David S. Bryson – Senior Vice President and Chief Financial Officer
Matthew Fields – Bank of America Merrill Lynch
HudBay Minerals Inc. (HBM) Bank of America Merrill Lynch 2013 Leveraged Finance Conference Call December 3, 2013 9:30 AM ET
Matthew Fields – Bank of America Merrill Lynch
My name is Matt Fields. I’m the high yield metals and mining analyst at BofA. It’s my pleasure to welcome HudBay Minerals to our 2013 Leveraged Finance Conference.
And with that, I’d like to introduce David Bryson, Senior Vice President and CFO.
David S. Bryson
All right, thanks very much. It’s a pleasure to be here and I appreciate you folks taking the time to hear our presentation today. I’ll start with an overview of our strategy, how we see ourselves creating value in this space. Mining and metals has obviously been a challenging space for investors for the past year or two and we think a lot of it comes down to being disciplined with investors’ capital. Our strategy is really focused on leveraging the 85 years of experience that we have in mining in Canada, particularly in northern Manitoba.
Hudbay was originally Hudson Bay Mining & Smelting, was listed on the New York Stock Exchange in the 1920s and was taken private under Anglo American ownership in the 80s, re-IPOed in 2004 in its present form and actually accessed the high yield market in 2004 as part of that re-IPO, was a very successful transaction that the company repaid the bonds earlier. We had a management change in about three years ago and following that, really reset the company’s strategy and focused it on certain types of geological settings, certain geographies, where we’re confident that we can create sustainable value through the cycle and it is a cyclical business.
We’re focused on six or seven mining friendly investment grade countries in the Americas, the green countries that you see on the map in North America and then certain countries in South America, where there is a well established track record of mining, where people get it. There is people, domestic – local people in the country are experienced in mining and that’s very much the case that we have in Peru, where substantially all of our employees in Peru are native Peruvians not expats.
We are also focused on certain types of geological settings. VMS or volcanogenic massive sulfide deposits are the types of deposits that we have been mining for over 85 years in Manitoba and we think that we are second to none in finding, developing, and operating these types of mining assets. And we think that that skill set lends itself well to copper porphyry deposits, they’re both sulfide with a lot of similarities that allows us to capitalize on that expertise that we have that we think is really unique for a company of our size in, what I call, the intermediate mining space, where having that institutional history, the processes and systems for efficient mining and safe mining operations is something that is a real asset as we look to developing new assets and ramping them up.
When we look at M&A strategy, our real focus is on tuck-in acquisitions of development stage assets. We generally don’t like big merger of equal transactions. We generally don’t like acquiring producing assets, because frankly, they are pretty efficiently valued by the market. It’s very difficult to create value. There is no synergies in the mining business to speak of and so we prefer to create value through exploration by getting our hands on a property that hasn’t been fully explored and growing the reserves and resources after we acquire it through exploration expertise. And we think we can sustainably create value by taking development projects and putting them into production, creating those annuities, so they trade at higher multiples than a risker development stage asset would.
So three years ago, we set out with a strategy. Over that time, we’ve added some projects to the development pipeline. We put three mines into construction and the results of that are within a year of seeing the completion of that. Across all three of our key metals; copper, precious metals as well as zinc, we’re going to see very substantial growth over the next several years from the trough production that we are seeing in early 2013. When the current management team took over three years ago, the company was in a bit of decline. It didn’t have growth in front of it. It had some mining assets that were higher cost that were going to be reaching the end of their reserve life, which happened for a couple of our mines in 2012.
So we’re now – we passed the trough and they’re starting to ramp up in terms of production, cash flow and EBITDA and expect very substantial growth, as we complete our two major projects in the second half of 2014 and ramp up towards commercial production. In terms of our commodity exposure, you can see it on the left in terms of our reserves and resources; on the right, in terms of our revenues; it’s a fairly similar story. It’s fairly leveraged towards copper with significant zinc and gold in the mix. I would say that the revenue mix will tilt probably more towards 60% copper from the current 40% once we complete Constancia, because Constancia’s production will be a very large part of our production profile going forward, but zinc and gold will still be significant part of the mix.
I like to talk about this slide, just to provide a proof point on what I’ve been saying about the 85 years of history and the experienced workforce we have. This slide in the grey bar shows our annual production guidance going back to 2006 in the range that we put about that production guidance and the red line shows what we actually delivered in terms of copper equivalent production and for all of those years, seven years running, we’ve consistently hit our guidance and I think that that’s something that we’re quite proud of. We set out to do what we say that we’re going to do and it’s really only with quality assets and a quality workforce that has the processes and systems in place that you can deliver these types of results consistently overtime.
We also bring low-cost operations to the mix. Some mining companies have come about or in production by having started out as a junior, got up – an operation up and running that are a bit of a higher cost operation, these are the Brook Hunt or Wood Mackenzie, C1 industry cost curves for both copper and zinc and we plotted our mines on one or the other just depending on where the revenue mix is. Then as you can see, our mines are all in the first or second quartile and that’s really our focus is, having mines that will consistently generate cash flows throughout the cycles, so that we’re not faced with a situation of having open and closed mines in response to fluctuations to metal prices. We want to sustain that advantage of an experienced stable workforce and we can do that by maintaining low cost, long life operations that will operate through the cycle.
Our flagship 777 mine is a good example of that. In this chart, you can see in the green bars, the annual tonnes of ores produced, very consistent production overtime, debottlenecking the mine, gradually growing the production, but I think just as important is the yellow line that you see, which is our unit operating cost per tonne of ore produced and it’s been very consistent over the past six years. We had a little bit of a blip in 2012, but that’s under control and we’ve had results very much in line with this over the last few quarters. And I think that that’s really unique in mining, when you consider the ramp in cost inflation, in labor, in power cost, that we’ve had in mining operations and I’d like to claim that we’re brilliant operators, but I think part of it is a stable workforce has led to modest wage inflation and where we are in Manitoba, benefits from low cost hydroelectricity and we haven’t had the power cost inflation that we’ve seen in other more hydrocarbon intensive areas of the world.
So we have about an eight-year mine life remaining on that. We own a 100% of the deposit and we’re continuing to try to incrementally improve 777. Our reserve replacement ratio is about one-third. so for each year of mining, we’re adding about one-third of the year of reserves. It’s been our track record for the past few years. We’ve just completed a new ramp from surface in order to expand our production rate by about 8% and gain some other operating efficiency.
So it’s a good cash flow generator. It’s something that we’re continually working to optimize, but the growth for HudBay is going to come from our other three projects: Lalor, Reed and in Peru, Constancia. I’ll start with Lalor and just also orient you a little bit to the infrastructure that we have in northern Manitoba. You can see the 777 mine off to the left hand side of the chart. The Lalor project is towards the east, near the Town of Snow Lake in an existing camp, where we’ve had other deposits over the years.
Our Reed project is just off of provincial highway in between Flin Flon and Snow Lake, and leveraging the existing infrastructure that we’ve developed over 85 years of mining is a key opportunity and advantage that we have in northern Manitoba. We own most of the, what we think are the good exploration properties in this camp and we have two concentrators a zinc plant that really allows us to take mineral deposits that might otherwise be economically challenged if they needed greenfield’s infrastructure and we can make good money from that by leveraging the existing infrastructure.
So Lalor, its initial production is already being milled at the existing Snow Lake concentrator. The Reed deposit, that’s a very simple ramp from surface that we’re just going to truck to Flin Flon to a mill at the concentrator there. The Lalor mine project itself has been a great success story today for us. We’ve been on time and if anything on budget – I’m sorry, and if anything, ahead of schedule. we have already started commercial production from some of the initial working that started earlier this year and our 1 kilometer production shaft that we’ve already completed the sinking of that on time and on budget. And so over the next six to eight months, we’ll be installing the steel, the [indiscernible] that’s commissioning the hoists, so that we can start production from the main shaft in the second half of next year.
Lalor is long-life, low-cost deposit, 20-year mine life that we own a 100% of and we still see significant exploration potential with Lalor. As I mentioned, a lot of the works are already done. we’ve completed, I think, we might have provided the laser pointer there, but as you can see on the left, there is ventilation raise; we’re already using that for production. we’ve completed an underground ramp from another closed mining operation that we can use for hauling waste and for bringing equipment to and from the mine. the main production shaft that you can see, the sinking is complete and so now, it’s just installing the facilities in there; a lot of the underground developments is already complete.
And in addition to that, as we move through 2014, we are going to be drifting an exploration platform across the much higher grade copper, gold zones that you see towards the lower right of the chart. That’s where we see very substantial exploration upside for the deposits. So we’ve already identified an inferred resource at depth that is over 4% grade copper, about 7 grams per tonne gold and we’re optimistic that with underground drilling access, that we can expand on that resource through underground exploration and continue to add value to this very strong deposit.
Reed is our other project in Manitoba. This is much smaller. This is a $70 million capital investment. we’ve already started production from Reed in the third quarter and we’re ramping up towards full production in the first half of next year, it’s – we own 70% of this project in a joint venture with a junior mining company, it’s – it is a smaller, but high grade project with a five-year mine life, 2014 through 2018 and a good example of what we can do to leverage the infrastructure that we have in Manitoba. This project wouldn’t justify concentrator of its own, but by utilizing available capacity, we can generate a 30% pre-tax IRR in this project and make good money doing so, and again, on time, on budget.
So moving to Peru, this is the largest of the three projects that we have. We acquired this project in early 2011 with the acquisition of a junior mining company that owned it. Constancia has a total CapEx of $1.7 billion. we’re well advanced on that. We’re about 50% complete on spending on project progress. We did have a hiccup in the middle of the year with about a 15% CapEx cost escalation. We weren’t happy about that. It arose mainly as a result of additional civil earth work spending that was required as a result of underestimating the volume of work that needed to be done, but we feel like we’ve significantly derisked the uncertainty around the scope of work to be done.
The detailed engineering is substantially complete on Constancia. The concentrator construction, as you can see from the slide, is well underway, and so we have a much higher degree of confidence in the new capital cost estimate to see us through the completion, and I’d say that we’re tracking well. We’ve had good results with drier than expected weather. Over the past month or two, we were expecting the onset of the rainy season that’s been slow to come. That’s helped with civil earth works productivity.
We have also with Constancia, a good situation with infrastructure. We’re located within an established mining camp. There we go. Las Bambas, which is a project under development by Glencore Xstrata is to the northwest. Xstrata Glencore also operates the Tintaya and Antapaccay mines; Tintaya now closed, Antapaccay just started up, to the southeast of us. There is existing road infrastructure, power; there is also a railhead just to the south at a location called Imata and we’re able to take advantage of all of that infrastructure. We’ve signed a 10-year contract with the port operator for the port access we need. We’ve signed a 10-year power purchase agreement for power supply, both of those were in line with our feasibility study expectations or stringing a 70 kilometer transmission line from Tintaya to our site and that’s also progressing well and we’ve just about wrapped up by securing the right-of-way for that and construction on the T-lines underway.
So – and this is one other element that’s helping to enhance the economics of Constancia. We don’t need to build a power plant, we don’t need to build a port, we don’t need to build a lot of the greenfield infrastructure that you’d find in an area that doesn’t have existing mining operations. So the projects we think at this point are well underway. Constancia, we expect to have first production in the fourth quarter of next year and ramp up the full production in the second quarter of 2015. As I mentioned, Lalor will have production from the main shaft in the second half of next year, so that will all contribute to the growth in production that we’re expecting.
Our most recent results are, you can see our metal production, our cost results. As I mentioned, our 777 unit costs are nicely back in line with expectations. We did indicate that we were expecting copper production this year to come in slightly below our guidance range, mainly because of a high grade stope at 777 that we expected to fully mine out this year. We’ve decided to take a more measured approach to mining that particular stope just because of the ground conditions. we’ll mine it out, it will just take a few years and instead of mining above reserve grade in 2013, we expect to be mining pretty much at reserve grade in 2013 and for the next several years.
In terms of financial results, as I mentioned, we’re really in a trough right now. the trailing 12-month results reflect that trough in production in cash flow. they also reflect the – some of the streaming transactions that we’ve entered into with Silver Wheaton on our 777 mine, in particular in order to arrange the funding for the growth. but going forward, we would expect to see a significant improvement in operating cash flow, as we move forward from here, as projects like Reed, Lalor and then ultimately Constancia, ramp up over the next 12 to 18 months.
In terms of balance sheet and liquidity, we currently have $650 million in high yield notes outstanding and we’ve arranged some other funding as well. so at the end of September, we had just under $800 million in cash and cash equivalents. the remaining payments under our stream agreements are $260 million. we have $100 million in tax refunds due in the next six or so months arising from some of the tax incentives around our new projects and also the cash refunds and then we’ve also have another $150 million in committed financing that’s been arranged that’s available.
We are also working on an additional standby facility for Constancia, almost a cost overrun facility, if you will, of another $100 million to $150 million and that’s well advanced and we’re – we’ve moved into a definitive documentation on that. and that liquidity is available to fund the remaining capital spending of just over $1 billion at the end of September of this year.
So we think that we’re in a good shape with respect to overall liquidity. We’re fully funded to see ourselves through to completion. We’re arranging additional standby contingency liquidity to make sure that there are no surprises as we look ahead to the completion of all of these projects and the minimum cash position we would expect to be in either the fourth quarter of 2014 or the first quarter of 2015 before we move into a strong free cash flow positive position with the completion of Lalor and Constancia.
So just to wrap up, we see good growth across all of our metals as we complete this significant CapEx build out, but I think distinguishing us from a number of other intermediate mining companies is the track record, the consistent performance from our operations, the experienced management team that delivers those results paired with what we think is a strong financial position as well as a very disciplined growth strategy. We aren’t looking at going and chasing projects in high political risk jurisdictions. We tend to be very focused on doing what we know well and it being conscious of the risks and ensuring that we’re effectively managing them as we develop projects and try to grow the company.
So with that, I’d be pleased to take any questions that people have. Yes.
David S. Bryson
David S. Bryson
Absolutely and that’s a good question. Peru has generated a fair bit of headline risk on mining projects and I think it’s important to understand that the national government in Peru has been absolutely pro-mining. the current President, Humala, when he was running for election, people thought he was going to be another Hugo Chávez from Venezuela. once he was elected, he governed very much from the center and every decision that he has made since then pertaining to our industry has been pro-mining.
The challenges that you’ve seen with mining projects in Peru have been on the community relations side. The issue in Peru is usually when you’ve got two or three or four indicators of difficulties in community relations, whether it’d be a very dry area with a lot of agriculture, where people are concerned about water impact, whether it’d be a legacy of difficult relations with the local community, whether it’d be local politics, and some of those issues have caused projects, Minas Conga is an example, to be postponed.
We don’t see any of those issues affecting our relations at the moment. We have life of mine agreements in place with both of our directly affected local communities. we’re also working through benefit agreements with the communities in our indirect area of influence. We have a community relations team of about 30 people full time continuously meeting with the communities, understanding what their concerns are and heading off issues before they arise. We just were advised that we won from the Peruvian Mining Association an award for best-in-class community relations and sustainable development.
So it’s a real focus for us. when people ask me, what’s the biggest risk in Peru for us; it’s community relations. It’s the one risk that I describe as a fat tail risk, where I think its low probability, but it seriously caused serious issues, but I’d say that that’s true in most mining jurisdictions. If you don’t have community support, it’s going to be very difficult to get a mining operation on the – off the ground. That’s as true in British Columbia or Arizona as it is in Peru. So we are focused on it. we think that we know what we’re doing from having 85 years of good community relations in Manitoba. And I think when you look at Peru and look at the headlines, I think it’s important to understand what the drivers are and what some of the indicators are that tend to cause those challenges.
Any color on – I think there were holdout families, was it for the power line, any updates on that?
David S. Bryson
Well, there were two separate issues. one is that we have 36 families that require relocation. We have definitive agreements in place with all the six of those families and those agreements are all under the framework of the life of mine agreements that we have with the community in question. So there is an agreement in place that we will – that those relocations will happen, we just need to work out family-by-family, the details of that and we’ve done so with 30 of those 36 families.
About, I think, 14 or so of those families have already relocated and we’ve just completed a community offsite that will allow us to commence moving the rest of the families. Of the remaining six, there is only a couple of them that have the potential to be critical path, but our experience today is that we’ve just been methodically working those through and we think that we’ve had good success. I think 36 families in the Peruvian context is actually not that many relocations. Projects like Las Bambas have hundreds and hundreds of families to relocate.
On the transmission line, we were a little concerned three to six months ago with the slow pace of right-of-way acquisition by the contractor. We’ve intervened in that and we’ve had very good results since then and we’re down to one or two agreements remaining and those are both with the parties where we don’t see any issues with getting those right-of-way agreements in place. The pylons are already going up and construction is well underway. So we were concerned about that, we think, but that’s in hand now. Thanks. Any other questions?
[Question Inaudible] that could run to – have a cost overrun and how do you sort of benchmark those?
David S. Bryson
Yes, the question just is to what could cause additional cost overruns with Constancia. The main risk right now, the cost is probably scheduled. If we’re delayed on schedule, then the carrying cost of that will show up in capital cost. Weather has actually been better than we had anticipated, as we’ve headed into the rainy season in the area that we’re at. So that’s been good. We’re not seeing anything right now that is clearly on the critical path, where we’re identifying that as a trend that could cause a serious impact on schedule. usually with these projects, there is a bit of a whack-a-mole exercise, if one issue comes up, you deal with it, another issue comes up, you deal with it and that’s really been the mole that we’ve been in and it seems to be working so far.
In terms of benchmarking, when we reset the cost estimate through that bottom-up exercise, we also rebased the contingency and that contingency was actually a meaningful chunk of the additional spending. So we reset it about 10% of remaining spending on the project and we think having completed detailed engineering, having completed a lot of the civil earth works, having a much higher degree of confidence on the scope and having seen productivity in the project, we think that that 10% is actually pretty generous contingency estimate through to completion.
Matthew Fields – Bank of America Merrill Lynch
Any last questions from the floor? I think we’re just about out of time, but I want to thank David for coming by and I appreciate him for participating in our conference.
David S. Bryson
Okay. Thanks very much.
Matthew Fields – Bank of America Merrill Lynch
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