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Executives

Oleg Novachuk - Chief Executive Officer

Andrew Southam - Chief Financial Officer

Mian Khalil - Head of Projects

Analysts

Alain Gabriel - Morgan Stanley

Fawzi Hanano - Goldman Sachs

Fraser Jamieson - JP Morgan

Mike Flitton - Citi

Danielle Chigumira - UBS

Myles Allsop - UBS

Rob Clifford - Deutsche Bank

Liam Fitzpatrick - Credit Suisse

Edward Sterck - BMO Capital Markets

Kazakhmys PLC (OTC:KZMYF) Q2 2014 Results Earnings Conference Call August 21, 2014 4:15 AM ET

Oleg Novachuk

I think we can start. Good morning ladies and gentlemen. Thank you very much for joining us this morning. I am very pleased to see such a good turnout today as well during our shareholders meeting it was a surprisingly good turnaround, better than the usual size.

First of all before I start, I would like to introduce our team. I am Chief Executive of Kazakhmys ,Oleg Novachuk. We have Chief Financial Officer, Andrew Southam. We have Head of our Major Project, Mian Khalil.

As usual we will run you through our results. In our agenda today we have the highlights of our production in 2014, operational results. Mian will run you through the growth projects and Andy will tell you about our financial results.

If you look back at the evaluation of our -- the development of our company, 18 months ago we started to think about where Kazakhmys is. I remember very well 2008 when the crisis happened, when we started to feel a lot of pressure from cost inflation, declining grade of our copper in most of our matured mines and also the lower copper price. And that was a challenge for us to decide what Kazakhmys will be in next few years. And we decided as our strategy which was stated before that Kazakhmys would like to focus on the core copper business. Kazakhmys would like to optimize the assets and deliver the major growth projects.

And that's what we have done during the last few years. And especially last 18 months we were very busy to make sure that we have optimized our assets. We started to review our asset base which led us to the conclusion that we need to take drastic steps. And we decided that first of all we need to dispose of our non-core assets. And previously, as you remember we had MKM, our downstream copper business in Germany. We also had investments in ENRC, 26% in ENRC, and also 50% in GRES-1. This is the largest power station in Kazakhstan. As previously, we plan to built BHP Billiton in Kazakhstan, but we realized that it doesn't work for us and it doesn't deliver the right value for our shareholders and that's why we decided to dispose our non-core assets and focus on our major copper assets.

We have successfully done it in last 18 months. We disposed of all of our non-core assets with 2.2 billion cash in proceeds and due to that reason, thanks to ENRC transactions, we became the company with the majority free float. Currently the free float of our company is 58%.

When we had started to review our assets, we understood that really we need to take drastic steps to make it work and to make sure that our company is lean, efficient, dynamic and can deliver the best value to our shareholders. We decided that we should take out from our group the mature mines which cannot be suitable for the listed company, which cannot generate enough return to our shareholders, but at the same time we cannot sell this asset because of their low performance. And we agreed that we will split the company in two parts. That's why old Kazakhmys and new Kazakhmys. Old Kazakhmys included the mature mines, smelters, power stations and the new Kazakhmys will consist of five mines, four mines concentrated in the eastern operations, the most profitable in our portfolio and the gold mining in Kyrgyz.

And also three major growth projects, Bozshakol, Aktogay and Koksay. Last February when we reported about that, I think many people are skeptical about the feasibility of that project and many people didn't believe when this project will be delivered, what will be the working capital provision to the old group. But our management team was pretty certain that that's the right way we do and we will definitely deliver that project. And likely on 15th of August we successfully -- we had the shareholders meeting and shareholders supported us and currently this project is in the final stage and we suppose to complete that in Q4 before the end of the year.

And also as a next target for us is to deliver on major growth projects. And that will complete execution of our strategy and that will position our company as the most competitive amongst our peers in the world. It will be a low-cost producer. Most of our operations will be open pit and we also have the highest growth rate amongst other peers.

In parallel, with the restructuring which required a lot of management time and a lot of efforts, we also paid attention to the efficiency of our operations. And in the first half, the group copper cathode equivalent output was 139,000 tons and the KAZ Minerals that was what the -- will be the new name of the new Kazakhmys after the completion of our restructuring, the KAZ Minerals output will be 41,000 tons of copper cathode. Group EBITDA for the first half was $324 million and KAZ Minerals EBITDA out of that is $175 million. You see what's the benefit of our restructuring is.

We also achieved 8% decrease in gross cash costs to 309 U.S. cents per pound, that mostly was due to the operational efficiencies and the Tenge devaluation also helped us to reduce the cost. Our cash fund was $2.5 billion and net debt was reduced to $192 million. As I said our restructuring has been approved on 15th in December -- 15th of August by our independent shareholders. No one from related parties has missed the game, (indiscernible) voted and I also decided not to vote to allow independent shareholders to take their view and vote for that.

Our economic separation started from first of August. I know that currently we haven't completed the transaction due to the regulatory requirements but economically we are separate from 1st of August. And completion is expected in Q4 this year, by the end of this year. Our major growth projects are on track. Our second mobilized at Bozshakol. As we previously said, we would like to strengthen our team and to meet the deadline to deliver all projects in time, we decided to on boarding the second contractor has been already mobilized.

On Aktogay, for SX/EW plant, contractor has been mobilized as well and work has started. Bozshakol and Aktogay on site remain on track and commissioning is expected in the second half of 2015. Unfortunately our health and safety records are still not acceptable. It's not worse than in 2013 but nevertheless it's not acceptable for us, we had 11 fatalities. But it's worthwhile to mention that last year, 2013 and 2014, were the first years when we started our major projects, Bozymchak and Aktogay and Bozshakol, and unfortunately we have lost three people. Two people died at Bozshakol's site, of subcontractor of our contractor and one person died in Kyrgyzs. Also that was employee of our subcontractor.

So overall from operation we have eight fatalities and three fatalities from the projects, and that's totally unacceptable. What we are currently doing, definitely the new KAZ Minerals would pay close attention to manage the safety properly. I have appointed the new safety head, who has very extensive experience working in BHP Billiton, and he joined us recently and we make sure that we will run our new company in the highest world standard.

We have changed the collective employee agreement to include the accountability for safety breaches. Before, unions in Kazak, labor unions in Kazakhstan were very keen to protect the rights of the employees and employee cannot be motivated to obey the rules and they know that whatever they do, they will never be responsible for the actions. And we agreed with the unions to revise the collective employee agreements and currently we have included the accountability for safety breaches.

We also increased responsibilities and accountabilities of the site managers. We changed our approach. Before that we had health and safety department which worked as a police to make sure that our managers on site worked properly and they obey all the rules and they follow all our policies. But currently we say that the responsibility and accountability will be on the site. The manager of the site is responsible and accountable for safety. And health and safety managers will be like coaching to help them to make sure that they understand what should be done. So we changed the approach and I think that will give us some results very soon. We have a very strong focus on the risk assessment for employees and of course we now, after the fatalities we have seen in our projects, we have a closer oversight of our contractors at major growth projects.

For the production, for first half we decided to show you the production profile only from new business to give you some more flavor. What is the new business is and what will be the guidance for the end of the year. The copper cathode production for the first half was 41,000 tons of copper and we decided to revise the guidance till the end of the year. We started to mine higher copper grade sections in Orlovsky mine which belongs to the eastern operations. And the guidance for the year-end will be about 80,000 to 85,000 tons of copper versus the 80,000 we previously have.

For zinc concentrate, currently we have produced 62,000 tons of zinc for six months and the guidance for the year-end will be 115,000 to 120,000 tons. That anticipates lower grades and because we focus -- our focus has been shifted to copper. And the same applies for silver and gold. The current production is almost 1.7 thousand ounces and the year-end forecast will be 3.3 to 3.7 thousand ounces. For silver, we produced 18,000 ounces -- 18 million ounces and by the year-end it will be between 37 and 42.

We also are working hard to complete modernization of our Nikolayevsky concentrator, which is moving very successfully. By the year-end we will finish because currently we are in the final stage. Just to give you some numbers. We started modernization of this concentrator with the recovery rate of copper at about 72%. Currently we have achieved 89% and the final number we would like to see will be above 90% to 92%. The refurbishment of this concentrator will be completed by the year-end.

The eastern region priorities, the major production site for us. Of course first of all is the focus of improving our safety performance. By the year-end we would like to complete this separation and put in place the new structure. We will review our supplies and service providers to make sure that we can achieve the maximum benefits from the independent work of this area. We will complete modernization program of our Nikolayevsky concentrator, as I said before. And definitely as a part of our organization we will upgrade our IT systems and infrastructure.

And we are also considering to build the second stage of Artemyevsky mine which will be -- the life of this mine is for next 3-4 years but we decided to study the opportunity to extend the life of the mine for 10 years. It is the continuation of the existing ore body and we are in the process of studying that and probably we will update you next time when we announce our year-end result.

And now I would like to pass it over to Mian to lead you through our major projects. Thank you.

Mian Khalil

Good morning. We have made some progress and we are going to quickly run you through what we have accomplished in the last half, first half of this year, and what our plans are going forward.

What we have, on Bozshakol we have completed the main concentrator building, you can see the picture up there. We can also open a IKEA facility there. Some people call it the IKEA building. It looks -- the color scheme is pretty -- but these are the Kazakhmys colors. We are almost complete with the permanent camp where our 1500 employees are going to be residing in operation. So that's a major step in the right direction. And as you can see in the bottom left-hand corner, the mine maintenance facility shell is complete, the inside is almost complete. And as we get into discussions of what we are doing in the second half, I will brief you on that. So quite a bit more to show you here than we did last time.

Continuing on. We have commenced the installation of the main sulphide mills. We have representatives from the mill manufacturer on-site assisting with that. We have begun the installation of all our internal steel platforms inside the building for the grinding and floatation area. As you can see from the impressive line-up of the trucks on the bottom left, our truck assembly is almost complete for the truck fleet, for the mine, as well as the shovels. And we have commenced construction of our overland conveyor which conveys the ore from the primary crusher to the main concentrator. The bottom right-hand picture shows the SAG mill foundation and the setting up of the sole plates for the SAG mill.

This is an indication of what are we planning to do in the second half of this year. Well, we are going to be a bit busy. We are planning to wrap up all the major concrete and steel works for the sulphide concentrator. The non-process buildings -- and let me explain what we mean by the non-process buildings. These are the support facilities, the admin, the laboratory, the truck shop, the maintenance facilities, change houses, that kind of stuff. And the permanent camp will be completed in the second half. We will complete the construction of the 220 KV power line. We do have power on-site. We have permanent power on-site through a 35 KV power line which we built almost two years ago. So that is more than adequate to provide power to the permanent camp. But the permanent 220 KV power which we need for the concentrator is going to be completed in the second half.

We will complete the assembly of the haul tracks and the shovels and what we didn't put up there is ancillary support equipment that goes with that, which are the drills et cetera. And a key thing that we want to make a big dent in before it gets really really cold, and it does get a bit cold up there, the installation of the heating units for the large building so that we can keep them above freezing and increase productivity during the winter months.

We will continue with the installation, obviously of the major mechanical and electrical equipment, ongoing till the concentrators, ready to operate. We will begin installation of bulk materials, that's cables, cable tray, pipe et cetera. Both underground and above ground. And the guideline that we have for amount of CapEx we are going to spend for 2014 is in the 750 million to 950 million range, which is not too far off what I believe we told you before.

The second half, the payments are more weighted towards the second half than the first half. Because as we told you, we brought a new contractor on board in the first half of this year and so all the bulk materials have been ordered. They are beginning to show up on site. So as the materials show up on-site payments are due, so that waits the payments a little bit to the second half compared to the first half.

The milestones. As you can see for this year, it's finishing of the key infrastructure and assembly of the mining fleet. First quarter of next year, start pre-production mining. So that's going to be the first operational step on the project in terms of getting ready to feed the concentrator. And in the second half of next year, wrapping up construction and starting commission.

Aktogay. We have progressed quite a bit since we last spoke about six months ago. The 110 KV power line, the main earthwork contracts, the railroad spurs, the water pipeline, pump station and the big off-site plant which is one of the two main processing units, have all been awarded and work is commencing on that. Tenders are out for the sulphide concentrator and we have just received the tenders and we are beginning the process over the next two months of education and award to get that going. And as we have promised before, the CapEx will be updated once we have done that.

In the first quarter of the year, our 110 KV line is about half complete and we will finish it this year. The bulk earthworks commenced and are continuing and are progressing. We will show you some pictures in a bit. The solvent extraction contractor has mobilized. and again we will so you some pictures where actually we have already started to work on the foundations within a week of them being mobilized. So that's going well. The mining equipment assembly has commenced and has progressed well there as well as Bozshakol. And the leach pads are just about ready for geo-membrane installation.

The milestones going forward is to complete the mining infrastructure in 2014. 2015 fourth quarter we expect to have first copper out of Aktogay, which is kind of ironic that it's almost the same time as Bozshakol started but this is oxide copper not sulphide copper, and 2017 have the first sulphide production.

To give you an idea of what's going on, it's a busy site right now. You can see there is a lot of equipment operating on the mass earthworks. You can see the 110 KV power is progressing well. Lot of towers up. You can see the mining equipment fleet there and in the bottom right-hand corner you can see the main building foundations for the solvent extraction building, are formed and getting ready to be poured.

Koksay. Third project. Attractive project, 3.4 million ton resource with upside potential. Average grade of 0.48%, which is better than Bozshakol and Aktogay. Estimated annual production rate of 85 kilotons of copper cathode equivalent, and 55,000 ounces of gold and 360,000 ounces of silver and about a kiloton of molybdenum concentrate. So it's a copper gold, moly ore body.

CapEx in 2014. This year is minimal. It's $5 million. We are commencing drilling in the second half of the year. And that drilling is going to confirm the previous drilling and expand upon it, out run to the flanks. And there will be minimal capital investment until Bozshakol starts products later next year. Drilling is going to take about a year. And that's it. CFO, Andy?

Andrew Southam

Kazakhmys' performance in the first half of 2014 is presented including the retained and disposal assets. This reflects that under accounting standards we have not met the held for sale criteria on the disposal assets and therefore this is how we reported in our half-yearly accounts. Also the economic separation under the restructuring was not effective until the 1st of August. So as noted on the slide, continuing operations is the full mining division, captive power division for both periods and excludes the non-core businesses disposed off of MKM, ENRC and Ekibastuz GRES-1. Later in this presentation I will talk about the results of the KAZ Minerals, the retained assets for the first half and also their outlook over the rest of the year.

Despite an 8% lower LME copper price and a 19 kiloton reduction in copper sales volumes, the EBITDA was only $30 million lower than the prior period due to the impact of the Tenge devaluation and cost initiatives. Kazakhmys has been battling high cost inflation of the past few years and you will recall that we commenced an optimization program in the second half of last year and the results presented today reflect the full impact of this program when compared to the first half of '13. In addition, we also see the benefits of the Tenge devaluation which occurred in February.

Free cash flow has improved on the [prop] (ph) here due to a number of factors. The sales terms to certain Chinese customers were changed this year which resulted in a one-off reduction in working capital, with sales receipts almost a month earlier than previously. As highlighted in the circular, at the half year the disposal assets have under spent on their sustaining CapEx budget, which is one of the adjusting items in the working capital payment and has assisted free cash flow.

The timing of a number of major items of CapEx will fall in the second half. For example, the largest item in the 2014 budget for the captive power stations are the replacement of turbines, the expenditure on that will take place in second half of the year. But in addition, the disposal management team, disposal asset management team, have been postponing CapEx to maximize their flexibility over future spend. For example, the retention of almost 2000 workers at the suspended Zhezkazgan smelter has led the disposal asset management team to consider reopening that smelter in the second half of the year. Any CapEx for that would be unbudgeted and would have to be financed by postponing other CapEx.

The gross cash cost of copper was 8% lower than the first half of '13. The benefit from the Tenge devaluation and the cost optimization program. We are however seeing considerable inflationary pressures as suppliers seek to pass on higher input cost of materials either as direct supplies to us or as service providers who consume materials themselves. For example, oil transportation providers are experiencing higher fuel, tire and spare parts costs.

We gave a 10% pay raise in April this year following the devaluation which will also impact us in the second half. The guidance we gave in February for the full-year was a gross cash cost of 315 cents to 330 cents per pound. This took into account the devaluation and our estimate of the full-year impact of inflation. So notwithstanding the restructuring, this remains our full cost for the full-year.

We started the year with net debt of $771 million and at 30th of June it had reduced to $192 million. During the period Kazakhmys received the proceeds from the sale of Ekibastuz, $1.25 billion. We also invested approximately $500 million on our development projects, Bozshakol, Aktogay and Bozymchak. And we also acquired Koksay for just under $200 million.

In the operations there was a $71 million working capital inflow, as changes to contractual terms for debtors and also linked to timing of payments, we saw an increase in creditors in the period. The tax payments for corporate income tax, mineral extraction tax were below the income statement charges and the group's corporate income tax receivable fell by about $40 million over the period. The sustaining CapEx of $157 million is below the run rate for 2014 guidance. It has already picked up in the second half and as I said earlier, the lower CapEx is partly a result of the timing of expenditure but also that disposal management group have restricted CapEx in the run up to this transaction.

This slide sets out the estimated key financial metrics for the retained operations. Due to the higher copper grade and presence of byproducts, the East Region operations had an EBITDA margin of over 40% compared to an overall mining EBITDA of 24%. The KAZ Minerals EBITDA of $175 million in the first half was being calculated including corporate costs and allocation of mining essential costs and applying the 2014 TC/RC for processing of concentrator bulk ash. The restructuring tax in the first half for the East region was $47 million.

The net cash cost in the first half was 96 cents per pound. The full-year guidance of 120 cents to 140 cents per pound includes the impact of post-devaluation inflation in the second half and also a net allowance for additional costs as the operational separation of the East Region is completed. On sustaining CapEx, the East Region incurred $30 million of spend in the first half. We are guiding $80 million-$100 million for the full-year as we have been deferring spend also and as the Nikolayevsky concentrator modernization program is largely completed this year.

The pie chart on the slide sets out a split of the East Region's cash operating cost by category. I will draw your attention to salaries, which has been a major source of inflation for us over the past few years and which represents only 24% of costs compared to approximately one-third of our cost base for the current full mining division.

This slide sets out the net debt position as of 31st of July, the date of economic separation. For the remaining months of 2014 until completion, the net cash flows of the disposal assets will be adjusted through the working capital payment. As of 31st July, the group had net debt of $328 million, including $2.3 billion as cash and cash equivalents. Of the 1.5 billion facility we have at Aktogay, 1.4 billion remained available for drawing.

We also have a $500 million pre-export finance facility which is currently fully drawn and that contains EBITDA-based covenants and also requires the banking group's permission to continue post the restructuring. We have sufficient funds available to repay the facility completion of the restructuring. However we may seek to retain all or part of the facility with amended covenants. The group's net debt to EBITDA ratio will increase in 2015 as the major growth projects development continues and as production is largely restricted to the East Region operations. However the commencement of Bozshakol is expected to sharply improve the financial metrics going forward.

The completion of the current restructuring will leave KAZ Minerals within a year of the launch of Bozshakol, which will combine its first quartile production with the higher margin East Region operations together, generating very significant cash flows. Oleg?

Oleg Novachuk

We have chosen to show you this slide to just give you more flavor about the future profile of our company. After the restructuring our company will be the most efficient amongst the peers. And as you can see here, cash cost of our eastern operations will be 120 to 140 cents per pound. Aktogay will be 110 to 130 cents per pound and Bozshakol is the most profitable at the moment, it's 80 to 100. And of course I think that will place us in a unique position. First of all our company is located very close to the major corporate markets in China. We have a very strong long-lasting relationships with our strategic partners in China, the most largest copper producers in the world. We strongly believe that copper is the commodity for next decade.

Regardless of all stories about the situation, economic situation in China, or what we have in copper market, we strongly believe that copper will be very well demanded for next decade. And I told you a few times the stories about what's happening now in China. The Chinese government decided to reallocate an enormous amount of people from the southeast to the western part of China which will lead to construction of about 150 cities with population of over 2 million people. Can you imagine how many apartments, how many grids, how many infrastructural stuff should be built in China and what will be the demand for next 10 to 15 years.

It's also important to note that China now has switched to green economy. They want to build the electric cars. And for those of you who have been in China, you have probably seen the pollution level in Beijing or big cities and even in small villages. The pollution is very big there because they still use coal. They have a lot of transportation. In Beijing you cannot use the car every day. They just introduced the rules that you can use your car only Tuesday or Thursday and they register the numbers and rich people are buying few cars to use them every day because of the pollution.

And of course the only way for them is to switch to electric cars. But electric cars use four times more copper than the normal one. But consumption of copper in China is comparatively low. As you know the average consumption in the world currently is about 12,000 tons per capita per annum, in China it's 2.5. That's the way up. That's why I think that after this restructuring, it's very important for our company first of all to deliver all major growth projects. To keep the cash cost under the strict control and, as you can see, if we will be successful that would be a great story.

And the copper production growth is enormous. You can see here from where we are now and where we will be in the very near future. It's 28%, the highest in the industry. And I think that that will really place us in a unique position if we will implement everything as we planned. We are back to the story during IPO. I remember when we were in IPO we had honeymoon period where (indiscernible) market but due to some reasons, due to the macroeconomic situation, cost inflation, crisis in 2008, we also experienced bad time.

Now we are in the beginning of the growth. This restructuring will open up the new page in the history of our company and will lead us to the prosperity of our shareholders in very near future because we are just probably 2-3 years away from where we should be.

On that I would like to finish and we will open up for your questions. Thank you.

Question-and-Answer Session

Alain Gabriel - Morgan Stanley

This is Alain Gabriel from Morgan Stanley. Quick question on the cost guidance that you have included in your presentation. So you are still standing by your gross cash cost and net cash cost guidance for the full year, which implies a big uptick in inflation in the second half. Can you shed more color on what's driving this inflation? Give us more granularity? And the second question is for Andy on the EBITDA reconciliation. So the EBITDA on your presentation for KAZ Minerals is 175 million but in the release you say the EBITDA for the East Region is 190 million. Can you give us the bridge of what's explaining the difference? Thank you.

Andrew Southam

I will take the second one first. So the KAZ Minerals, we have allocated almost all of the copper cost. So in the first half we had copper cost of $ 16 million negative in the group EBITDA figure. So if all of that's applied to that mining figure of 190, you get down to -- for almost all of that, you get down to the 175 that I have shown for KAZ Minerals. In terms of sticking with the 315 to 330 cash cost guidance, we were 309 for the first half. So we were slightly below the full-year guidance. Where we are seeing inflation coming through, we are seeing all -- effectively anyone who is importing goods into Kazakhstan is seeking to pass on the impact of that devaluation to their customers. And that's across fuel and other consumables but also in service providers. And the 10% pay rise that we have ordered in April, that is not out of line with what other companies have done. So again we are seeing higher salary cost coming through and that's not fully reflected in the H1 figures.

Fawzi Hanano - Goldman Sachs

It's Fawzi Hanano from Goldman Sachs. Just a few questions on the East Region mines. Firstly with regards to copper production. You are guiding 80,000-85,000 tons this year. One of the four mines depleting in the end of next year. Will you have capacity to increase at other three mines or will we see production in East Region fall to around 70,000 tons beyond the '15. Secondly with regards to byproduct production. You have reduced it for this year. Is this something you could expect for the guidance in future years in terms of silver, zinc and gold. And lastly with regards to East region cost. Good cost performance, nice [sense] (ph) in the first half. You kept your guidance for the full year at 120 to 140. Kind of bridging on the question that Alain had asked earlier. And also can you explain what the gross cost look like? Is it close to 300 cents a pound at East Region mines.

Oleg Novachuk

I would suggest you start from the cost and if you can cover that and I will answer on the production.

Andrew Southam

Okay. So the 96 cents per pound in the first half for the East Region. First of all, the East Region didn't operate as a totally separate division for the full first half. And so in keeping with our previous guidance of 120 to 140, we have allowed for some additional cost to come in from that separation in the second half. That's one of the factors there. Secondly, there is a devaluation factor I have mentioned previously. And other factor is we have now introduced, as you point out there, slightly new guidance on the byproduct credits. We have put in ranges which also may impact the net cash cost which is the guidance we are giving in the second half of the year.

So there will be -- we would expect a slightly higher gross cash cost and may be some variation in the byproduct credits. So slight element of uncertainty there which is why we are sticking with the 120 to 140 cent per pound guidance for the East Region for full year.

Oleg Novachuk

And as to the production profile, in the nearest future we don't foresee any significant reduction in production because we still have reserves to increase our production in case if the mine -- if one of the old mines will be depleting. But at the same time as I mentioned, we are considering extension, program of extension for our existing mines. And one of them is Artemyevsky mine. We have ore body which is a little bit deeper than the existing one. So we have built the drifts to have access to this ore body. But of course we need to study that exercise carefully as a separate project to make sure that we can extend the mine life of this mine for next, for probably 10 to 15 years. But for the nearest future, the production profile will stay the same, nearly the same.

As to the zinc and silver grade, yes, we should expect that next year and year after, zinc and silver grade will reduce. But that wasn't unexpected, that was planned in our geological model. But we will guide you separately when we will announce about our year guidance. Thank you.

Fraser Jamieson - JP Morgan

Thanks. It's Fraser Jamieson from JP Morgan. I just one question to each of you probably. Andy, firstly on the project cost estimates. To what extent -- I think you said in the past that they include your expectations around increased inflation, post Tenge devaluation and that was what led to the increase in the guidance previously. But could you just confirm that and just confirm that you are still very comfortable with those ranges. Secondly, Mian, it seems from the few photos that you have provided on the commentary on Bozshakol, the construction is going very well. Is it fair to say that your assessment of the risk around that project is now moving from the construction phase to the commissioning phase? And, I guess, the extension to that, what are the remaining sort of key hurdles that you need to get over on the construction side of things to get to commissioning. And then, Oleg, I suppose the company is now becoming basically a development company. It's all about development risk. How do you get the market more comfortable about the development risk in both of those projects?

Andrew Southam

I think that the -- first of all the answer is, there is no reason at the moment for us to change the guidance on either Bozshakol or Aktogay in terms of the cash operating cost we have given previously. So that did, those numbers do include an expectation. We feel that it's within those ranges. We are comfortable that those ranges are still appropriate given the inflation we are seeing in Kazakhstan. They do have slightly lower exposure to the Tenge anyway. They do have a far lower [LEPA] (ph) component, for example, then our existing operations. So to that extent they don't have the same exposure. So we are quite happy with that and we will continue to review it but at the moment, no reason to change.

Mian Khalil

On the project in terms of the construction, yes, I think we are doing well. The introduction of the second contractor has been proven to be successful. We still have the normal construction hurdles to do and things to watch out for, weather and labor and all that but that's normal on every project. So I don't see anything unusual risk on the construction side going forward. The focus is going to start turning to commissioning but the way we have managed this project is -- we have got a stage we call operational readiness. And we have brought in and we have taken a wise decision to invest in bringing in much much earlier than normal key operating staff. They have already been on the team for over a year. Some of the operating staff on the concentrator side, couple of key members were there during the design phase. So we are not going to have the same issues that many projects have, where the operation team parachutes in in the last three months of the construction and say, what the hell are you going to give us. That's not going to happen. These people have been involved. They are integrated into the construction right from the beginning.

The operational readiness is going on. The training is going on. People are being hired. They are chomping at the bit actually to get going. So there is a strong interaction. The pre-commissioning plan has been done and has been discussed with the operations. So knock on wood, everything should run okay.

Fraser Jamieson - JP Morgan

And just the critical path items on construction.

Mian Khalil

The critical path items on this job is going to be the same as any job, the mills. We have three mills, the SAG and two ball mills. We have representatives from FLSmidth, the mill manufacturer, already on site to do the mechanical installation of the will. Within probably a month's time we will have representatives of the gearless motor drives, ABB, on-site also. A lot more representatives then I think may be necessary but that's the way the world is nowadays with these guys. So we will end up with maybe 20-25 people between these two companies on-site just helping us put the mills together are advising us [NFC] (ph) how to put the mills together properly. Expensive, but well worth it. That should again ensure smooth commissioning and ramp up.

Oleg Novachuk

And Fraser that directly links to your question about the execution risk. As you know to build any mine you need at least 5 to 6 years. And we spend about three years for feasibility study, I think about three years, Mian, right. And then involve the same long sign for construction to make sure that we run our operations. I remember six years ago when we said to the market that we have Bozshakol, no one reacted because of the execution risk. You are too far from the completion. The closer you are to completion, the less risk you have. On Bozshakol, situation is very clear. All the equipment has been already purchased. There is no risk that we will overspend for. We had the prices fixed and most of the equipment has been delivered to the site.

The construction contracts, all of the construction contracts have been made as lump-sum. The change in the cost of the construction is also limited. And the execution risk only involve the, not meeting the timetable. But we are probably, as we said that we will deliver the project in the second half of 2015 and we are slightly more than one year away from the completion and every day closer to completion, we have less risk. And we have, as with our Chinese friends, we have clocks, electronic clocks which take the seconds and minutes, how long it remains to start the production and everybody watches it every morning. So I am pretty sure that the risk for Bozshakol is not high.

For Aktogay, the advantage of Aktogay is that it's almost identical to Bozshakol. All our lessons learnt in Bozshakol will be implemented in Aktogay strategy. And of course it will be easier for us to deliver that project without the mistakes we have made during the construction of Bozshakol. And Koksay is too far. Currently it's very early stage, it's a scope study. We need to delineate the ore body to understand what the project will have. I am pretty sure that in terms of attractiveness for me, Koksay is the most attractive. But to make decision about the size of the project, quality of the project, it's too early. I think when we finish drilling, when we start the feasibility study, will be ready to answer that. Thank you.

Andrew Southam

Probably just one more thing on just on the devaluation. Overall, it's definitely a benefit. Okay. So we lower -- and if you look at our cost rate, 113-336 cents per pound growth. And that was a major factor in contributing to the 309 cents per pound we see in the first half this year. What happens with inflation is your just give up some of that again. And so going to bat the cash cost of both the projects, do we think they are going to increase because of inflation falling the devaluation, the answer is no because the devaluation overall will have a benefit to both of those projects. Yes, some of that will be given up. We are giving cash costs over the first 10 years. So over that period we would expect the benefit to be probably not be in inflation over that period. But overall this is a net benefit to both projects.

Mike Flitton - Citi

Mike Flitton from Citi. Just a couple of questions. Firstly, again on the inflation rate. Given the low sensitivity, can you give us just a sense of how you think that will develop on an annual basis on a medium-term? You know previously we have looked to 7% annual inflation rates but obviously lower exposure now. And secondly on the (indiscernible), obviously the 240 is still for adjustment from the cash flows. I was wondering if you can just give us a sense of a range of what that could be, it's $20 million to $30 million a month, higher or lower. Just a bit of color on that. Thanks.

Andrew Southam

Okay, on the inflation. You know Kazakhstan inflation as you say has been running around 7%-8%. If you look at our, Kazakhmys inflation, it's actually been running considerably higher than that in the period since. So you have that last evaluation to 2009. So it's running at a 20 odd percent. So I think the new -- the Kazakhmys in the East Region, some of the factors behind the higher level inflation was in particular coming from wages. We have approximately 24% or so of the cash cost in the East Region come from wages and that’s more than say one-third of the full group at the moment. If you look at Bozshakol and Aktogay, it should be a much larger portion of our cost base going forward. Labor there is somewhere between 10% and 15%. So significantly lower than the previous group.

So I think our exposure to higher levels of inflation generally seen in Kazakhstan is greatly reduced. We will have increased exposure to factors such as power. And Bozshakol and Aktogay will make up a slightly higher percentage of our cost base than in the past. But I feel that the new group is much better positioned in respect of outlook on inflation. So I would expect us to be much closer to that kind of Kazakhstan level of inflation than running considerably about that as we saw in the past.

Mike Flitton - Citi

You can continue for the cash adjustments. I think -- did you mean the restructuring?

Andrew Southam

Yes, the cash flow adjustments until the actual group is.

Oleg Novachuk

I think currently it's better to say that we have guided the market that it will be 150 million in cash, which will be provided to the old group. And adjustments on spent CapEx and the refundable VAT. I think it's better to keep the worse scenarios to 240. Okay, and everything else would be only better.

Danielle Chigumira - UBS

It's Danielle Chigumira from UBS. On Aktogay, can you give us an idea when the tendering process for the sulphide plant is expected to be complete, giving us some better clarity on the overall CapEx. And just on Bozshakol, could you give us some more clarity on the production profile year term. Previously you again very helpful charts in terms of the near-term spike in production. Could you give us an idea where that is currently?

Mian Khalil

On Aktogay, in the next quarter will have the tendering process complete for the main sulphide concentrator. As I alluded to earlier, the bids are in. It takes a month or two to evaluate, sort out and award and sign a contract. So that's imminent in the scheme of things. On the production profile, Andy?

Oleg Novachuk

Also on production profile we have previously said that we will increase the peak of our production will be in first 10 years. And that's still the case but probably the closer we are to production, the more details we will have from drilling and from mining planning. So the profile is still the same. It might be slightly lower than we previously showed you and I think that that information was reflected last time when we reported about slightly higher operation costs. Previously we guided, it will be 60 cents to 80 cents, now we are saying it to be 80 cents to 100 cents per pound. But averagely the production profile is the same. No changes.

Myles Allsop - UBS

Myles Allsop, UBS. Just going back to BHP doing spin-off late, kind of talk about $3.5 million of incremental savings, whereas you're talking about incremental cost coming out of the spin out. I mean are we in sort of three-four months time going to be talking more about the potential of reducing cost within the East Region or is it just actually tough out there given the politics, labor, devaluation, sort of inflation and so on.

Oleg Novachuk

You mean to improve the cost in these. Right?

Myles Allsop - UBS

Yes. I mean to talk about the benefits of being able to reduce the kind of -- you have got four or five mines to focus on as opposed to 17. Can you not kind of a squeeze that lemon a bit harder now?

Oleg Novachuk

That’s not wrong in part. The current cost of the group is -- if we take everything together...

Andrew Southam

We had net cash cost of over 200 in the first half going down to 96 cents for the East Region. Myles, let me just turn to start and turn that question around, okay. In the first half we had G&A summer around $350 million odd on its own. And that's supporting the 16 mines. Our starting point for the East Region was to leave behind that corporate center which supports those operations. So when you talk about us having additional costs, it's not additional costs above what we currently have in any way, shape or form. This is about making sure and a region which previously did not have a management team running it, is being spun out. Leaving behind as default any of those shared corporate costs previously and yet, we have to put a management team on top of it, to run it efficiently and to drive it forward. But it's certainly not the case but this is additional cost, far from that we are turning what is currently the fourth quartile offset of operations into good second quartile cash generative business.

Oleg Novachuk

And maybe to say, can we squeeze this lemon harder, yes we can. So what we are doing on that we are just trying, as I mentioned in my presentation we are trying to optimize the material supplies and service supplies to the company. When we were as a one group of course we, Kazakhmys was built as vertically integrated company. Historically it was necessary to have everything in house to produce copper. Beginning from ore and ending with the final product. Currently we have a lot of services available on the market but due to the inherited productions and services which are in the group, we were forced to use them because we invested money in equipment. For example we use our shaft sinking construction company, transportation companies and maintenance companies. Currently, when this group is separate, we will evaluate the best available options on the market. We are not tied to use the internal sources for that. So that will be the way for optimization.

And also we have, as Andy said, previously we had enormously high volume of administrative expenses which will be definitely reduced and due to the restructuring we are losing a few layers of management between the top management and the mine managers. Previously, between me and the manager of the mine, I had about six layers, now I have only two. And now they can directly talk to me and all these managers which were necessary to manage a big group are not necessary anymore. So it will be very lean and very dynamic company.

Myles Allsop - UBS

You are confident that yr 120 to 140 in East is not going to be turning into 160 to 180 in 2-3 years time?

Oleg Novachuk

It depends on the economy, of course, but if everything stays as is, we don't see big signs of that.

Rob Clifford - Deutsche Bank

Rob Clifford, Deutsche Bank. Just you can pay off the PXF facility but you clearly don't want to. What happens if the banks don't come to the party and soften the covenants on that. And as you go through this big project phase, your debt is going up. How do you think about where you want to position KAZ Minerals balance sheets? What gearing do you want, what credit writing do you want? What are you targeting post settling down?

Andrew Southam

I think an additional source of corporate liquidity is a nice to have, it's not a must have. We are prepared to the working capital for [pool] (ph), which went out in the circular last month, on the basis of us having no additional corporate facilities. So if we can do a corporate facility on the PXF basis on acceptable terms than that something we would quite like to look at. If you can't, well that's the -- that's the way we would just weigh up of the pricing on that and decide what we want to do. In terms of long-term debt ratios, I think we would like to move back to eventually to 2.5 times EBITDA. That’s through the cycle EBITDA as a sort of target level of debt. But we still fully recognize that what the group is going through this phase of major development, we will be above that certainly until Bozshakol is fully ramped up.

Liam Fitzpatrick - Credit Suisse

Liam Fitzpatrick from Credit Suisse. Two questions. Just on the financing side. You have looked at partnering in the past. Is that something you would still consider given Koksay and given where your balance sheet is going. So partnering off of Aktogay or Bozshakol. And then just in terms of thinking about the projects. What sort of ramp up period should we think about? Is it 12 months, is it 18 months or is it shorter?

Oleg Novachuk

On partnering, I would say we would like to keep our options open. We have very strong relationship with our strategic partners in China. And yes, we do with them. We discuss with them the potential partnership in the future but currently we have no immediate need for that. We are just building the relationship for future. That's like, what will be the project of Koksay in next three years. If that will be a large project it will be similar to Bozshakol and Aktogay, probably we will find the options to finance. If it will be a big project and it will require a lot of, lot more money than we think, then maybe we will consider the partnership. But currently we have no immediate need but we developed a relationship for some case if we need those.

And for commissioning, Mian, if you would?

Mian Khalil

Yes. The previous figures we have disclosed show a 2 to 2.5 year ramp up which is conservative. And that's what we put into the feasibility study and that's been in every forecast we have done. That's based on some very industry specific ramp up curves called (indiscernible) curves that you do for new projects.

Andrew Southam

Well, just to be clear. That is a ramp up in terms of ore processing and the grade on Bozshakol is higher at the beginning. So what you will therefore see is a much sharper ramp up in terms of your cathode output the new would, on the sort of actual physical throughput of ore. So you do see quite a sharp ramp up on Bozshakol.

Mian Khalil

So it's not a straight line between zero and 2.5 years. It gets very quickly up to the 80% production rate and then the last 15%-20% sometimes takes a little bit of tweaking. That's typically how ramp up curves work.

Oleg Novachuk

Let me say that the average production level of Bozshakol will about 100,000 tons but the peak of production is 140, and then after 10 years it will be down to 80. So if we are talking about ramp up, it means that what will be the take when we reach that peak. So that’s...

Liam Fitzpatrick - Credit Suisse

So how long after the initial commissioning, do you think you will get to say 100. Would it be within 12 months?

Mian Khalil

I would say we are very close. 12 to 18 months. And by the end of the year we will have more guidance on that from the operations group.

Edward Sterck - BMO Capital Markets

Edward Sterck, BMO. Just a question on the CapEx for the new projects. Does the guidance includes all of the working capital requirements to free cash flow or is that working capital in addition to the CapEx guidance?

Andrew Southam

In the project CapEx that includes the working capital required for those projects to commence. So the project will be delivered by the project team in a state in which it can be operated by the operations that's been included in the CapEx.

Oleg Novachuk

Can we switch to questions on telephone? Do we have somebody online?

Operator

We have no questions from the telephone.

Oleg Novachuk

Any more questions? So let us conclude at this stage. Thank you very much for coming and it was great pleasure to see you all here. Thank you. See you next time.

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Source: Kazakhmys' (KZMYF) CEO Oleg Novachuk on Q2 2014 Results - Earnings Call Transcript

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