth Ahead at an Attractive Valuation: Raising Target Price In our view, the merger will likely be approved, but the final valuation of Asarco may be revised. By creating an independent special committee and seeking approval of the majority of the minority shareholders, Grupo Mexico technically tames the inherent power by being both on the board and the majority shareholder of SCCO. However, neither of the procedures necessarily assures that the valuation of Asarco is fair in a substantive sense, only that it was derived using a fair process and that it was acceptable to the majority of the minority shareholders, in our view. Grupo Mexico s use of these two procedures would shift the burden of proof to establish fairness to the minority shareholders. There is evidence that some SCCO minority shareholders may bring legal action against Grupo Mexico to contest the fairness of the price set for Asarco, especially given the lack of information about Asarco s long-term plans. As such, we believe that it is possible that the final price may be revised for the merger to go ahead. TRANSPORTATION DIVISION: ACCELERATING GROWTH Strong YTD 2010 performance by the transportation division. Our updated valuation of the transportation division (ITM) is US$4.0 billion. This valuation compares positively with our previous valuation of US$2.8 billion and the US$480 million acquisition cost at which Grupo Mexico acquired these operations from the Mexican government in The increase in ITM valuation is primarily a result of higher long-term load volume and pricing growth assumptions following the strong recovery of the Mexican economy and a lower WACC assumption. Specifically, we are now expecting a long-term load volume growth rate of 4.9% per year versus our previous conservative assumption of 3.5%. With respect to the WACC, it declined to 6.8% from 8.4%, as the risk free rate declined to 2.7% from 4.0%, and Mexico s country risk premium declined to 150 bps from 220 bps. We are raising our 2010 and 2011 load volume growth assumptions to 19.9% and 6.0%, respectively, in line with stronger economic activity in Mexico and management guidance. This follows 18.1% load volume growth during YTD 2010 YoY, reaching a record high in the number of rail cars transported and load volume by Ferromex. This growth is significantly higher than the 8.4% growth at U.S. railroads YTD, according to Grupo Mexico and Association of American Railroads. This year s strong load volume growth is the result of higher intermodal freight, higher export activity and general economic recovery in Mexico. In addition, we note that Santander s macroeconomic team also increased its 2010 GDP growth estimate for Mexico to 5.0% recently from 3.9%, thus further supporting the estimates in volumes for the railroad division. Our 2011 and 2012 load volume growth estimates of 6.0% and 5.0% represent 1.7 and 1.4 times our macroeconomic team s GDP growth forecasts, respectively. In addition, Grupo Mexico recently announced an extraordinary capex of US$170 million for The additional capex will be used to purchase 44 new locomotives (8% increase in installed capacity) and to expand and construct new sidings (i.e., low-speed tracks for storing, loading and unloading cars). The newer locomotives are intended to meet additional volume and not for upgrading of the fleet, according to management. The US$146 million of capex guidance previously announced for 2010 has been spent primarily for development of the railyard at the Piedras Negras border crossing. We are assuming a total capex of US$380 million for 2011 (original capex assumption of US210 million plus extraordinary capex mentioned above) and US$250 million for The normal 2011 and 2012 capex amounts were previously announced, and are being directed to upgrading existing tracks to allow longer trains to run at higher speeds, consequently increasing productivity. Still holding for the approval of the Ferromex-Ferrosur merger. In May, the Federal Court of Justice on Tax and Administrative Matters approved the merger of Ferromex and Ferrosur, notifying Mexico s antitrust commission in October. Grupo Mexico is currently waiting for the antitrust commission to review the court s decision. If the antitrust commission decides to appeal the decision, then the matter will be turned over to the Federal Circuit Court. Grupo Mexico 6 U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212)

7 believes that the Federal Circuit Court s legal process would take less than six months. As such, we are now assuming that Ferrosur will consolidate into ITM s results beginning in 3Q11 and that the IPO of the ITM s shares will occur in the second half of We believe our assumptions are reasonable given the delays that the merger process has faced. The IPO will result in new publicly trading ITM shares, and provide an exit strategy for Sinca Inbursa, which currently holds 25.1% of ITM, as well as a potential carve-out of some 10% to 15% of stake held by Grupo Mexico. The current implied valuation of the railroad operation is US$1.9 billion, well below our US$4.0 billion fair valuation estimate. This suggests that the transportation division has 107% upside potential. Moreover, when ITM is compared with other railroad companies in the Americas, it is currently trading at a discount: its 2011E P/E ratio is 9.2 times, or a 32% discount to the sector average of 13.5 times, as shown in Figure 2. We believe the creation of the tracking stock will unlock ITM s value as its valuation will be less affected by the holding company structure. Figure 2. ITM Railroad and Logistics Company Valuation Multiples, 2010E 2012E P/E FV/EBITDA 2010E 2011E 2012E 2010E 2011E 2012E Union Pacific Corp CSX Corporation Norfolk Southern Corp Canadian Pacific Railway Ltd Average Railroad Cos ALL (Bz Logistics) ITM Discount vs. Railroad Cos. -36% -32% -31% -9% -10% -13% Discount vs. Logistics Co. -77% -75% -68% -42% -41% -41% Note: Valuation multiples calculated using prices as of November 16, Sources: Bloomberg and Santander. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

8 Grupo Mexico: More Growth Ahead at an Attractive Valuation: Raising Target Price EARNINGS OUTLOOK We are raising Grupo Mexico s 2011 and 2012 EBITDA estimates by 13.4% and 12.0%, respectively, primarily reflecting higher copper prices and their positive impact on SCCO and Asarco. In addition, higher load volumes and pricing assumptions at ITM contribute to our higher EBITDA estimates. These favorable operating assumptions result in EBITDA margin expansions of 130 bps and 30 bps compared to our prior estimates. Figure 3. Grupo Mexico Estimate Revisions, 2010E 2012E (U.S. Dollars in Millions*) 2010E 2011E 2012E Previous Current Change Previous Current Change Previous Current Change Revenue 8,571 8,280 (3.4)% 10,421 11, % 11,625 12, % Op. Profit 3,757 3,501 (6.8)% 5,230 6, % 5,960 6, % EBITDA 4,448 4,094 (8.0)% 5,980 6, % 6,806 7, % EBITDA Margin 51.9% 49.5% (240) bp 57.4% 58.7% 130 bp 58.5% 58.8% 30 bp Net Income 2,230 1,872 (16.0)% 3,238 3, % 3,537 4, % EPS (16.0)% % % *Except per share data. NA not available. NM not meaningful. Sources: Company reports and Santander estimates. Our new copper price estimates are US$4.00/lb. on average for 2011E and 2012E, then declining in 2013E, as a significant amount of capacity enters the market. For 2011 and 2012, we recently increased our copper price estimate from US$3.65/lb. to US$4.00, or some 9.6%. However, our model shows copper prices declining by 7% starting 2013, when we expect over 1.8 million metric tons of new copper mine capacity to enter the market, breaking another record. Figure 4. Grupo Mexico Sales and EBITDA Breakdown, 2011E Sales EBITDA 68.4% 76.6% 12.8% 18.8% Southern Copper Corp Asarco Transportation 6.5% 16.9% Sources: Company reports and Santander. Strong cash generation should allow Grupo Mexico to finance its expansion plan, pay dividends and accumulate cash. Given our favorable fundamentals for the mining and railroad divisions, we are expecting Grupo Mexico to reach annual EBITDA of US$6.8 billion, to US$7.7 billion for the period. We believe this would be more than enough for Grupo Mexico to finance its estimated US$7.6 billion capex plan for the period and still have enough to pay dividends of some US$14 billion for this five-year period (over US$2.8 billion per year, on average), suggesting that the company s financial position is very healthy. As of 3Q2010, Grupo Mexico had a net debt of US$1.2 billion and we expect this to turn to a net cash position by For SCCO s sales volumes, we follow the company s 2010 guidance of 500,000 metric tons 8 U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212)

9 (similar to 2009) and increased production by 34% in 2011, largely reflecting Cananea s operating at full capacity and 20% in 2012, reflecting the start up of Tia Maria and the expansion of Cuajone s concentrator. In 2010, we lowered our estimates for SCCO s total sales volumes to 500,000 metric tons from 535,000 metric tons previously, as some operations were affected by lower ore grades and higher production costs. Investors should bear in mind that the start-up of the Cananea mine in September 2010 did not go to increase total sales volumes, but to offset the decline in production in Peru. In addition, the revaluation of the Peruvian Sol during the year did not help either. Please refer to our Southern Copper s report As Red as It Can Get, dated November 22, 2010 for further discussion on its earnings outlook. At Asarco, we estimate 220,000 metric tons of copper sales and EBITDA of US$1,145 million in 2011, representing 17% of total company EBITDA. We are maintaining our sales volume estimate of 220,000 metric tons per year for later years, as the company has not provided any concrete capacity expansion guidance. However, Asarco should benefit from the higher copper prices we project, and we are assuming that recent improvements in cash costs will be maintained. The slight decrease we expect in Asarco s revenue and EBITDA in 2012 is based on our assumption that its current sales price premium to international spot metal prices will moderate. Our transportation division s 2011 EBITDA growth estimate of 11.1% reflects 6% growth in load volume and the consolidation of Ferrosur beginning in 3Q11. Our load volume growth assumption is in line with guidance, or 19.9% for 2010 and 6.0% for 2010, driven by the rebound in exports and economic activity in Mexico. We estimate load volume growth of 5% for Ferromex starting in We estimate transportation s EBITDA margins to contract in 2011 and 2012 to reflect the consolidation of Ferrosur, which has lower EBITDA margins. As an illustration, the 2010 YTD EBITDA margin at Ferromex is 32% versus 27% at Ferrosur. Figure 5. Grupo Mexico Segment Sales and EBITDA Estimates, 2010E 2012E (U.S. Dollars in Millions) 2010E Δ% YoY 2011E Δ% YoY 2012E Δ% YoY Southern Copper Revenue 5, % 7, % 8, % EBITDA 3, % 5, % 6, % EBITDA Margin 57.6% 920 bps 66.4% 870 bps 66.9% 50 bps Asarco Revenue 1, % 2, % 2,084 (3.0)% EBITDA % 1, % 1,086 (5.1)% EBITDA Margin 45.6% 1,470 bps 53.3% 770 bps 52.1% (120) bps Transportation Revenue 1, % 1, % 1, % EBITDA % % % EBITDA Margin 32.7% 310 bps 30.1% (260) bps 29.3% (80) bps Source: Company reports and Santander. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

10 Grupo Mexico: More Growth Ahead at an Attractive Valuation: Raising Target Price Figure 6. Grupo Mexico Mining and Transportation Division Sales Volume and Price Estimates, 2010E 2012E Mining Division 2010E Δ% YoY 2011E Δ% YoY 2012E Δ% YoY Sales Volume Copper (m.t.) 702,139 (0.8)% 892, % 1,025, % Molybdenum (m.t.) 20, % 19,000 (5.0)% 19, % Zinc (m.t.) 95,000 (8.5)% 117, % 112,646 (3.7)% Silver (K oz) 20,591 (10.0)% 20,077 (2.5)% 22, % Average Metal Prices Copper (US$/lb) % % % Molybdenum (US$/lb) % % % Zinc (US$/lb) % % % Silver (US$/oz) % % % Transportation Division 2010E Δ% YoY 2011E Δ% YoY 2012E Δ% YoY Load Volume Ferromex (Mn Tons/Km) 47, % 49, % 52, % Ferrosur (Mn Tons/Km) 7, % 7, % 7, % Price/Ton Ferromex ('000 US$) % NA NA NA NA Combined ('000 US$) % % % NA: Not applicable. Source: Company reports and Santander. VALUATION We are increasing our YE2011 target price to US$4.10 (M$52.00) from US$3.40 (M$44.80), which implies a total upside potential of 29.0% in U.S. dollar terms, including a 5.1% dividend yield. We are also reiterating our Buy recommendation on the stock. Our target price implies a target FV/EBITDA trailing multiple of 7.3 times. We value Grupo Mexico using a sum-of-the-parts DCF valuation, taking into account different country risks, beta, tax rates, and growth in perpetuity for each segment. Then we deduct our estimate for holding company net debt and a 20% holding company discount, which is related to the taxes that the company would incur if it sold its main assets. We are assuming that the merger transaction between Southern Copper and Asarco does not affect our sum-of-the-parts valuation, and, if any, there is only upside risk depending on the synergies to be achieved and the final valuation at which the assets were combined. Investors should bear in mind that Southern Copper s valuation considers a 2011 target price of US$47.40 per share (for further details, please refer to our latest SCCO report, As Red as It Can Get, published November 22, 2010). For ITM, we assume that Ferromex and Ferrosur consolidate in 3Q11. We continue to estimate a pro forma Union Pacific minority stake proportionally to Ferromex and Ferrosur s EBITDA contribution assuming the actual IPO occurs at year-end Please refer to the Appendix of this report, for DCF valuation analyses of Asarco and the transportation division (ITM). 10 U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212)

11 Figure 7. Grupo Mexico DCF Assumptions by Segment Southern Copper Asarco Transportation Risk Free Rate 2.7% 2.7% 2.7% Beta Equity Risk Premium 5.5% 5.5% 5.5% Country Risk a 1.50% 0.00% 1.50% Cost of Equity 9.6% 9.3% 7.6% Cost of Debt 7.8% 8.3% 6.8% Tax Rate 32% 35% 32% After-Tax Cost of Debt 5.3% 5.4% 4.6% Equity as % of Total Capital 65% 85% 75% WACC 8.1% 8.7% 6.8% Perpetual Growth 3.0% 2.0% 1.0% a Blended EMBI of Peru and Mexico at 50% each for Southern Copper. Sources: Bloomberg, Damodaran Data Page, company reports, and Santander estimates. Figure 8. Grupo Mexico Sum-of-the-Parts DCF Valuation at Year-End 2011 (U.S. Dollars in millions, Except per Share Figures) Segments Firm Value Net debt Gmex Stake Equity Contribution Southern Copper 40,299 (32) 80.0% 32, % Asarco 3,790 (960) 95.6% 4, % Transportation 5, % 4, % Infrastructure % % Sum of the Parts 49,390 (887) 40, % Holding Co net debt 772 (772) (1.9)% Grupo Mexico, gross 49,390 (115) 40,096 Holding Co discount (8,019) (20.0)% Grupo Mexico, net 32,076 Shares outstanding 7, Year-end share price $4.10 M$52.00 Source: Company reports and Santander. Figure 9. Current Implied Valuation Analysis for Segments as of November 16, 2010 Current Equity Target Equity Upside Grupo Mexico market cap 25,768 32, % Holding Co. Disc Reverse (+20%) 6,442 Holding Co. Net Debt 772 Southern Copper Market Cap 36,066 Southern Copper 80% Stake 28,852 32, % Residual Value - Subsidiaries 4,130 Asarco Implied Valuation (53%) 2,179 4, % ITM Implied Valuation (47%) 1,951 4, % Note: Grupo Mexico and Southern Copper Corp. upsides exclude dividend yield. Source: Santander estimates. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

12 Grupo Mexico: More Growth Ahead at an Attractive Valuation: Raising Target Price Figure 10. Macroeconomic and Operating Assumptions, E E 2011E 2012E Macroeconomic Assumptions Peru GDP (%) Inflation (%) S//US$ Exchange Rate Period End Mexico GDP (%) Inflation (%) M$//US$ Exchange Rate Period End Sources: Santander estimates. GRUPO MEXICO AT A DISCOUNT TO ITS NAV We estimate that the stock currently trades at a 30.3% discount to its NAV, considering the current market cap of SCCO, and market multiples based on LTM results of its subsidiaries. This is more than the fair holding company discount of 20% and the average NAV discount in the last 12 months of 23.3%. Grupo Mexico s NAV discount has recovered from significantly high levels of almost 60% in the midst of the credit crisis; however, it has some more room to recover to 20% fair discount, in our view. We are incorporating the US$5.9 billion transaction value announced for Asarco in calculating the current NAV discount (not our estimated fair value). This relatively high level of NAV discount reinforces our attractive view on Grupo Mexico s stock. Figure 11. GMexico NAV Calculation- Assuming Current Market Prices (US$ in Millions) Equity Value of Valuation Assets Valuation Ownership Investment Methodology Southern Copper Corp 36,066 80% 28,852 Market Cap (11/16) Asarco 5, % 5,940 Transaction Ferromex 2,660 56% 1, x LTM EBITDA Ferrosur % x LTM EBITDA Total Gross Assets 36,642 Net Cash 3Q10 - Grupo Mexico (Holding) 219 NAV 36,861 GMexico Market Cap (11/16) 25,686 Difference vs. NAV - US$ 11,175 Difference vs. NAV -30.3% Historical Difference (Last 12 Months) -23.3% Source: Company reports and Santander. 12 U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212)

13 RISKS Lower-than-expected copper prices. We are currently estimating average copper prices of US$3.42 for 2010 and US$4.00 for both 2011 and These estimates assume an ongoing increase in demand, including the introduction of copper ETFs in 2011, a deficit of copper concentrates worldwide and low inventories, as well as healthier world economic growth. However, if we were to experience a decline in the price of copper, it would have a negative effect on our estimates, given that copper is the single most important product that the company sells, representing approximately 94% of total EBITDA in A slowdown in economic growth in China could have a significant impact on global demand for copper. China accounts for approximately 36% of world copper consumption. Given China s significant influence on copper consumption, a deceleration in copper demand from China could have a negative effect on copper prices and commodities, in general. Political and economic instability in Peru and/or Mexico. Southern Copper s production is divided approximately 50/50 between Peru and Mexico. Therefore, an increase in Peruvian or Mexican risk could adversely affect our valuation of SCCO and Grupo Mexico. Potential delay in Tia Maria copper project. With the Tia Maria project in the final stages of obtaining permits in order to start construction there are significant risks that no agreements are reached with the communities and the company will have to wait until a new government takes office (July 2011) to continue the negotiations. If SCCO does not obtain the necessary permits in the next three months, then there are serious risks of this project not starting up in 2012 as projected. Production interruptions. Southern Copper s production is approximately 50/50 divided between Peru and Mexico. In both countries, operations are frequently affected by strikes, however, the situation in Mexico has been more serious after having Canane mine shut-down for almost three years due to a strike. These types of incidents may continue to happen in the future. Mining taxes and/or royalties may increase more than we are expecting in Mexico and/or Peru. There is a risk that new royalties or taxes may be proposed in the future that are higher than our assumption, thus affecting our estimates. An 18% stake in GAP and partnering with GAP to bid for the Riviera Maya airport project raises questions about Grupo Mexico s overall long-term strategy. SOUTHERN COPPER VALUATION AND RISKS Southern Copper (SCCO: US$42.43, Hold, target price: US$47.40). Our YE2011 target price is based on a DCF analysis. Main risks include the high correlation to copper prices, ongoing strikes mainly in Mexico, delay in the start of projects and in the restart of the Cananea mine, and a slowdown in economic activity, mainly in China. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

14 Grupo Mexico: More Growth Ahead at an Attractive Valuation: Raising Target Price FINANCIAL STATEMENTS Figure 12. Grupo Mexico Income Statement, Balance Sheet, and Cash Flow Statement, E, (U.S. Dollars in Millions) Income Statement 2009A % 2010E % 2011E % 2012E % Sales 4, % 8, % 11, % 12, % Cost of Sales 2, % 3, % 4, % 5, % Gross Profit 2, % 4, % 7, % 7, % Oper. and Adm. Expenses % % % % Operating Profit 1, % 3, % 6, % 6, % Depreciation % % % % EBITDA 2, % 4, % 6, % 7, % Interest Paid (133.3) (2.8)% (307.5) (3.7)% (358.9) (3.1)% (286.4) (2.2)% Interest Earned % % % % Derivative Instruments % (3.6) (0.0)% % % FX Gain/Loss % % % % Other Financial Operations % (10.6) (0.1)% % % Profit before Taxes 1, % 3, % 5, % 6, % Tax Provision (563.5) (11.7)% (909.6) (11.0)% (1,531.0) (13.2)% (1,823.4) (14.1)% Subsidiaries % % % % Minority Interest (270.6) (5.6)% (466.4) (5.6)% (701.3) (6.1)% (463.7) (3.6)% Net Profit % 1, % 3, % 4, % Balance Sheet 2009A % 2010E % 2011E % 2012E % Assets 11, % 14, % 16, % 17, % Short-Term Assets 3, % 5, % 6, % 7, % Cash and Equivalents 1, % 3, % 4, % 4, % Accounts Receivable % % 1, % 1, % Inventories % % % % Other Short-Term Assets % % % % Long-Term Assets 8, % 8, % 9, % 10, % Fixed Assets 5, % 6, % 8, % 8, % Leachable materials % % % % Other Assets 2, % 1, % 1, % 1, % Liabilities 5, % 6, % 6, % 5, % Short-Term Liabilities 1, % 1, % 1, % 1, % Short-Term Loans % % % % Other Short-Term Liabilities % 1, % 1, % 1, % Long-Term Loans 2, % 4, % 3, % 3, % Other Liabilities % % % % Net Worth 5, % 6, % 8, % 10, % Minority Interest 1, % 1, % 1, % 1, % Net Debt 2, % % (85.3) (0.5)% (1,421.1) (8.1)% Cash Flow 2009A 2010E 2011E 2012E Net Majority Earnings , , ,335.7 Depreciation and Amortization Changes in Working Capital (1,480.5) (73.5) (354.2) (152.3) Other Non Cash Items (2.7) (2.8) Capital Expenditures (580.7) (721.0) (1,952.1) (1,056.5) Change in Debt 1, (152.7) (797.4) Dividends (455.7) (712.3) (1,310.5) (2,561.6) Capital Increases / Other (992.8) Net Change in Cash (450.8) 2, Beginning Treasury 1, , , ,255.4 Ending Treasury 1, , , ,793.9 Sources: Company reports and Santander estimates. 14 U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212)

15 APPENDIX DCF FOR ASARCO AND ITM Please refer to our Southern Copper s report As Red as It Can Get, dated November 22, 2010 for its DCF analysis. Figure 13. Asarco DCF 2011E-2021E (US$ in Millions) Operating Profits (-) Taxes in Oper Profits (340) (324) (273) (258) (225) (194) (162) (140) (116) (89) (87) (+) Depreciation (+/-) Changes in WC (41) (1) (6) (-) Capital Expenditures (75) (50) (50) (50) (50) (50) (50) (50) (50) (50) (50) (=) Free Cash Flow NPV Cash Flow 2,767 NPV Terminal Value 1,022 Net Debt (960) Minority Interest 237 Equity Value 4,513 Sources: Company reports and Santander estimates. Figure 14. Transportation Division (ITM) DCF 2011E-2021E (US$ in Millions) Operating Profits (-) Taxes in Oper Profits (109) (118) (123) (130) (140) (149) (157) (170) (183) (198) (213) (+) Depreciation (+/-) Changes in WC (10) (15) (17) (20) (23) (26) (30) (34) (38) (43) (49) (-) Capital Expenditures (380) (250) (250) (250) (250) (250) (200) (200) (200) (200) (200) (=) Free Cash Flow (59) NPV Cash Flow 1,693 NPV Terminal Value 3,558 Net Debt 104 Minority Interest 1,106 Equity Value 4,040 Sources: Company reports and Santander estimates. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

16 Grupo Mexico: More Growth Ahead at an Attractive Valuation: Raising Target Price IMPORTANT DISCLOSURES Grupo Mexico 12-Month Relative Performance (U.S. Dollars) IPC Grupo Mexico 80 N-09 J-10 M-10 M-10 J-10 S-10 N-10 Sources: Bloomberg and Santander. Grupo Mexico Three-Year Stock Performance (U.S. Dollars) H$ /10/08* H $ /1/08 *Initiation of Coverage B $2.40 9/30/09 B $ /8/09 B $3.40 6/3/ H $ /30/08 S-07 D-07 M-08 J-08 S-08 D-08 M-09 J-09 S-09 D-09 M-10 J-10 S-10 Grupo Mexico (L Axis) MEXBOL (R Axis) 3,300 2,800 2,300 1,800 1, Analyst Recommendations and Price Objectives B: Buy H: Hold UP: Underperform UR: Under Review Source: Santander. 16 U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212)

17 Southern Copper 12-Month Relative Performance (U.S. Dollars) IGBVL Southern Copper 70 N-09 J-10 M-10 M-10 J-10 S-10 N-10 Sources: Bloomberg and Santander. Southern Copper Three-Year Stock Performance (U.S. Dollars) H $ /10/08 H $ /1/08 B $ /29/09 B $ /8/09 B $ /30/09 B $ /3/10 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1, S-07 D-07 M-08 J-08 S-08 D-08 M-09 J-09 S-09 D-09 M-10 J-10 S-10 Southern Copper (L Axis) IGBVL (R Axis) 0 Source: Santander. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

18 Key to Investment Codes IMPORTANT DISCLOSURES Rating Definition % of Companies Covered with This Rating % of Companies Provided Investment Banking Services in the Past 12 Months Buy Expected to outperform the local market benchmark by more than 10% % 60.47% Hold Expected to perform within a range of 0% to 10% above the local market benchmark % 39.53% Underperform/Sell Expected to underperform the local market benchmark. 7.69% -- Under review The numbers above reflect our Latin American universe as of Tuesday, October 12, For a discussion, if applicable, of the valuation methods used to determine the price targets included in this report and the risks to achieving these targets, please refer to the latest published research on these stocks. Research is available through your sales representative and other electronic systems. Target prices are 2010 year-end unless otherwise specified. Recommendations are based on a total return basis (expected share price appreciation + prospective dividend yield) unless otherwise specified. Stock price charts and rating histories for companies discussed in this report are also available by written request to Santander Investment Securities Inc., 45 East 53 rd Street, 17 th Floor (Attn: Research Disclosures), New York, NY USA. Ratings are established when the firm sets a target price and/or when maintaining or reiterating the rating. Ratings may not coincide with the above methodology due to price volatility. Management reserves the right to maintain or to modify ratings on any specific stock and will disclose this in the report when it occurs. Valuation methodologies vary from stock to stock, analyst to analyst, and country to country. Any investment in Latin American equities is, by its nature, risky. A full discussion of valuation methodology and risks related to achieving the target price of the subject security is included in the body of this report. The benchmark used for local market performance is the country risk of each country plus the 1-year U.S. Treasury yield plus 5.5% of equity risk premium, unless otherwise specified. The benchmark plus the 10.0% differential used to determine the rating is time adjusted to make it comparable with the total return of the stock over the same period. For additional information about our rating methodology, please call (212) This research report ( report ) has been prepared by Santander Investment Securities Inc. ("SIS"; SIS is a subsidiary of Santander Investment I, S.A. which is wholly owned by Banco Santander, S.A. ["Santander"]) on behalf of itself and its affiliates (collectively, Grupo Santander) and is provided for information purposes only. This report must not be considered as an offer to sell or a solicitation of an offer to buy any relevant securities (i.e., securities mentioned herein or of the same issuer and/or options, warrants, or rights with respect to or interests in any such securities). Any decision by the recipient to buy or to sell should be based on publicly available information on the related security and, where appropriate, should take into account the content of the related prospectus filed with and available from the entity governing the related market and the company issuing the security. This report is issued in Spain by Santander Investment Bolsa, Sociedad de Valores, S.A. ( Santander Investment Bolsa ) and in the United Kingdom by Banco Santander, S.A., London Branch. Santander London is authorized by the Bank of Spain. This report is not being issued to private customers. SIS, Santander London and Santander Investment Bolsa are members of Grupo Santander. The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed, that their recommendations reflect solely and exclusively their personal opinions, and that such opinions were prepared in an independent and autonomous manner, including as regards the institution to which they are linked, and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report, since their compensation and the compensation system applying to Grupo Santander and any of its affiliates is not pegged to the pricing of any of the securities issued by the companies evaluated in the report, or to the income arising from the businesses and financial transactions carried out by Grupo Santander and any of its affiliates: Victoria Santaella and Sergio Matsumoto. *Employed by a non-us affiliate of Santander Investment Securities Inc. and not registered/qualified as a research analyst under FINRA rules, and is not an associated person of the member firm, and, therefore, may not be subject to the FINRA Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearances, and trading securities held by a research analyst account. The information contained within this report has been compiled from sources believed to be reliable. Although all reasonable care has been taken to ensure the information contained within these reports is not untrue or misleading, we make no representation that such information is accurate or complete and it should not be relied upon as such. All opinions and estimates included within this report constitute our judgment as of the date of the report and are subject to change without notice. From time to time, Grupo Santander and/or any of its officers or directors may have a long or short position in, or otherwise be directly or indirectly interested in, the securities, options, rights or warrants of companies mentioned herein. Any U.S. recipient of this report (other than a registered broker-dealer or a bank acting in a broker-dealer capacity) that would like to effect any transaction in any security discussed herein should contact and place orders in the United States with SIS, which, without in any way limiting the foregoing, accepts responsibility (solely for purposes of and within the meaning of Rule 15a-6 under the U.S. Securities Exchange Act of 1934) for this report and its dissemination in the United States by Santander Investment Securities Inc. All Rights Reserved. 2010