new york, june 3, 2010 mexico – mining grupo mexico b · pleaser refer to appendix e on page 23...

Important disclosures/certifications are in the “Important Disclosures” section of this report. U.S. investors’ inquiries should be directed to Santander Investment Securities Inc. at (212) 583-4629/ (212) 350-3918.

* Employed by a non-US affiliate of Santander Investment Securities Inc. and is not registered/qualified as a research analyst under FINRA rules.

Latin American Equity Research Company Report

New York, June 3, 2010 Mexico – Mining

GRUPO MEXICO BUYValue Proposition of Hidden Assets: Introducing YE2011 Target Price Victoria Santaella Sergio MatsumotoNew York: Santander Investment Securities Inc. New York: Santander Investment Securities, Inc.+1 212 350-3919 +1 212 [email protected] [email protected]

(6/1/10) CURRENT PRICE: M$30.02/US$2.31 TARGET PRICE: M$44.80/US$3.40 What’s Changed Rating Maintaining Buy Price Target (M$) to 44.80 from 41.00 EBITDA Estimates (US$ Mn) ’10 to 4,448 from 4,240 ’11 to 5,980 from 5,171 ’12: 6,806

Company Statistics Bloomberg GMEXICOB 52-Week Range (US$) 0.92-3.00 2011E P/E Rel to the IPC (x) 0.5 2011E P/E Rel to Mining(x) 0.6 IPC (US$) 2,409 3-Yr EPS CAGR (09-12E) 58.5% Market Capitalization (US$ Mn) 18,138 Float (%) 40.0 3-Mth Avg Daily Vol (US$ Mn) 45.2 Shares Outst - Mn 7,785 Net Debt/Equity (x) 0.3 Book Value per Share 0.68

Estimates and Valuation Ratios 2009A 2010E 2011E 2012E Net Earn (US$ Mn) 887 2,230 3,238 3,537 Current EPS 0.11 0.29 0.42 0.45 P/E (x) 20.4 8.1 5.6 5.1 P/Sales (x) 3.8 2.1 1.7 1.6 P/CE (x) 14.0 6.2 4.5 4.1 FV/EBITDA (x) 11.5 5.5 4.1 3.6 FV/Sales (x) 5.1 2.9 2.4 2.1 FCF Yield (%) (2.6) 9.8 15.0 20.4 Div per share (US$) 0.06 0.08 0.20 0.29 Div Yield (%) 2.5 3.4 8.6 12.5

Sources: Bloomberg, company reports, and Santander estimates.

Investment Thesis: We are introducing our YE2011 target price of US$3.40 (M$44.80) implying a total upside potential of 56.8%, including an 11.0% dividend yield, thus we maintain our Buy rating on the stock. We remain positive on the company mainly due to: Positive outlook for copper demand and prices, averaging US$3.33 per lb. in 2010 and US$3.65 in 2011. Lower ore content, junior mines out of the market, strikes affecting global production and few large-scale projects should only limit the availability of supply going forward, translating into sustainable high prices, in our opinion. Moreover, the deficit in the copper market (some 2.9 million tonnes in 2009 or some 16% of demand) is expected to widen as global demand recovers. Grupo Mexico offers a 45% discount to the sum-of-its-parts. Even after applying the 20% holding company penalty, the discount remains attractive at 31%. Southern Copper should be the main driver of growth as it is undergoing a 49% capacity increase, further enhanced by the Cananea restart. Please refer to our June 3, 2010 report, Fundamentals Stronger than Sentiment. ITM (the railroad division) to unlock value through a potential IPO and the consolidation of its two subsidiaries (Ferrosur & Ferromex). The IPO will provide an exit strategy for Inbursa, which currently holds 25.1% of ITM and will allow the market to appreciate the 46% discount at which the largest railroad network in Mexico is trading at now. Attractive valuation multiples and high dividend yield. According to our estimates, Grupo Mexico is trading at only 4.1 times 2011E FV/EBITDA and 2011E P/E of 5.6 times, which represents a 39% and 55% discount, respectively, to the global mining sector, further enhanced by an estimated 11% dividend yield in the next 18 months. Reasons for Change to Price Target/Estimates: Higher copper prices, higher royalties and taxes affecting the mining division, new sum-of-the-parts DCF valuation methodology with segment-specific WACCs. Valuation and Risks: Our target price is based on a sum-of-the-parts DCF valuation analysis with beta, country risk, tax rate, and perpetuity growth specific for each subsidiary. Main risks include the high correlation to copper prices, ongoing strikes mainly in Mexico, delays in the start of projects and in the restart of the Cananea mine, higher-than-expected royalties and taxes in Mexico and Peru, and a slowdown in economic activity, mainly in China.

Grupo Mexico: Value Proposition of Hidden Assets: Introducing YE2011 Target Price


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Grupo Mexico 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 is expected to account for 86.2% of 2010E consolidated revenues and 91.6% of EBITDA, are represented by an 80% stake in Southern Copper Corp., which has operations in Peru and Mexico, and a full ownership of Asarco with operations in the U.S. Grupo Mexico currently owns the largest copper reserves in the world with over 56.4 million tons. The transportation division is comprised of 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’s largest stock holder is a trust that holds 33.7% of the company, followed by Mr. German Larrea, with 12.8%. The company is listed in the Mexican Bolsa.

WHAT HAS CHANGED? The year 2010 has proven to be one with many changes for Grupo Mexico; the company is starting to move from resolving legal matters to focusing on its operations and on growing its businesses. Following this change in the company’s priorities, we have concentrated on closely analyzing its railroad division, Asarco, and its newly organized infrastructure business. On the negative side, we incorporated higher taxes and royalties to be paid by Southern Copper following global trends. This report presents the main events that we believe will have an impact in the company’s valuation, including a positive outlook on the copper market, while we introduce a new valuation methodology in order to better assess what we believe to be the true value of Grupo Mexico.

• Transportation division (ITM): Unlocking value with the consolidation of Ferrosur and Ferromex and potential IPO. ITM is expected to consolidate the results of its two main operating subsidiaries: Ferrosur and Ferromex. Our model considers the impact of the consolidation, and we determined a valuation in anticipation of a potential IPO in the second half of the year. According to our valuation, ITM is worth US$2.8 billion, while its current implied value is only US$1.5 billion, suggesting that the division is significantly undervalued.

• Grupo Mexico regained control of Asarco at a very attractive valuation, and it is also significantly undervalued, in our opinion. Grupo Mexico included Asarco in its consolidated results for a full quarter (1Q10) for the first time in over four years, following regaining control in December 2009. This provided increased visibility on the subsidiary’s financial situation, which allowed us to make more accurate projections, and to reflect Asarco’s full impact on Grupo Mexico’s balance sheet. We value Asarco at US$3.5 billion, significantly above its current implied value of only US$1.9 billion, and the US$1.85 billion Grupo Mexico paid to regain control thus proving to be highly accretive.

• Grupo Mexico’s stock provides 56.8% total potential upside through 2011, according to our new valuation methodology, which includes performing an independent DCF for SCCO, Asarco, and ITM. Given the increased visibility of ITM and Asarco, we introduce a DCF valuation of these divisions with which, along with our updated DCF valuation model for SCCO, we believe we arrived at a more detailed valuation. We maintained the stock’s “holding company discount” at 20%.

• Increasing taxes and royalties. Given the global trend of governments to increase their share in the profits of natural resources companies, we incorporated a 4% royalty in the company’s revenues coming from Mexico, this percentage is in line with a proposal currently considered by the Mexican Congress. In Peru we increased by 2 pp the royalties paid in Peru to 4% starting 2011,which accounts for the risks we see in Peru.

Grupo Mexico is undervalued, in our opinion.

Important disclosures/certifications are in the “Important Disclosures” section of this report. U.S. investors’ inquiries should be directed to Santander Investment Securities Inc. at (212) 583-4629/(212) 350-3918.

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• Copper prices’ long-term trend continues to be positive in our opinion, averaging US$3.33 per lb. in 2010 (some 2% above our November estimates), and US$3.65 in 2011. We believe copper prices have a “ceiling” at US$4.00 per lb. because at that level, substitution is viable (mainly aluminum) and scrap appears in the market in large quantities. The long-term upward trend is now more solid than it had been, as many junior mines that were expecting to start up production in 2011 are now out of business or dormant due to the lack of financing available, thus reducing future supply. Lower ore content, strikes affecting global production and limited large scale projects only limits the availability of supply going forward translating into sustainable high prices. On the other hand, increasing production and capacity expansion costs has made us to increase our perpetuity copper price from US$2.06 per oz. to US$2.50 per oz. Our perpetuity begins in 2021. In the short term, we expect a mild recovery in copper prices from current levels of US$3.05 towards a band of US$3.25 to US$3.50 per oz. following a period of high volatility observed in April and May as financial markets are starting to stabilize and real economic growth is evident in most regions of the world. Pleaser refer to Appendix E on page 23 for further details.

We elaborate on each of these topics, which we believe are key to understanding the dynamics of Grupo Mexico as a holding company. Figure 1 below is a summary of our estimated valuations supporting our position that the market has not fully valued Grupo Mexico’s main subsidiaries, the significant cash generation that it will start accumulating, and the generous dividend yield that the company is capable of paying. Investors should consider the organizational chart in Figure 2 to better understand the consolidation dynamics.

Figure 1. Current Implied Valuation Analysis for Segments as of June 1, 2010

Current Equity Target Equity Upside Grupo Mexico market cap 18,138 26,439 45.8% Holding co disc reverse (+20%) 4,534 Holding co net debt (cash) (373) Southern Copper Corp market cap 23,724 Southern Copper Corp 80% stake 18,979 27,200 43.3% Residual Value - Subsidiaries 3,321 Asarco implied valuation (56%) 1,852 3,509 89.4% ITM implied valuation (44%) 1,469 2,782 89.4%

Sources: Santander estimates. Note: Grupo Mexico and Southern Copper Corp upsides exclude dividend yield.



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Figure 2. Grupo Mexico – Organization Chart as of March 2010

100% 100%

100%100% 100%

100% 100%100% 100%

74.9% 25.1%

74%80%

Americas MiningCorporation (AMC)

México Proyectosy Desarrollo

Infraestructura y TransportesFerroviarios

GrupoFerroviarioMexicano

México Constructora

Industrial

MineraMexico

Southern PeruCopper

Ferrosur

26%20%

40% FreeFloat

Infraestructura y TransportesMexico (ITM)

100% 100%

100%100% 100%

100% 100%100% 100%

74.9% 25.1%

74%80%

Americas MiningCorporation (AMC)

México Proyectosy Desarrollo

Infraestructura y TransportesFerroviarios

GrupoFerroviarioMexicano

México Constructora

Industrial

MineraMexico

Southern PeruCopper

Ferrosur

26%20%

40% FreeFloat

Infraestructura y TransportesMexico (ITM)

Sources: Company reports and Santander.

UNLOCKING THE VALUE OF THE TRANSPORTATION DIVISION THROUGH AN IPO

As previously indicated by management, we expect Grupo Mexico to conduct an IPO of the transportation division, in order to achieve two goals: unlock the value of this division; and provide an exit strategy to Sinca Inbursa, which currently holds 25.1% of Infraestructura y Transportes Mexico (ITM). In order to accomplish this, we expect to see a merger or consolidation of Grupo Mexico’s two main railroad assets, which is pending approval from Mexico’s federal court (Tribunal Federal de Justicia Fiscal y Administrativa). We expect that the approval and subsequent IPO to happen by year-end 2010. From that point on, new ITM shares will trade publicly as a tracking stock for the division. Our model considers that Ferrosur and Ferromex will consolidate their results starting 4Q10 and that the IPO would take place at year-end 2010.

Our year-end 2011 valuation of ITM is US$2.8 billion based on our DCF valuation. ITM’s valuation compares positively with our previous valuation of US$1.4 billion based on market multiples and the US$480 million acquisition cost at which Grupo Mexico acquired these operations from the Mexican government in 1997.

The current implied valuation of the railroad operation is US$1.5 billion, suggesting that this division has significant upside potential. Moreover, when ITM is compared with other railroad companies in the Americas, it is currently trading at a discount: its 2011E FV/EBITDA is 4.8 times, or a 32% discount to the sector average of 7.0 times. In terms of 2011E P/E ratio, the discount increases to 53%. 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.

We expect the IPO of ITM by year-end.


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Figure 3. ITM – Railroad and Logistics Company Valuation Multiples, 2010E–2012E

P/E FV/EBITDA 2010 2011 2012 2010 2011 2012 Union Pacific Corp. 15.3 12.9 10.7 7.5 6.7 5.9 CSX Corporation 15.0 12.6 10.4 7.5 6.7 5.9 Norfolk Southern Corp. 15.5 12.9 10.9 8.1 7.2 6.4 Canadian Pacific Railway Ltd. 16.1 13.3 11.6 8.4 7.4 6.8

Average Railroad Cos 15.5 12.9 10.9 7.9 7.0 6.3 ALL (Bz Logistics) 31.5 27.1 18.9 8.7 7.8 6.7

ITM 8.1 6.1 5.7 5.9 4.8 4.5 Discount vs. Railroad Cos 48% 53% 48% 26% 32% 27%

Discount vs. Logistics Co 74% 78% 70% 33% 39% 32% Note: Valuation multiples calculated using prices as of June 1, 2010. Sources: Bloomberg and Santander.

IPO of the transportation division as an exit strategy for Inbursa. Grupo Financiero Inbursa1, through its venture capital subsidiary Sinca Inbursa, currently holds 25.1% of ITM, and is seeking to cash-out as previously agreed. Inbursa acquired the stake in November 2005, and recorded it at a book value of M$1,076 million (US$87 million) as of 1Q10. Grupo Mexico may also consider a carve-out of a portion (some 10%-15%) of its ITM stake simultaneously with the IPO. Although Grupo Mexico has not decided whether it will execute the carve-out, doing so would to increase ITM’s free float to between 35% and 40%. We note that Grupo Mexico has no financing need to sell a stake given its solid cash generation and low leverage.

Consolidation or merger of both divisions? Even though Grupo Mexico has not decided yet whether it will consolidate or merge Infraestrucutra y Transportes Ferroviarios (ITF, the holding of 100% of Ferrosur) with Grupo Ferroviario Mexicano (GFM, the holding of 100% of Ferromex), we assumed in our model that both subsidiaries will remain independent, but that their results would start consolidating at the ITM level beginning 4Q10. If a merger were to happen, Grupo Mexico would have to exchange Union Pacific’s stake in GFM for a stake in ITM, such that Union Pacific would have economic ownership in the combined entity. We believe this issue would be determined prior to the IPO.

Where is the value of the transportation division? We believe that the three main value drivers are (please refer to Appendix B for more details on the business and sector):

• Size matters. ITM represents the largest and most profitable railroad in Mexico with a 55% market share. ITM’s tracks cover 71% of Mexico, including the main agricultural and urban areas (Mexico City, Monterrey, and Guadalajara), as seen in Figure 4. Also the ITM network covers key gateways for foreign trade including five border points with the United States, four ports on the Pacific Ocean, and three ports on the Gulf of Mexico. ITM’s scale and gateways access are important because any increase in Mexico’s foreign trade with the U.S., other LatAm countries, Asia, and Europe will directly increase the load volume. In addition, freight from China with a final destination of the U.S. is increasingly arriving at Mexican ports as the ports in Los Angeles and Long Beach are close to reaching capacity, benefiting ITM.

• Steady cash flow and less volatile than the mining division. With a consolidated EBITDA of approximately US$384 million estimated for 2010, the company enjoys very

1 Grupo Financiero Inbursa is a Mexican holding company of various subsidiaries with interests in banking, broker dealer, insurance, consulting and others. The Slim family is the main stock holder of Inbursa.



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steady margins over time generally in a range of 30% to 35% (see Figure 5). Fluctuations in the cash generation of this division are minor, thus partly compensating for the volatility observed in the mining division. Moreover, this division’s annual cash generation is enough to cover the net interest expense of consolidated Grupo Mexico (US$179 million in 2010) in the event that the mining-related divisions could not cover them.

• Growth and resilience to economic slowdowns. The railroad’s fuel efficiency relative to that of trucks provides a significant cost advantage given the increasing energy prices today, making it more resilient to an economic slowdown. During the 2009 crisis, when Mexico’s GDP’s contracted 6.5%, the transportation division only experienced a 15% revenue decline on U.S. dollar basis, which compares favorably with the 23% revenue decline at Grupo Mexico’s mining division (SCCO). Moreover, the Mexican freight railroads are underutilized, in our view, considering that its current share of total Mexican freight load volume is only 18% versus 41% in the U.S., according to ITM management and the Association of American Railroads (AAR). We also note that President Calderon has a goal to increase freight railroad load volume by at least 18% from 2009 to 2012, according to the U.S. Commercial Service. (However, we note this plan may be delayed somewhat due to the recent global crisis).


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Figure 4. Transportation Division’s Railroad Coverage in Mexico

Source: Company reports and Santander.

Figure 5. Transportation Division Sales and EBITDA Margin Trends

Sales

0

400

800

1,200

1,600

2008 2009 2010E 2011E 2012E

US$

in M

illio

ns

Ferromex Combined Ferrosur

EBITDA Margin

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

1Q08

2Q08

3Q08

4Q08

1Q09

2Q09

3Q09

4Q09

1Q10

2Q10

3Q10

4Q10

1Q11

2Q11

3Q11

4Q11

FY20

12

FerromexCombinedFerrosur

Sources: Company reports and Santander. Note: We assume that Ferrosur begins consolidation in 4Q10.

Areas where there is room for improvement, in our opinion. Even though we recognize that the transportation division offers a very interesting upside potential from a growth and valuation point of view, we also identified some areas were efficiency could be enhanced, thus improving profitability.



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• Ageing railroad fleet and tracks. ITM has approximately 720 locomotive cars with an average age of 20-22 years at Ferromex and 28-29 years old at Ferrosur. Moreover, only 190 units (33%) of Ferromex’s 566 locomotives were acquired in the past five years. The newer locomotives are more fuel-efficient, which can help mitigate rising diesel prices. On the other hand, newer tracks allow ITM to attach more rail cars to lengthen its trains and run at higher speeds, therefore increasing productivity.

• Low leverage and inefficient use of the balance sheet. With an estimated net debt-to-EBITDA ratio of only 0.2 times expected for year-end 2010 and a 13% return on equity expected for 2010, ITM’s balance sheet seems underutilized, in our view.

• Far from being a logistics company. Management is currently focusing on maintaining ITM as a pure railroad company and has no immediate plans to transform into a logistics company. Such transformation would include heavy investments in IT, a distribution center, warehouse, inventory management, supply chain process, tracking systems and “last mile” solutions. However, one way to expand beyond railroad services is for ITM to increase its intermodal operations, which is the carrying of shipping containers and truck trailers on rail cars. The combination of the two modes of transportation benefits from both railroad’s fuel efficiency and truck’s door-to-door service. Ferromex’s revenue share of intermodal is currently 5%, compared to 22% for U.S.-based freight railroads. In the U.S., intermodal grew four-fold between 1980 and 2007 (5.1% CAGR), driven by significant growth in the consumer goods sector, according to the AAR. Having an adequate infrastructure in place would be key for intermodal growth, in our view, and we note that there are about 70 intermodal terminals in Mexico today with 12 new ones planned for construction in the next few years, according to the USCS.

Why not grow faster and transform the company? We believe that engaging in such a large endeavor; including renovating the locomotive fleet and/or becoming a logistics company is not feasible given the modest growth that the Mexican economy experienced in the past decade and is expected to experience in the foreseeable future, especially compared to other emerging countries in the world. In addition, there might be freight transportation market structure issues such as the dominance of truck transportation and the existence of pure logistics service companies. The issue of violence and security concerns in Mexico could also be an issue.

ASARCO: VALUATION, VALUATION, VALUATION

We assigned a US$3.5 billion year-end 2011 value to Asarco, almost double its current implied valuation. Grupo Mexico regained control of Asarco for a net consideration of US$1.85 billion (US$3.6 billion minus US$1.4 billion cash in Asarco and a tax refund of US$360 million in cash), which represented a 2009 FV/EBITDA ratio of only 5.1 times or only US$9,250 per metric ton of production capacity. This compares very positively with the 9.2 times 2009 FV/EBITDA multiple of the sector or the US$34,760 per ton of installed capacity that the market is paying for SCCO and US$25,995 per ton for Antofagasta. According to our new discounted cash flow valuation, Asarco is worth US$3.5 billion, even without considering any capacity growth. This valuation implies a 90% upside potential from the current implied valuation, making any investment highly attractive.

Tax credits. Grupo Mexico has paid all the liabilities related to asbestos and environmental claims for a total consideration of US$3.6 billion. This payment generated a tax credit of approximately US$1 billion, of which US$360 million was reimbursed in cash during 1Q10. Going forward, the US$600 million balance in tax credits should reduce Grupo Mexico’s effective tax rates in 2010 and 2011.

We believe the Asarco asset is undervalued.


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Strengthening the balance sheet. All environmental and asbestos-related liabilities have been settled and Asarco is expected to be debt-free as soon as 2Q10. In addition, Asarco’s fixed assets and inventory were revalued to fair market value in order to reflect a more realistic financial picture of the company. For example its fixed assets are US$1.48 billion as of March 2010 compared to US$558 million book value registered a year ago. As a result, the company now has a positive equity structure on its balance sheet.

Until Grupo Mexico’s management assesses the current situation of the mines, obtains updated reserves figures, defines the priorities, and re-launches an exploration program, an aggressive expansion plan will not be set. Grupo Mexico’s regaining control of Asarco in December 2009 put an end to Asarco’s four and a half years of legal battles and bankruptcy status. This will allow management to focus on growth and produce a new expansion and modernization plan. In the mean time, we assumed annual copper sales volumes of 220,000 tons per year (of which 20,000 are lower-margin processing of third-party ores) and a minimum capex program of US$150 million over the next three years primarily focused on implementing metallurgic plants modernization and increase molybdenum recovery.

However, management has indicated certain initiatives for operating efficiencies and growth in the medium term. We note that successful execution of some these initiatives may take some time due to logistical/technical issues and the more stringent environmental regulations in the U.S. Nonetheless, investors should expect to have more visibility on Asarco’s future EBITDA growth driven by the following factors as Grupo Mexico announces them in the coming years.

• Modernization and re-engineering. In addition to the metallurgic plants modernization mentioned above, the integration into Grupo Mexico’s modern mining operations using GPS and automations and advanced IT systems would improve Asarco’s efficiency and productivity, and result in lower cash costs. We note that Asarco’s 1Q10 effective cash costs have already decreased to US$2.35/lb compared to US$2.89/lb in 4Q09

• Copper reserves expansion. Asarco currently has approximately 5 million tons of contained copper reserves, or approximately 30 years of mine life. However, these reserves are based on exploration and drilling results conducted more than 10 years ago. As such, new positive drilling results could significantly expand its reserves. For 2010, Grupo Mexico has US$10 million slated for exploration and drilling at Asarco. Given the relatively small size of this exploration budget, we believe this will be expanded once Grupo Mexico determines Asarco’s growth path.

• Potential cost synergies with Southern Copper’s operations in Mexico. In the medium term, Grupo Mexico can optimize cash costs by reducing inter-company transportation costs given the proximity of its mines and plants in Arizona and northern Mexico. Asarco currently ships a portion of its concentrates from Mission and Ray to Hayden, and then from Hayden to Amarillo for further treatment. Instead, Grupo Mexico could use its own freight train network and also benefit from lower operating costs in Mexico under NAFTA by using Southern Copper’s concentrators and SX/EW plants in La Caridad and Cananea, should the technological and logistical requirements allow. In terms of distance as seen in Figure 6, Mission and La Caridad are 132 miles (213 km) apart, which is only 40 miles farther than the distance between the Mission and Hayden. On the other hand, the distance between Hayden and La Caridad is 190 miles (307 km), significantly closer than the Amarillo refinery located 668 miles (1,075 km) away. We also note that we expect that the Cananea mine will reopen imminently, and it is located 50 miles (85 km) closer to Asarco’s mines than La Caridad. (Please refer to Appendix A for a detailed description of Asarco’s assets.)

Ascertaining a growth path is still pending.



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Figure 6. Map of Asarco Assets and Southern Copper Northern Mexico Assets


HIGH RISK OF TAXES AND ROYALTIES INCREASING IN MEXICO AND PERU After the inclusion of a 40% “natural resources” tax in Australia (effective in 2012), which negatively affected the mining companies operating there; the risk that governments around the world could try to increase their share of the record-high profits by increasing taxes on the mining companies is very high, in our opinion. Although we are not factoring in a large magnitude of potential increases in taxes and/or royalties imposed on mining companies in Mexico and Peru, we are now using a new 4% royalty payment in Mexico’s operations starting in 2011 and an additional two-percentage-point royalty payment in Peru, doubling the current 2% rate. Overall, we are expecting SCCO to pay US$215 million in additional royalties in 2011 and US$247 million in 2012.

• Mexico – a new 4% royalty payment on revenues is now included in our earnings model for SCCO. In September 2009, two opposition parties in Mexico, which together have majority control of Congress, submitted a proposal to tax the sales of mining companies at a rate of 4%. This is a significant increase from the current payment of M$1.0 to M$101.00 (US$0.08 to US$7.75) per hectare of land under concession and could have a significant impact on SCCO’s revenue. Although details such as deductions and the effect in integrated operations are still unknown, we believe this could be implemented as early as in 2011. This proposed tax increase is now considered in our projections for Southern Copper, and we believe the likelihood of its being approved is high.

• Peru – we are increasing royalty payments by 2 p.p. in our model for SCCO to 4% on total revenue in order to account for the risk of increasing royalties and/or compensate


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for the termination of the five-year “voluntary contribution” program, which ends in 2010. SCCO has been making voluntary contributions of US$15 million per year. In addition, elections will be held in Peru in 2011, and we expect to see increased pressure on the issue of how to better distribute the profits of the mining industry among the population.

• On the other hand, the new tax on capital gains in Peru is not expected to affect Southern Copper’s stock holders, as SCCO is a U.S. (Delaware) corporation. Only in the event that investors sell their holdings on the Lima Exchange, would this tax be imposed at a rate of 30% on Peruvian entities and at a rate of 5% on individuals and/or non-domiciled entities.

EARNINGS OUTLOOK We are raising Grupo Mexico’s 2010 and 2011 EBITDA estimates by 4.9% and 15.7%, respectively, reflecting increased visibility in Asarco and ITM, the positive impact of higher copper price estimates on the mining division, and the consolidation of Ferrosur. Consolidated EBITDA margin expansion of 780 basis points in 2010 and 550 basis points in 2011 reflect these factors. Figure 7. Grupo Mexico – Estimate Revisions, 2010E–2012E (U.S. Dollars in Millions*)

2010E 2011E 2012E Previous Current Change Previous Current Change Introducing

Revenue 8,125 8,571 5.5% 9,481 10,421 9.9% 11,625Op. Profit 3,829 3,757 (1.9)% 4,723 5,230 10.7% 5,960EBITDA 4,240 4,448 4.9% 5,171 5,980 15.7% 6,806EBITDA Margin 52.2% 51.9% (30)bp 54.5% 57.4% 280bp 58.5%Net Income 3,014 2,230 (26.0)% 3,781 3,238 (14.4)% 3,537EPS 0.39 0.29 (26.0)% 0.49 0.42 (14.4)% 0.45*Except per share data. NA not available. NM not meaningful. Sources: Company reports and Santander estimates.

Figure 8. Grupo Mexico Sales and EBITDA Breakdown, 2010E

Sales

66.1%

20.1%13.9% Southern Copper CorpAsarcoTransportation

EBITDA

14.0%8.5%

77.6%


At Southern Copper, the main changes in earning estimates include the positive impact of slightly higher copper prices, which partly offset the negative impact in revenues of a 3% average royalty payment starting in 2011. In addition, costs are expected to be higher in 2010 than previously expected due largely to the extended strike in Cananea, lower ore grades and increasing fuel costs.



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Sales volumes and capacity expansions to continue growing as previously expected in SCCO. In terms of sales volumes, we continue to follow for 2010 the company’s guidance of 505,000 metric tons (similar to 2009) without including any sales volumes from Cananea. However, in our model we are assuming Cananea will start production in 4Q10, contributing 30,000 metric tons in the last quarter or the year as we believe a resolution to the strike is imminent.

In 2010 we are expecting SCCO’s EBITDA to grow by 95% YoY due largely to a 43.5% increase in copper prices and a 56% increase in molybdenum prices. In 2011, we are expecting EBITDA to grow by 38% largely due to a 9.6% increase in copper prices and 25% increase in sales volumes, largely related to the re-start of Cananea.

Please refer to our Southern Copper’s report “Fundamentals Stronger than Sentiment,” dated June 3, 2010 for further discussion on its earnings outlook.

At Asarco, we estimate 220 thousand tons of copper sales volume and EBITDA generation of US$635 million in 2010, representing 14% of consolidated EBITDA. For 2011 and beyond, we have assumed constant sales volume and only moderate improvements in cash costs. Hence, as discussed above, there is a potential for positive EBITDA surprise in our medium-term Asarco estimates from the effects of efficiency gains from modernization of its operations by its parent, higher sales volume following copper reserves expansion, and synergies with Southern Copper’s operations in northern Mexico.

Our transportation division’s 2010 EBITDA growth estimate of 40.8% reflects a 16% growth in load volume and the consolidation of Ferrosur beginning in 4Q10. Load volume grew 21.4% YoY in 1Q10 from the rebound of economic activity in Mexico, particularly sectors such as agriculture, automotive, steel making, mining, and intermodal. Management expects load volume of 45.5 million tons/km for 2010, in line with our estimates, and we estimate a conservative 2011 load volume growth of 5.2% for Ferromex which is 1.5 times our GDP growth estimate. We estimate Transportation EBITDA margin to contract slightly in 2011 and 2012 to reflect rising diesel cost which is partially offset by efficiency gains from investments in locomotives and track upgrades.

Figure 9. Grupo Mexico Segment Sales and EBITDA Estimates, 2010E–2012E (U.S. Dollars in Millions) 2010E Δ% YoY 2011E Δ% YoY 2012E Δ% YoYSouthern Copper Revenue 5,638 51.0% 7,189 27.5% 8,250 14.7%EBITDA 3,523 94.9% 4,866 38.1% 5,582 14.7%EBITDA Margin 62.5% 1,410bp 67.7% 520bp 67.7% 0bp Asarco Revenue 1,713 47.1% 1,808 5.5% 1,807 (0.1)%EBITDA 635 76.2% 753 18.5% 758 0.8%EBITDA Margin 37.1% 610bp 41.6% 460bp 42.0% 30bp Transportation Revenue 1,184 28.7% 1,470 24.2% 1,560 6.1%EBITDA 384 40.8% 474 23.4% 496 4.8%EBITDA Margin 32.5% 280bp 32.2% (20)bp 31.8% (40)bpSource: Company reports and Santander.


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Figure 10. Grupo Mexico – Mining and Transportation Division Sales Volume and Price Estimates, 2010E–2012E Mining Division 2010E Δ% YoY 2011E Δ% YoY 2012E Δ% YoYSales Volume Copper (m.t.) 755,000 6.6% 890,000 17.9% 1,022,000 14.8%Molybdenum (m.t.) 19,000 2.2% 19,000 0.0% 19,500 2.6%Zinc (m.t.) 105,000 1.1% 117,000 11.4% 112,646 (3.7)%Silver (K oz) 22,180 (3.1)% 21,000 (5.3)% 21,275 1.3% Average Metal Prices Copper (US$/lb) 3.33 41.8% 3.65 9.5% 3.65 0.0%Molybdenum (US$/lb) 17.49 53.2% 18.37 5.0% 19.29 5.0%Zinc (US$/lb) 1.05 39.9% 1.11 5.0% 1.27 15.0%Silver (US$/oz) 17.30 17.7% 18.37 6.2% 18.57 1.1% Transportation Division 2010E Δ% YoY 2011E Δ% YoY 2012E Δ% YoYLoad Volume Ferromex ('000 Tons/Km) 45,478 16.0% 47,865 5.2% 49,660 3.8%Ferrosur ('000 Tons/Km) 6,992 2.3% 7,132 2.0% 7,274 2.0% Price/Ton Ferromex ('000 US$) 26.03 10.9% NA NA NA NACombined ('000 US$) 26.23 5.6% 26.73 1.9% 27.39 2.5%Source: Company reports and Santander.

Grupo Mexico’s 2010 net income estimate decreases to reflect higher effective tax rates as a result of applying the tax credit over two years as opposed to our prior assumption of only during 2010. In 1Q10, the company received a tax credit in cash for the amount of US$370 million, which positively increased Grupo Mexico’s cash flow during the quarter. Grupo Mexico registered this reimbursement directly in its cash flow. Going forward, Grupo Mexico still has a tax credit balance of approximately US$600 million which is registered on the balance sheet under “Other Current Assets” and which we expect to be deductible in the next two years. In our model, we assumed a US$300 million tax credit during 2010 and the remaining US$300 million during 2011 resulting in an effective tax rate of only 24% in 2010, which compares positively with its historical effective rate of over 32%. Also a more accelerated pay-down assumption of the US$1,500 million AMC loan (Southern Copper and Asarco’s parent) results in lower net interest expense estimate for 2011.

Our assumptions for Grupo Mexico’s capex are US$998 million in 2010 and US$3,531 million in the next three years, which are in line with management’s guidance. At Southern Copper, the Tia Maria and Toquepala mill expansion projects in Peru represent a large portion of 2010’s capex. The La Caridad concentrator expansion project in Mexico begins in 2011. We have yet to incorporate capex for Cananea, pending the resolution of the union protests. At the Transportation division, capex is directed to purchase newer fuel-efficient locomotives, tracks (maintenance, renewal, and expansion), IT systems, and infrastructure. IT systems integration between Ferromex, Ferrosur, and Union Pacific would result in efficiency gains within three years, according to management. The infrastructure investments include construction of a rail yard to support Grupo Modelo’s new Piedras Negras brewery with significant exports to the U.S. Please refer to Figure 11 below for details of Grupo Mexico’s capex by segment.

We estimate Grupo Mexico will pay a generous dividend in the upcoming years, supported by strong cash flow generation primarily from its mining division. Grupo Mexico has paid a quarterly dividend with an annualized payout ratio in the range of 80% to 90% and annualized dividend yields of approximately 10%. However, we note that during the 2009 credit crisis, the company paid stock dividends instead of cash for three quarters. We estimate for 2010 and 2011 dividend payouts of 70%, which implies a dividend yield through the year-end 2011 of 11.0%.



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Figure 11. Grupo Mexico – Capital Expenditure Assumptions by Segment, 2010E and Three-Year (U.S. Dollars in Millions)

Division Entity Project 2010E 2010E to

2012E Mining Minera Mexico La Caridad 10 300 Energy plant 44 200 Others 148 517 Southern Peru Tia Maria 347 694 Toquepala expansion 122 564 Others 132 520 Asarco 50 150 Mining subtotal 852 2,945 Transportation Ferromex 126 Ferrosur 20

576

Transportation subtotal 146 576 Infrastructure Mexico Constructora Industrial 0 10

Consolidated Total 998 3,531 Source: Company reports and Santander.

GRUPO MEXICO’S VALUATION SUM-OF-THE-PARTS DCF ANALYSIS Unlike in our previous model, where the value of Asarco and the Transportation division was determined applying market multiples, this time we are reaching a valuation of the three most important divisions of the company via a DCF. By doing this, we are fully considering the growth potential of the company, in a more accurate manner. This was largely possible from increased visibility from Asarco and the Transportation Division as their legal issues were resolved or are in the process of being resolved. Investors should bear in mind that Southern Copper’s valuation considers a 2011 target price of US$40.00 per share -- for further details, please refer to our latest SCCO report, “Fundamentals Stronger than Sentiment” published June 3, 2010.

Our valuation of Grupo Mexico is US$26.4 billion or M$44.80 (USD$3.40) per share by year-end 2011, representing an upside potential from current levels of 45.8%, which compares positively with our 28.3% benchmark for Mexico. Moreover, the total return on the stock is estimated at 56.8%, after considering a dividend yield of 11.0% estimated through December 2011.

Our target price was determined by adding the estimated NPV of each of Grupo Mexico’s three main divisions (SCCO, Asarco, and ITM) for the next 10 years, starting in 2012. This was particularly important as each of them has a different country risk, beta, tax rates, and growth in perpetuity, as shown in Figure 12. For Asarco, we assume a value for Mitsui’s 25% stake in Silver Bell Mining based on Asarco’s reported minority interest adjusted for our 2011 P/BV multiple estimate. For ITM, we assume that Ferromex and Ferrosur consolidate, but not yet merge, and estimate a pro forma Union Pacific minority stake proportionally to Ferromex and Ferrosur’s EBITDA contribution. We applied their respective ownership stakes at Grupo Mexico level. Finally, we subtracted the estimated 2011 net debt of the holding company, and we deducted a 20% “holding company” discount, which is very much related to the taxes that the company would incur in case it sold its main assets.

Pleaser refer to the Appendix D of this report, for DCF valuation analyses of Asarco and ITM segments.


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Figure 12. Grupo Mexico – DCF Assumptions by Segment Southern Copper Asarco Transportation Risk Free Rate 4.0% 4.0% 4.0% Beta 0.98 1.20 0.61 Equity Risk Premium 5.5% 5.5% 5.5% Country Risk 2.21%a 0.00% 2.24% Cost of Equity 11.6% 10.6% 9.6% 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 9.4% 9.8% 8.4% Perpetual growth 3.0% 2.0% 1.0% a Blended EMBI of Peru and Mexico at 50% each. WACC: weighted average cost of capital. Sources: Bloomberg, Damodaran Data Page, company reports, and Santander estimates.

Figure 13. 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 33,131 (869) 80.0% 27,200 81.1% Asarco 2,474 (1,225) 94.9% 3,509 10.5% Transportation 3,439 (95) 78.7% 2,782 8.3% Infrastructure 50 0 100.0% 50 0.1% Sum of the Parts 39,095 (2,188) 33,541 100.0% Holding Co net debt * 492 (492) (1.5)% Grupo Mexico, gross 39,095 (1,696) 33,049 Holding Co discount (6,610) (20.0)% Grupo Mexico, net 26,439

Shares outstanding

7,785 2011 Year-end share price $3.40 M$44.80 Source: Company reports and Santander. * Includes debt of American Mining Corp.

Figure 14. Macroeconomic and Operating Assumptions, 2009–2012E 2009 2010E 2011E 2012E

Macroeconomic Assumptions Peru GDP (%) 0.9 4.4 4.7 4.5 Inflation (%) 0.2 2.2 2.2 2.0 S//US$ Exchange Rate Period End 2.9 2.9 2.9 2.9 Mexico GDP (%) -6.5 3.9 3.5 3.0 Inflation (%) 3.6 5.2 3.9 3.8 M$//US$ Exchange Rate Period End 13.1 12.8 13.2 13.4

Sources: Santander estimates.

GMEXICO AT A FAIR DISCOUNT TO ITS HISTORICAL NAV We estimate that the stock currently trades at a 21.2% (discount to its NAV) considering the current market cap of SCCO, and market multiples based on LTM results of its subsidiaries. This is in line with the 20% holding discount that we believe the company deserves to trade at. This suggests that there is not significant ‘spread trading” to be done between SCCO and Grupo Mexico, in our opinion.



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Figure 15. GMexico NAV Calculation- Assuming Current Market Prices– (US$ in Millions) Equity Value of Valuation

Assets

Valuation

Ownership Investment Methodology Southern Copper Corp 23,723.5 80% 18,978.8 Market Cap (6/1) Asarco 2,183.4 100% 2,183.4 7.6 X LTM EBITDA Ferromex 2,137.8 56% 1,186.5 7.3x LTM EBITDA Ferrosur 385.9 75% 289.4 7.3x LTM EBITDA Total Gross Assets 22,638.1 Net Cash 1Q10 - Grupo Mexico (Holding) 372.5

NAV 23,010.6 GMexico Market Cap (6/1) 18,137.8 Difference vs NAV - US$ 4,872.8 Difference vs NAV - % -21.2% Historical Difference (Last 12 Months) -29.7%

Historical Difference (Last 24 Months) -38.4% Sources: Santander, Asarco web site, Grupo Mexico and Southern Copper Reports


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RISKS • Lower-than-expected copper prices. We are currently estimating average copper prices of

US$3.33 for 2010 and US$3.65 for 2011. These estimates assume an ongoing increase in demand, a deficit of copper concentrates worldwide and low inventories, as well as healthier world economic growth starting 2010 as oppose to the contraction observed in 2009. 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 92% of total EBITDA in 2010.

• The Cananea strike may take longer to be resolved, which may significantly impact our valuation. We are considering in our projections that the Cananea strike will end some time in 2Q10 or 3Q10, and that production will resume starting 4Q10, reaching full capacity in 2011. Any delays in this scenario could significantly reduce the company’s future profitability and valuation. Cananea has a nominal installed capacity of 180,000 metric tons per year of copper, which represents 20% of Grupo Mexico’s total copper capacity.

• A slowdown in economic growth in China could have a significant impact on the global demand for copper. China accounts for approximately 30% 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.

• Mining taxes and/or royalties may increase more than we are expecting in Mexico and/or Peru. In our model, we are considering royalties of 4% over revenues generated in Mexico and Peru starting 2011. However, there is a risk that new royalties or taxes may be higher than our assumption thus affecting significantly our valuation estimate.

Southern Copper (SCCO: US$27.91, Buy, Target Price: US$40.00); Valuation and Risks: 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.



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FINANCIAL STATEMENTS Figure 16. Grupo Mexico—Income Statement, Balance Sheet, and Cash Flow Statement, 2009–2012E, (U.S. Dollars in Millions) Income Statement 2009A % 2010E % 2011E % 2012E % Sales 4,830.8 100.0% 8,570.9 100.0% 10,421.4 100.0% 11,625.2 100.0% Cost of Sales 2,544.8 52.7% 3,939.2 46.0% 4,238.5 40.7% 4,602.4 39.6% Gross Profit 2,286.0 47.3% 4,631.7 54.0% 6,183.0 59.3% 7,022.8 60.4% Oper. and Adm. Expenses 138.3 2.9% 183.5 2.1% 202.7 1.9% 217.0 1.9% Operating Profit 1,735.2 35.9% 3,757.3 43.8% 5,230.1 50.2% 5,959.5 51.3% Depreciation 412.5 8.5% 690.9 8.1% 750.2 7.2% 846.2 7.3% EBITDA 2,125.9 44.0% 4,448.2 51.9% 5,980.3 57.4% 6,805.8 58.5% Interest Paid (133.3) (2.8)% (255.2) (3.0)% (213.6) (2.0)% (170.3) (1.5)% Interest Earned 97.0 2.0% 76.7 0.9% 76.3 0.7% 86.9 0.7% Derivative Instruments 4.7 0.1% (0.8) (0.0)% 0.0 0.0% 0.0 0.0% FX Gain/Loss 0.0 0.0% 0.0 0.0% 0.0 0.0% 0.0 0.0% Other Financial Operations 0.4 0.0% (30.0) (0.4)% 0.0 0.0% 0.0 0.0% Profit before Taxes 1,703.9 35.3% 3,547.9 41.4% 5,092.8 48.9% 5,876.1 50.5% Tax Provision (563.5) (11.7)% (843.4) (9.8)% (1,356.0) (13.0)% (1,903.1) (16.4)% Subsidiaries 17.3 0.4% 15.3 0.2% 0.0 0.0% 0.0 0.0% Minority Interest (270.6) (5.6)% (490.1) (5.7)% (499.2) (4.8)% (435.8) (3.7)% Net Profit 887.1 18.4% 2,229.7 26.0% 3,237.7 31.1% 3,537.2 30.4% Balance Sheet 2009A % 2010E % 2011E % 2012E % Assets 11,566.6 100.0% 13,147.8 100.0% 14,432.0 100.0% 14,863.1 100.0% Short-Term Assets 3,475.2 30.0% 4,535.4 34.5% 5,204.8 36.1% 5,569.0 37.5% Cash and Equivalents 1,357.6 11.7% 1,005.4 7.6% 1,859.3 12.9% 1,996.0 13.4% Accounts Receivable 627.9 5.4% 964.7 7.3% 1,133.0 7.9% 1,273.7 8.6% Inventories 824.5 7.1% 1,027.0 7.8% 971.5 6.7% 1,055.6 7.1% Other Short-Term Assets 665.2 5.8% 1,538.2 11.7% 1,240.9 8.6% 1,243.7 8.4% Long-Term Assets 8,091.4 70.0% 8,612.4 65.5% 9,227.2 63.9% 9,294.1 62.5% Fixed Assets 5,697.6 49.3% 7,106.2 54.0% 7,868.0 54.5% 8,043.3 54.1% Leachable materials 107.3 0.9% 178.3 1.4% 179.4 1.2% 181.6 1.2% Other Assets 2,286.6 19.8% 1,327.9 10.1% 1,179.8 8.2% 1,069.2 7.2% Liabilities 5,121.9 44.3% 5,697.2 43.3% 5,442.5 37.7% 4,724.3 31.8% Short-Term Liabilities 1,475.7 12.8% 1,459.1 11.1% 1,391.6 9.6% 1,460.5 9.8% Short-Term Loans 570.0 4.9% 348.6 2.7% 248.6 1.7% 248.6 1.7% Other Short-Term Liabilities 905.7 7.8% 1,110.5 8.4% 1,143.0 7.9% 1,211.8 8.2% Long-Term Loans 2,848.1 24.6% 2,648.1 20.1% 2,450.6 17.0% 1,653.2 11.1% Other Liabilities 798.1 6.9% 1,590.0 12.1% 1,600.2 11.1% 1,610.7 10.8% Net Worth 5,054.8 43.7% 6,014.6 45.7% 7,553.4 52.3% 8,702.4 58.6% Minority Interest 1,389.9 12.0% 1,435.9 10.9% 1,436.1 10.0% 1,436.3 9.7% Net Debt 2,060.5 17.8% 1,991.3 15.1% 839.9 5.8% (94.1) (0.6)% Cash Flow 2009A 2010E 2011E 2012E Net Majority Earnings 887.1 2,229.7 3,237.7 3,537.2 Depreciation and Amortization 412.5 690.9 750.2 846.2 Changes in Working Capital (1,480.5) (462.7) (61.0) (158.8) Other Non Cash Items 308.3 (873.1) 297.3 (2.8) Capital Expenditures (580.7) (997.7) (1,512.1) (1,021.5) Change in Debt 1,451.0 (421.4) (297.4) (797.4) Dividends (455.7) (621.0) (1,560.8) (2,266.4) Capital Increases / Other (992.8) 0.0 0.0 0.0 Net Inc/ (dec in cash (450.8) (455.2) 853.9 136.6 Beginning Treasury 1,808.4 1,460.6 1,005.4 1,859.3 Ending Treasury 1,357.6 1,005.4 1,859.3 1,996.0 Sources: Company reports and Santander estimates.


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APPENDIX A – ASARCO BUSINESS DESCRIPTION Asarco is headquartered in Tucson, Arizona, and is the third-largest copper producer in the United States. Asarco was founded in 1899 as the American Smelting and Refining Company, and was taken over by Meyer Guggenheim and his sons in 1901. Asarco was one of the companies with which the Guggenheim family amassed its fortune. Asarco operated as a holding company for various mining, smelting, and refining operations throughout the U.S. While it originally consolidated primarily lead and silver smelters, following WWII it began focusing on mining and processing of copper. In its heyday, from 1901 to 1958, Asarco was a member of the Dow Jones Industrial Average.

In 1955, Asarco organized Southern Copper Peru Corporation, the predecessor to today’s Southern Copper Corporation, as a joint venture with Phelps Dodge, Newmont Mining, and Cerro de Pasco. In 1967, a 51% stake of its Mexican operations, Asarco Mexicana SA, was sold to Mexican investors, and this became the predecessor to today’s Grupo Mexico. Asarco gradually reduced these ownerships stakes over time. In turn, Grupo Mexico purchased Asarco through an LBO in 1999. For various reasons including high indebtedness and environmental and asbestos-related liabilities, Asarco entered into a U.S. Chapter 11 bankruptcy protection in August 2005, and the consolidation of its results into Grupo Mexico’s were discontinued. In December 2009, the reorganization was concluded, liabilities paid and Asarco resumed consolidation with Grupo Mexico.

Asarco currently has 5 million tons of contained copper reserves, which implies more than 30 year’s of mine life. All of its currently operating mines are located in the state of Arizona. The following table provides an overview of Asarco’s primary assets.

Figure 17. Asarco’s Primary Assets

Name Facilities Location Annual Production Reserves & Mine Life / Plant Capacity Remarks

Ray operations

Open pit mine

Concentrator

SX/EW plant

82 miles (132 km) southeast of Phoenix, AZ

Copper & silver concentrate (Cu 69.6 kmt)

Copper cathode 34.0 kmt

Copper reserves 3,110 kmt

Mine life 33 years

Concentrates sent to the Hayden smelter using an 18 mile (29 km) rail link owned and operated by Asarco.

Mission operations

Open pit mine

2 concentrators

18 miles (29 km) south of Tucson, AZ

Copper & silver concentrate (Cu 65.3 kmt)

Copper reserves 1,158 kmt

Mine life 18 years

Concentrates sent to the Hayden smelter 90 miles (145 km) away via Union Pacific railroad.

Silver Bell Mining LLC

4 open pit mines

SX/EW plant

45 miles (72 km) northwest of Tucson, AZ

Copper cathode 22.2 kmt Copper reserves 553 kmt

Mine life 25 years

25% owned by Mitsui & Co since 1996. Copper cathodes sold to copper rod, tubing and wire producers.

Hayden smelter

Concentrator and smelter plants, and warehouse

18 miles (29 km) east of Ray and 90 miles (145 km) northeast of Mission

Copper cathode, rod, and cake 256 kmt

Copper concentrate input 720 kmt

Copper anodes sent to the Amarillo refinery 668 miles (1,075 km) away via rail and truck.

Copper cathodes sold to third-parties.

Amarillo refinery

Anode dept, tank house, refined casting dept, precious metals refinery, etc.

9 miles northeast of Amarillo, TX

668 miles (1,075 km) east of Hayden

Copper cathode, rod, and cake 605 kmt

Silver & Gold bars

Copper cathode production 550 kmt

Patented process called “Reagent Control” allows plant to exceed capacity and elevates production quality.

Sources: Company reports and Santander. Note: KMT = Thousands of Metric Tons



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Other Asarco assets include Tucson corporate headquarters, dormant plants in El Paso, TX, Globe, CO, and East Helena, MN; and industrial warehouse and port facilities in Perth Amboy, NJ. In addition, there is a potential mine cite in Sacaton, AZ with high copper grades based on historical geological summary reports. The Sacaton site has not been mined since 1984.

APPENDIX B – TRANSPORTATION DIVISION (ITM) BUSINESS AND SECTOR DESCRIPTION The transportation division provides national and international freight services. It operates through Infraestructura y Transportes México (ITM) which indirectly owns its two main assets: Ferromex and Ferrosur. Sinca Inbursa has a 25.1% minority stake in ITM. Union Pacific has an indirect 26% minority stake in Ferromex. Ferromex was formed in 1998 as part of the privatization of the Mexican railroad system. Ferromex owns approximately 30% of its rail cars and other domestic and foreign railroad companies own the rest. ITM and its subsidiaries operate under various 50-year renewable concessions from the Mexican government for use of the tracks with the obligation to maintain them.

Longest track network in Mexico. Ferromex has Mexico’s largest track network of 8111 km, which is 71% of Mexico’s territory, including the main agricultural and urban areas (Mexico City, Monterrey, and Guadalajara). Ferrosur has a track network of 1,813 km, covering primarily the southeastern part of Mexico.

Market share potential. Ferromex has the largest Mexican freight railroad load volume market shares with 46%, complemented by Ferrosur’s 9% share. The next largest player, Kansas City Southern, has a 40% share, and small regional lines serve the remaining 5%. However, railroad’s share of total Mexican freight is only 18% because trucks transport the remaining 82% share, according to ITM management. Railroad’s share has been increasing since its 1997 trough of 11%. However, the railroad can significantly increase its share, in our view, considering that the current U.S. railroad’s share is 41%, according to the Association of American Railroads (AAR) and its lower cost when compared to other transportation alternatives. We also note that the record Mexican railroad share is 35% in 1974, during the “Oil Shock”. Now, President Calderon has a goal of increasing railroad load volume by at least 18 to 20% from 2009 to 2012, according to U.S. Commercial Service. The railroad’s fuel efficiency relative to that of trucks provides significant cost advantage given the increasing energy prices today.

Freight type mix, customers, and pricing policy. ITM’s freight types are diversified among sectors such as: agricultural, industrial, minerals, automotive, petrochemical, energy, cement, and steel products. Large customers represent approximately 80% of revenues; such customers include Crown Imports (Grupo Modelo’s U.S. beer importer), Cemex, General Motors, Ternium, Nissan, and Pemex. However, smaller customers are more profitable because large customers have more negotiation leverage, contracts are longer term, and volumes are significantly higher. In terms of pricing, if a freight route competes with trucks, the price is generally set at 20% to 25% discount to the trucks’ prevailing rate. However, ITM may also compete for freight with other railroads such as Kansas City Southern. Prices are higher for services such as on-time delivery and depending on load complexity (e.g., automotive is more complex than agricultural grains). ITM’s price may also include a fuel surcharge if diesel price increases beyond a certain level.


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APPENDIX C – INFRASTRUCTURE DIVISION BUSINESS DESCRIPTION Grupo Mexico began its construction operations in 1942 to assist its own growth in the mining and railroad sectors. In 1984, Grupo Mexico formed Mexico Constructora Industrial (MCI). MCI performs engineering, procurement, and construction services for Grupo Mexico and third parties both public and private. Projects include: hydroelectric dams, warehouses, canals, irrigations, highways, thermoelectric plants, manufacturing and petrochemical plants, and residential facilities. The Infrastructure Division is the smallest of the four of Grupo Mexico’s with estimated 2009 revenue of US$38 million.

In 2009, Grupo Mexico increased its stake to 100% in Pemsa (Compañía Perforadora México). Pemsa primarily performs engineering and drilling services for Pemex anbd had revenues of US$90 million in 2009. Another company acquired in 2009 is Servicios de Ingeniería Consutec which is active in petrochemical projects with Pemex, hydroelectric generation projects for the chemical industry, and the Tia Maria mining project with Southern Copper.

A current project includes the construction of two deviation tunnels on the Grijalva River in southeastern Mexico for US$50 million. The tunnels are designed to prevent flooding in the area, and are expected to be completed in September 2010.



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APPENDIX D – DCF FOR ASARCO AND ITM Please refer to our Southern Copper’s report “Fundamentals Stronger than Sentiment,” dated June 2, 2010 for its DCF analysis.

Figure 18. Asarco – DCF 2011E-2021E (US$ in Millions)

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Operating Profits 614 629 560 418 386 328 323 326 321 244 240 (-) Taxes in Oper Profits (215) (220) (196) (146) (135) (115) (113) (114) (112) (85) (84) (+) Depreciation 138 129 122 77 75 56 56 47 47 43 43 (+/-) Changes in WC (4) (21) 2 18 (1) (11) (22) (23) (24) (11) (25) (-) Capital Expenditures (50) (50) (40) (40) (40) (40) (40) (40) (40) (40) (40) (=) Free Cash Flow 483 468 448 326 285 218 204 197 192 151 134 NPV Cash Flow 1,801 NPV Terminal Value 673 Net Debt (1,225) Minority Interest 188 Equity Value 3,510

Sources: Company reports and Santander estimates.

Figure 19. Transportation Division (ITM) – DCF 2011E-2021E (US$ in Millions)

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Operating Profits 364 378 390 407 371 395 421 450 482 514 548 (-) Taxes in Oper Profits (116) (121) (125) (130) (119) (126) (135) (144) (154) (165) (175) (+) Depreciation 110 119 130 138 199 202 204 203 202 201 201 (+/-) Changes in WC (11) (13) (15) (17) (20) (22) (25) (28) (31) (35) (39) (-) Capital Expenditures (215) (215) (250) (250) (250) (250) (200) (200) (200) (200) (200) (=) Free Cash Flow 132 147 130 147 182 198 265 282 298 316 334 NPV Cash Flow 1,410 NPV Terminal Value 2,029 Net Debt (95) Minority Interest 752 Equity Value 2,782

Sources: Company reports and Santander estimates.


23

APPENDIX D – COPPER MARKET

COPPER OUTLOOK REMAINS SOLID Copper prices are down 5.8% YTD, reflecting growing concerns about Europe’s economic growth, as several southern European countries are facing problems with their sovereign debt payments, and the risk that this problem may spread globally. This has been further aggravated by China’s decision to slow down its economic growth and construction development. Nevertheless, demand for metals continue to show a recovery from the levels observed last year, and copper is no exception. Copper prices went up 55.9% in the last 12 months at US$3.15/lb, mainly driven by a recovery in global consumption and a growing supply deficit. Inventories on the LME have recovered from their historical low levels observed last year, reaching 476,725 tonnes. However, they are 5.1% down YTD. According to our estimates, this level represents less than 10 days of global consumption, still low by any measure.

Copper demand increased 5.9% in the first two months of the year. Global copper demand according to the ICSG during the first two months of 2010, increased by 5.9% or some 163,000 tonnes compared with that in the same period in 2009. (This is the latest available data published on May 20, 2010.) While apparent usage in China remained basically unchanged and usage in the U.S. declined modestly during the first two months of 2010 compared with the same period in 2009, the growth in world usage reflected increases in Japan (up over 50,000 tonnes) and the EU (an increase of over 15,000 tonnes). Other contributors to the year-on-year growth in refined copper usage included Brazil, India, Korea, and Taiwan. World usage recovered in all regions except North America.

World mine production grew 1% (28,000 tonnes) during the first two months of 2010 compared with that in the same period in 2009, suggesting that we may see continuous tightness in the market as demand continues to surpass mining capacity. The deficit is expected to continue to be covered by scrap; as we have seen in the past years.

Figure 2. LME Copper Inventories (In Tons)

-

200.0

400.0

600.0

800.0

1,000.0

1,200.0

1/0/

00

7/25

/00

2/16

/01

9/14

/01

4/16

/02

11/1

1/02

6/12

/03

1/7/

04

8/3/

04

2/28

/05

9/26

/05

4/24

/06

11/1

6/06

6/18

/07

1/14

/08

8/8/

08

3/5/

09

10/1

/09

4/29

/10

$0.50$1.00$1.50$2.00$2.50$3.00$3.50$4.00$4.50

Inventory - Tons 000's Copper Prices LME - US$ Lb

Sources: Bloomberg and Santander estimates.



24

HIGH COPPER PRICES FOR LONGER

We believe the long-term trend continues to be positive, with copper prices averaging US$3.33/lb in 2010 (some 2% above our November estimates), and US$3.65/lb in 2011. According to our estimates, copper prices have a “ceiling” when they reach US$4.00/lb because, at that level, substitution is viable (mainly with aluminum) and scrap appears in the market in large quantities. The long-term upward trend is now more solid than it had been, as many junior mines that were expecting to start production in 2011 are now out of business or dormant due to the lack of financing available, thus likely reducing future supply. Lower ore content, strikes affecting global production, and limited large scale projects, only limit the availability of supply going forward, translating into sustainable high prices. On the other hand, increasing production and capacity expansion costs have led us to increase our perpetuity copper price from US$2.06/oz to US$2.50/oz. Our perpetuity begins in 2021.

In the short term, we expect a mild recovery in copper prices from current levels of US$3.15/oz toward a range of US$3.25-US$3.50/oz following a period of high volatility observed in April and May. This is because financial markets are starting to stabilize and real economic growth has become evident in most regions of the world, in our view.

Figure 3. Copper Price Projections – Annual Average (U.S. Dollars per Pound) 2008 2009 2010E 2011E 2012E Perp

Copper - US/Lb New Estimates 3.20 2.33 3.33 3.65 3.65 2.50 % Change YoY -27% 43% 10% 0% -31% Previous Estimates 3.20 2.34 3.25 3.58 3.58 2.06 % Change YoY -27% 39% 10% 0% -42%

% Change New vs Old Est. 2% 2% 2% 21% Molybdenum - US/Lb New Estimates 29.67 11.38 17.49 18.37 19.29 15.00 % Change YoY -62% 54% 5% 5% -22%

Previous Estimates 29.67 11.46 16.50 17.33 18.19 15.00 % Change YoY -61% 44% 5% 5% -18%

% Change New vs Old Est. 6% 6% 6% 0% Sources: Santander estimates, Bloomberg, ICSG, and GFMS.


25

IMPORTANT DISCLOSURES Grupo Mexico —12-Month Relative Performance (U.S. Dollars)

Grupo Mexico

IPC

80

130

180

230

280

330

J-09 A-09 O-09 D-09 J-10 M-10 M-10

Sources: Bloomberg and Santander.

Grupo Mexico —Three-Year Stock Performance (U.S. Dollars)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

M-07 J-07 S-07 D-07 M-08 J-08 S-08 D-08 M-09 J-09 S-09 D-09 M-10300

800

1,300

1,800

2,300

2,800

3,300

Grupo Mexico (L Axis) MEXBOL (R Axis)

H$27.756/10/08*

H $2.577/30/08

*Initiation of Coverage

H $0.7512/1/08

B $2.409/30/09

B $3.1012/8/09

Source: Santander.

Analyst Recommendations and Price Objectives SB: Strong Buy B: Buy H: Hold UP: Underperform S: Sell UR: Under Review



26

Southern Copper – 12-Month Relative Performance (U.S. Dollars)

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

M-09 J-09 A-09 S-09 N-09 D-09 F-10 A-10 M-10

SCCO

IGBVL

Sources: Bloomberg and Santander.

Southern Copper – Three-Year Stock Performance (U.S. Dollars)

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

M-07 J-07 S-07 D-07 M-08 J-08 S-08 D-08 M-09 J-09 S-09 D-09 M-100

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

Southern Peru Copper (L Axis) IGBVL (R Axis)

B $26.506/29/09

H $38.336/10/08

H $15.0012/1/08

B $36.009/30/09

B $30.004/10/07

H $37.008/1/07

B $41.1012/8/09

Source: Santander.

2010

IMPORTANT DISCLOSURES Key to Investment Codes 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%. 55.56% 60.00%Hold Expected to perform within a range of 0% to 10% above the local market

benchmark. 37.57% 37.14%

Underperform/Sell Expected to underperform the local market benchmark. 6.88% 2.86%Under review -- –The numbers above reflect our Latin American universe as of Thursday, May 13, 2010. 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 53rd Street, 17th Floor (Attn: Research Disclosures), New York, NY 10022 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) 350 3974. 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, Sergio Matsumoto. 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. © 2010 by Santander Investment Securities Inc. All Rights Reserved.

new york, june 3, 2010 mexico – mining grupo mexico b · pleaser refer to appendix e on page 23...

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