Escalating costs weigh on copper miner Antofagasta

* Announces 31.5 percent increase in interim dividend

* H1 EBITDA down 11.5 pct to $1.13 bln vs forecast $1.22 bln

* Shares (Frankfurt: DI6.F - news) fall almost 4 percent (Adds analyst, CEO comments, detail, background)

By Silvia Antonioli

LONDON, Aug 26 (Reuters) - Escalating production costs and weaker copper prices took their toll on Chilean copper miner Antofagasta (Other OTC: ANFGF - news) in the first half of this year, with its core profit sliding 11.5 percent.

Like its peers, Antofagasta is battling falling copper grades and higher output costs, and is spending billions on projects to replace ageing mines and boost capacity.

Containing costs is proving tough, however, and the miner said it was implementing moves aimed at cutting them, including merging its Esperanza and El Tesoro mines into a single operation called Centinela. It did not give a savings target.

"We expect costs to remain Antofagasta's main challenge going forward," Bernstein analysts said in a research note.

Antofagasta's first-half core profit, or earnings before interest, tax, depreciation and amortisation (EBITDA), came in at $1.13 billion, below analysts' average forecast of $1.22 billion, according to Thomson Reuters I/B/E/S.

Profit was hit by a 2.2 percent fall in realised copper prices and an almost 16 percent increase in net cash costs, mostly on the back of a one-off bonus agreed with labour unions and lower revenue from by-products such as gold and silver.

Shares in Antofagasta were down about 4 percent by 0945 GMT within a UK mining sector down 0.3 percent.

The London-listed stock tends to trade at a multiple of earnings at the top end of the sector, mostly because historically the firm has paid generous returns to shareholders.

It has paid special dividends in 10 of the last 11 years and in March announced a bumper annual dividend despite a 30 percent drop in core profit, opting to distribute cash rather than hold it amid low interest rates.

The miner, controlled by Chile's Luksic family, said it would pay an interim dividend of 11.7 cents a share, above analyst forecasts of 9.9 cents and up from 8.9 a year earlier.

This is in line with the company's new policy to pay out a minimum of 35 percent of net earnings.

Following last year's large payout, however, the group's net cash position fell 76 percent to $403 million, weighing down expectations of a higher full-year return to shareholders.

CHALLENGING MARKET

Antofagasta said it was cautious on the short-term outlook for the copper price, but optimistic for the longer term.

Even (Taiwan OTC: 6436.TWO - news) after staging a recovery in the last four months, copper prices are still down 4 percent on the year.

Analysts expect additional supply of the metal coming on stream and weaker demand growth in top consumer China will curb the price of the red metal used in power and construction.

"We continue to operate in a challenging market, however we believe that the market fundamentals for copper are strong," mining division Chief Executive Diego Hernandez said. "Despite recent increases in new mine supply from various projects coming onstream, the market remains balanced, contrary to expectations earlier in the year that a supply surplus would emerge."

Hernandez said he now expected a 150,000 tonne surplus by the end of this year. That is below a previous expectation for a surplus of 400,000 tonnes due to new project delays and a ban in Indonesia that cut exports from the country in the first half.

Antofagasta reiterated its full-year production guidance of 700,000 tonnes of copper at a net cash cost of $1.45 per pound. On July 30, the group reported first-half production volumes slightly ahead of analysts' mean forecast but 4.4 percent below the same period a year before, hit by falling copper grades.

To battle a fall in production due to ageing mines and declining grades, Antofagasta is focusing on its brownfield expansions and on its $1.9 billion Antucoya greenfield project, construction of which is now 74 percent complete and on budget and on time for first production in the first half of 2015.

The miner hopes a total $3 billion investment over the next five years will allow it to increase its annual output to 900,000 tonnes by 2018 from about 700,000 tonnes currently.

The company said last week that Hernandez's role would be expanded from Sep. 1 from CEO of the mining division, by far the largest branch of the company, to chief executive of the whole group, which also includes a transport and water businesses.

Paul Luksic, a member of the controlling family, decided to step down as group CEO for personal reasons but will remain chairman, though in a non-executive capacity.

"I have always wanted to have a railway," joked Hernandez in a call with investors. "It is a little more work for me and business as usual. Jean-Paul (Luksic) will lead the board and the strategy but not the day-to-day business." (Editing by Keiron Henderson and Mark Potter)