Sherritt International Corp. (OTCPK:SHERF) Q1 2016 Earnings Conference Call April 27, 2016 10:00 AM ET
Flora Wood - Director, IR
David Pathe - CEO
Dean Chambers - CFO
Orest Wowkodaw - Scotia Bank
Greg Barnes - TD Securities
Good morning, ladies and gentlemen. Thank you for standing-by. Welcome to the Sherritt International Corporation First Quarter 2016 Results Release Conference Call and Webcast. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] I would like to remind everyone that this conference call is being recorded today, Wednesday, April 27, 2016 at 10:00 AM Eastern Time.
I will now turn the conference over to Ms. Flora Wood, Director, Investor Relations. Please go ahead.
Thank you, Ron. Good morning everyone and thanks for dialing in, I now a lot of issuers are reporting today. You will see our presentation on our website and the forward-looking statements in Slide 2 of the presentation. The forward-looking statements apply to the content of the presentation and anything we say in Q&A. With me today, I have David Pathe, CEO; and Dean Chambers, CFO. And with that, I'll turn over to David.
All right. Thank you, Flora, and thanks once again everybody for joining us this morning. Steve Wood is out of town this week so for this quarter Dean and I are going to cover things up between us. Steve would normally start touching on safety, so I'm going to do that this time.
We had a pretty good quarter overall, lower reportable incidents compared to the same quarter last year and some of the initiatives we've had in safety in the last twelve months were being much more proactive on leading indicator tracking and we've had much higher management safety interactions in the field and we're hoping that's a harbinger of future strong performance.
On safety, specifically, you will have seen as well in our press release that we're now about 95% complete on our asset plant construction in Cuba, and that project has going very well from a safety perspective, as well as construction perspective. We're now 95% completed and then quite a tight space with a lot going on. We've had over a one million exposure hours and we've all had three last time incidents on that project and so we're quite pleased with the way that has gone as well.
Moving on to the quarter then, really once again it's a story of currency and commodity prices, so I've highlighted that a bit on the first slide here. Nickel for the quarter was hitting out lows that we haven't seen since 2002-2003. Now we had a low of 3.50 during the month which is - the vast majority of nickel production in the world under water. Now we have seen nickel pick up off the bottom of that in the last few weeks, we're now 15% to 20% off of those lows and potentially some reasons for some optimism there and we'll talk about nickel markets in a few minutes.
Oil, obviously, people will follow closely in and that has picked up more significantly off of its lows but one of the stories of the quarter for us is Fuel Oil Number 6 which you all know is our as the market reference price that we use for pricing our oil in Cuba, that hasn't thus far kept pace with the VTI. Well look over the page here you'll see that Fuel Oil Number 6 over a year ago was actually trailing pretty close to WTI but quite a spread has now has opened between WTI and GCF6 starting in the fourth quarter has continued to widen the first quarter this year, we're now trading at sort of 60% to 65% to WTI.
We historically get 70% to 75% of the GCF6 pricing in our - for our Cuban oil and that ratio hasn't changed. But that spread that has opened up between Fuel Oil Number 6 and WTI is resulting in lower realized pricing for us at the moment. The U.S. Canadian dollar exchange rate is a story of this quarter as well and Dean will touch on a bit more about that in his comments on the impact of that. Interesting quarter this time though and that the Canadian dollar is weaker compared to where it was a year ago but stronger relative to where it was last quarter. So it has some effects one way or the other depending on what quarter you're comparing against.
Moving on to our nickel production then, nickel production overall was down about 4% from Q1 '15. In Moa, production was up marginally from the same quarter last year, heavy rainfall at the mine faces in Moa, particularly some of the higher grade mine phases impacted their ability to get some of the higher grade ore and that followed through to a lower mix sulfide production. And we're able to supplement some of the lower mix sulfide with third-party feed at the refinery but the third-party feed we're able to acquire was more cobalt rich than nickel rich. And so you see the modest drop in nickel production while cobalt production hung in reasonably well.
Ambatovy's production was down a couple of hundred tons from Q1 last year and frankly a few 100x short of our plan for this year. In our press release we refer to a number of unrelated liability issues, for example, the number of valves and pipeline into bonus the sales a little ahead of their original design life which was meant to be around three years. I mean - so they would have been up for replacement otherwise sometime later this year. There was - and now largely been replaced and the replacement is migrated to other materials and stainless steel rather than rubber lining for example. But we've been able to do that without really changing our production or capital gains for the full year.
We do have a maintenance shutdown coming up in late August and at that time we'll be making some additional modifications to address some of the issues we've had with viability. More broadly, we continue to revise our preventive maintenance processes as part of our plan to improve equipment availability, increased production and lower costs.
You would have seen over the quarter we talked about the Advance Cargo Declaration, the attempt to put in a container fee at the port. That has all wrapped up now, didn't have any significant impact on production but it has some impact on the timing of shipments and some marginal impact on pricing as a result. But that has now gone away with our protections under the Malagasy mining law upheld, and frankly, a few weeks after they recognized that we were unaffected due to the LGIM, the Advance Cargo Declaration was scrapped in this entire year. So we carried on as we were before that issue rose up.
We'll take a look at the net direct cash cost in the next couple of slides but overall it was a good quarter for NDCC. It was down significantly from the first quarter a year ago, just over $1 a pound at Moa and about $1.30 at Ambatovy. Before we do that, nickel markets more generally - despite roughly 60% of nickel production being underwater in a cash margin basis, we've still really only seen some minor supply side responses, seen some minor operation shutdown, most of the cuts thus far have been in nickel pig iron production. The general consensus seems to be that about 125,000 tons of nickel pig iron production came off in 2015, our people are expecting another 70,000 or so this year.
On the demand side, we are seeing some general signs in the last few weeks of the market potentially coming in more into balance after a few years of surpluses. The trend towards increased demand from China that we saw towards the end of last year is continued and strengthened into the first quarter of this year. We ourselves have very little material available at this point in time, we've been getting some calls from buyers that we haven't heard from in quite some time. In fact we're at the point now we've got to turn some potential customers away because we simply don't have material available for them, and that's something we haven't seen in quite some time.
As a consequence of that we are seeing some signs that the discounts to LME pricing are shrinking and in some case premier emerging against LME pricing and that kind of environment is - has generally in the past been positive for the prospect about nickel prices going forward.
Cobalt after falling in late 2015 has stabilized and the outlook there is relatively stable. Nickel and copper supply cuts often have an immediate impact on cobalt supply as much of the cobalt production in the world is really byproduct driven, and we'll see how much of that impacts cobalt supply through the course in 2015.
On Page 6, you're seeing, you've seen this slide before that shows our net direct cash cost relative to the performance of the 50th percentile. You can take from that page the 50th percentile of nickel production in the world is still above the spot price today, so more than half the world's production is underwater on a cash margin basis still. You did see our more cost uptick a bit from the 2.90 that we had in the fourth quarter last year which was bit of an aberration based on some maintenance timing and the large fertilizer credit but over the course of this year we do expect Moa to still benefit from normal seasonality in fertilizer sales with higher credits in Q2 and Q4.
And our assets plant operation which you saw on the press releases is going well, should be starting to contribute assets in third year and with the spot commodity prices where they are we still think that's worth $2.50 cents a pound for us.
Ambatovy's NDCC in the quarter was about 10% higher than the fourth quarter. On production it was about 10% lower due to the downtime that we just spoke about. Now with better production this quarter, Ambatovy should be able to get net direct cash cost back of course in the $4 mark. Just over the page to finish off, the cash costs, there you see our two operations plotted against the most recent with Mackenzie cost curve both firmly in that second quartile and continuing to work those down towards the bottom quartile.
Before I move on to just talk briefly about our power and oil before turning it over to Dean on some more specific financial accounting matters. I just wanted to take a minute and talk about pick up on our conversation, the Q4 and where we are and Ambatovy funding. As we discussed on our year-end call, we have ceased funding our share of cash costs of the projects at this point in time and the achievement of financial completion at the end of third quarter last year has made that possible. This relates to our 40 for 12 issue where we're expected to fund 40% of the cash calls but due to the 70% cash, our future distributions from the project to the non-recourse partner loans we would really only have an effective 12% economic interest in the project for the foreseeable future. And that creates a significant disincentive for us from a capital allocation perspective to contribute into the project.
Sumitomo and KORES have now provided $51 million and funding to Ambatovy so far pursuing to cash cost of $85 million in 2016, that $34 million difference is the amount that we have not funded. Dean will speak to the accounting for that, it doesn't get added to the partner loan total but it is a non-recourse to Sherritt and only funded from our future distributions from the project unless we choose to do otherwise.
A project debt payment on the original $2.1 billion U.S. financing is due on June 15th and negotiations continue with the lenders who are on the amortization schedule, again made possible by the achievement of financial completion and the fall in the way of the parental guarantees. I'm not much in the way of progress to report to you on that frankly, there have been a couple meetings in London with the sponsors and the lenders over the last couple months. I expect, frankly, that June 15th deadline will begin to insert some greater urgency into those conversations since the payment of the project alone is not funded to be able to make at this point in time and we'll update you as we get closer to that date and have some more meaningful news for you.
The partner side, and our 40 for 12 issue, I mean we are still operating the project and everybody is still working constructively towards that. The focus frankly and more recently has been on the lender discussions rather than the intra partner discussions. I suspect that will continue as we get closer to some sort of resolution with the lenders.
Turning to oil and gas and power, in the oil business as expected, oil production declined year-over-year but the 52% drop in Fuel Oil Number 6 prices meant we received a higher number of cost recovery barrels which kept our networking interest figure relatively flat. We talked about the spread between WTI and GCF6 and how we saw that widen beyond anything we saw last year and that obviously hurt our realized prices.
Unit operating costs on the other hand remained low even with the drop in production, a bit of an anomaly there and there was a relatively low expenditure quarter from a work over perspective and we will see that pick up a bit over the next few quarters with unit operating cost probably coming more in line with what we saw in Q4 last year, a $1 or $2 higher. Power, a good quarter, slightly higher production and 32% higher revenue, that's driven in part by the weaker Canadian dollar against the U.S. dollar, and also there is some construction revenue there from the pipeline we're building to some incremental gas supply to the operation.
Power, adjusted EBITDA is up from the same quarter a year ago on cash from operations and free cash flow or both by $20 million lower. Now the main difference being the interest and principal received on the CSA that can - which is the construction financing loan from Q1 last year. And we do expect to see some cash flow from interest and principal repayment this year and we're expecting about $34 million overall.
Just to finish up, for me anyway one change to our guidance this quarter and that's on our capital spending in the oil business, we reduced that by $9 million. Now that relates to the capital for the second of the two wells that we were planning to drill and block 10 this year. Given that the timing of permitting the time to drill the well and the time that we want to assess the results of the first well before starting drilling on the second, we now expect the bulk of the spending on that second well to be in early 2017, hence the revision to our 2016 capital spending guidance there.
Before we come then and take your questions, Dean's going to touch on a few things from a finance and accounting perspective. And then we'll come back and take your questions. Dean?
Thanks David, and good morning. I have five slides today covering some new accounting treatment that arose this quarter, the impact of foreign exchange on our results, cash flow and liquidity, and some changes to our bank credit facilities.
As David has described, Sherritt is not funding Ambatovy cash calls due to the structure of the Ambatovy partner loans which effectively reduces our 40% equity interest to a 12% economic interest. In the first quarter, Sherritt share of the unfunded cash call was $34 million. Essentially Sherritt owns the Ambatovy joint venture, this amount, plus accrued interest at LIBOR plus 3%. Our share of future distributions that they used to repay this liability or maybe set off against other amounts owed to Sherritt. Of course, we could elect to pay this amount at any time.
This underfunding gives rise to the recognition of a new liability. A corresponding asset is also recognized relating to the right to receive future distributions from Ambatovy. This was a different situation than the subordinated loan receivable because the subordinated debt reflects financing that has been provided to the Ambatovy joint venture. Slide 10 gives you a snapshot from those '14 and '17 from our quarterly financial statements. In Canadian dollars, the unfunded amount is approximately $44 million. The asset is recorded as another financial asset in the advances loans receivable and other financial assets lined on our balance sheet. The liability is contained in other financial liabilities line, also on our balance sheet. Although this liability shows as a separate item, it is somewhere to the Ambatovy additional partner loans in a sense that if it's not repaid by distributions from Ambatovy, the only recourse is to our share in the joint venture.
On another note, on our year-end call, we discussed in depth the impairment of Ambatovy's assets. What impact of the reduced caring value of Ambatovy's property, plant and equipment is reduced depreciation going forward. And this is the first quarter where we can see that impact. This quarter Ambatovy's depreciation and amortization on a 100% basis with $92.5 million, Canadian, compared to approximately $133 million in the fourth quarter.
Now I'll turn to our usual introductory slides, Slide 11, showing our adjusted net loss versus consensus. As while the relatively quiet quarter with few adjustments but foreign exchange always has an impact. We've spent some time on foreign exchange on last quarter's call where we reviewed our sensitivity table. As David mentioned, this is somewhat of an unusual quarter and that the Canadian dollar was weaker this quarter compared to Q1 of 2015, but straightened significantly during the quarter compared to year-end.
Like most mining companies that report in Canadian dollars, operating earnings are generally positively impacted by a weaker Canadian dollar. However, in a period of operating losses, as we experienced this quarter, where U.S. dollar expense has exceeded revenues, the impact of a weaker Canadian dollar this quarter compared to last year had a negative impact on operating earnings compared to the first quarter of 2015. In addition, our U.S. based financial liabilities exceed our U.S. dollar based financial assets. With the strengthening of the Canadian dollar during the quarter this resulted in the unrealized translation gain of $76 million impacting our earnings.
Finance expense, which in the past four quarters has generally increased was additional unrealized foreign exchange losses. This quarter is mitigated by this unrealized foreign exchange gain turning the expense into income of $50.6 million. We have updated our sensitivity table in the MD&A where we indicate that the strengthening of the Canadian dollar relative to the U.S. dollar of $0.05 has a positive impact on net earnings of approximately $51 million in the first quarter. Based on the actual amount, the Canadian dollar strengthened during the quarter, we estimate that having approximately $10 million positive impact on operating earnings because of operating losses during this quarter, in addition to the translation again we just discussed.
Our reported adjusted net loss of $0.43 compares to analyst consensus of negative $0.35 and David has covered the main drivers being Ambatovy's lower production and the lower average realized price in oil.
Turning now to Slide 12 which shows the combined adjusted operating cash flow this quarter compared to the fourth quarter. On this basis overall operating cash flow declined by approximately $7 million compared to last quarter. Despite the drop in average realized price and a drop in production, Ambatovy has a higher adjusted operating cash flow. The main difference is the interest payment on the senior project debt that was paid in December last year.
The Moa joint venture in oil and gas had lower adjusted operating cash flow with lower revenue from the commodity price impact. The magnitude of change at Moa relates to the seasonal higher cash flow with higher fertilizer sales that occurred in Q4. We typically see higher fertilizer sales again in the second quarter although we have experienced higher sales in the first quarter compared to the same period last year due to warmer weather in Western Canada.
In Power, there was no interest received on the CSA loan largely due to capital spending. In this quarter we had lower interest payments on our debentures with $10 million being paid compared to $20 million typically paid in the second quarter and the first quarter.
Slide 13 shows the change in cash during the quarter. We had a small working couple change of roughly $4 million. Overdo oil and gas receivables increased to U.S. $62 million by the end of March compared to U.S. $50 million at year-end. Quebec is generally paying in accordance to an agreed payment plan forecasted to return these receivables to current by the end of the year. But the payment schedule is weighted towards the latter part of this year. Almost significant change in our cash balance is the repayment of $45 million of debt which I will discuss in more detail on the next slide.
Ignoring the repayment of debt, our cash balance declined by approximately $20 million during the quarter. During our year-end call, I reviewed the covenants that existed in all of our debt facilities. At that time we disclosed that we have received labors for our breach of a financial debt to equity covenant, and that we would be working with our lenders to amend the terms of these facilities to deal with this low commodity price environment and avoided future potential breaches and the need for waivers.
Slide 14 describes the results of these discussions. With respect to the $115 million revolving term credit facility which is secured by receivables and inventory, we have negotiated the following updated covenants. There is a net financial debt-to-EBITDA covenant of 3.75:1.0 at March 31 which is the same as the previous covenant. However, as you can see this ratio increases each quarter up to 4.25:1.0 at the end of the third quarter. All these covenants are calculated on a moving four quarter basis. So this reflects the fact that if commodity prices remain at current levels, the calculation will include more low EBITDA quarters while dropping higher EBITDA quarters from the prior year.
In addition, there is a requirement to maintain cash equivalents 50% of the lower as a borrowing base of the facility amount if this ratio is greater than 3.75. There is a net debt, a financial debt to equity covenant of 0.55:1.0. 0.55 is unchanged but the calculation has changed from financial debt to net financial debt including the benefit of cash balances. And EBITDA to interest covenant is changed from 3:1 to 1.75:1. I will remind you that these covenants have their own calculations defined in the agreement and cannot be directly calculated from our financial statements but based on our current forecasts, these covenants are not expected to be breached prior to the maturity of the facility in November.
As a result of the amended covenant package, the interest rates on this facility have increased by 25 basis points. And during the quarter we repaid $10 million on this facility due to decline in the borrowing base simply related to declining nickel prices.
Now with respect to the $35 million line of credit which was unsecured, we were unable to negotiate new terms acceptable to Sherritt, so the facility has been repaid and has been terminated.
This concludes our formal remarks. So I will turn the call back to Ron to open the lines for questions.
Thank you. [Operator Instructions] We'll now take the first question from the line of Orest Wowkodaw with Scotia Bank. Please go ahead.
Hi, good morning. I was wondering if you could give a little bit more color on what your expectations may be for the resolution of I guess this ownership and funding emphases at Ambatovy? I mean at some point you take the partners, how long do you think the partners will continue to fund your share if you like not to contribute? Thank you.
Hi Orest, it's Dave. I'll comments a bit and Dean's been involved in negotiations, so if he has to add, I'll ask him as well. It's difficult to say exactly what the outcome will be until we got to something. Generally I expect that we will get to some sort of arrangement that will see several principle deferrals on the Ambatovy project financing, that's certainly the nature of what's being discussed right now. And that will alleviate a big part of the of the cash requirements to Ambatovy for the next few quarters as really the last couple years the biggest demand for cash from the partners has been making those principal and interest repayments on the senior financing. In terms of our partners, their commitment to the project remains strong, and certainly the discussions we've had with them in the last few months and between with them, with us, and them and the lenders; their commitment to the project seems intent on seeing it through to cash neutrality and ultimately profitability.
Obviously, there is no obligation on them to do that but they do have a significant exposure to the project and the converse of our 40 for 12 issue is, if we were funding they do get 88% of the cash flow and to the extent that they find the circumstances where we don't, they will get 100% of the cash flow until they recoup any incremental spending that they put in that we don't match. So my expectation at this point is that they will continue to fund through to what needs to see the project be able to stay on its own assuming that some reasonable accommodation can be reached with the Ambatovy lenders.
Okay. So it sounds like it could still take a couple months to resolve at least. And then, a question for Dean, I thought obviously you put some new financial leverage covenants into your credit facility. Can you explain kind of what's included in both, the EBITDA and the debt part of the calculation? Like are the partner loans included in the debt, and are you looking at kind of an adjusted EBITDA including sort of the contributions from Ambatovy and/or sort of how - I'm wondering how to piece that together.
Yes, we could probably spend some time offline doing a lot more detail but things like the partner loans are not included but things like letters of credit are. I think with respect to EBITDA sometimes it gets to look at actually cash flow as opposed in some cases. So there are a lot of different adjustments depending on the actual calculation. We'd be happy to spend a bit more time offline but that's one of the bigger changes is that the partner loans are not included in the debt.
Okay. So could you give us what your - say, net debt to EBITDA was for the purposes of this calculation say as the end of the first quarter?
I don't have the number with me but obviously we were in compliance with the covenant.
Can you give us a sense of how close you were to that threshold in terms of breathing room?
I actually don't know the exact number at this moment. I know that it was not particularly - it was not a concern, that's all I really know at this moment but I could talk to our treasury guys and get a more precise answer for you.
Okay. I'll leave it there. I guess we'll take it offline. Thank you.
[Operator Instructions] We'll take our next question from the line of Greg Barnes with TD Securities. Please go ahead.
Thank you. David, a couple questions. Ambatovy has made a cash pull for $85 million of which only $51 million was funded. What happens with the $34 million they're missing? Does Ambatovy have a problem in terms of undercapitalizing the business? Are they running out of cash at the Ambatovy level or is this all just funding for the debt repayments that's coming up in June?
While to-date the cash calls have been basically appropriately sized so that the 60% of them gives the project the cash it needs to carry on to operate. The future amount of cash that the project needs will depend on where nickel prices go and how production performs. The $50 million that KORES and Sumitomo have put in out of that $85 million has been what the project is needed to carry on so far this year and that will see us through, probably the next month or two here just depending on how the world unfolds. There isn't funding going into the project at this point in time anticipating the project having the cash to make the June principle repayment.
Okay. So Dean, you said that this revolving credit, the $115 million facility has been obviously amended but it matures in November. What do you think happens then?
Well, I think one of the things that's important is the fact that it is secured, and has good security and that's obviously one of the main differences between it and the unsecured line of credit that we have. I would fully anticipate that we would negotiate and extend the term of that facility at maturity. And obviously we would be looking at what covenants make sense at that time.
Okay, fair enough.
It is an annual facility Greg, we just renewed it last November, it's renewed every November for as long as I've been here.
Okay, good. Thanks.
It appears there are no further questions at this time. Ms. Wood, I'd like to turn the conference back to you for any additional or closing remarks.
Okay, thank you, Ron. And I want to thank everybody for dialing in. Just a reminder to those of you who are in Toronto or near Toronto, we do have our AGM coming up May 10th and hope to see you there. And for everyone else, we'll look forward to talking to you in the Q2 results. Thanks.
This concludes today's call. Thank you for your participation. And you may now disconnect.
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