Hudbay Minerals: Rosemont Mine Significantly Improves The 5-Year Production Outlook

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About: Hudbay Minerals Inc. (HBM)
by: Aitezaz Khan
Summary

HBM receives Section 404 Water permit for its Rosemont Project.

Rosemont mine will improve the long-term mining dynamics for HBM.

There's a favorable outlook for copper in the long term.

HBM is well positioned to obtain financing for project development.

HBM has reasonable growth opportunity in both the short and the long term.

Thesis

Hudbay Minerals (HBM) has recently received Section 404 Water Permit from the ACOE (read: US Army Corps of Engineers) relating to its RM (read: Rosemont) project in Arizona, US. This approval will enable HBM to make a construction decision regarding its RM project.

In this article, I have considered HBM's copper production outlook in the long term (say, the next five years), and that is expected to improve significantly with added production potential from the RM project. Moreover, with multiple financing options at its disposal, HBM will be able to conveniently finance the development CAPEX. This should enable the company to complete the project in time, thereby improving the long-term growth outlook of the company.

Figure-1 (Source: Website)

HBM receives Section 404 water permit for its Rosemont project

On 8th March 2019, HBM announced its receipt of the '404 Permit' from the ACOE for its RM project. The company had previously received the final 'Record of Decision' from the US Forest Service. Now, HBM expects to receive the approved mine 'Plan of Operations' that would pave the way for the development of the RM project. It's relevant to quote HBM's CEO, Mr. Alan Hair, on the regulatory approval:

The receipt of Rosemont's 404 water permit is a major milestone in our efforts to build a modern mine that will fulfil the requirements of its permits, create jobs and provide benefits for all of our stakeholders. There is positive momentum at Rosemont and across our business as we continue to position Hudbay to create long-term and sustainable value for shareholders. We appreciate the diligence that the Army Corps has put into its consideration of Rosemont's permit application, and look forward to advancing Rosemont into construction.

As shown in Figure-2, The '404 Permit' is the last key approval that would enable the company to take a construction decision on the RM project. Now, HBM is expected to begin construction of the project during FY 2019.

Figure-2 (Source: Presentation)

Rosemont mine will improve HBM's long-term mining dynamics

HBM, currently, has three producing mines including the Constancia, Lalor, and 777 mines. The RM project is particularly significant in terms of having a longer LOM (read: life of mine) than HBM's existing mines (Figure-3). With a reserve life of ~19 years from the commencement of production, the RM project could continue to deliver production for the next 31 years.

Figure-3 (Source: Presentation)

The construction of this project is expected to take approximately 3 years. If HBM begins construction in FY 2019 (and assuming that things move as per plan), then we can expect the RM project to commence production from FY 2022. During the first 10 years, the RM project will deliver ~127,000 Mt (read: metric tons) of copper at a cash cost of ~$1.14/lb of copper production. The good thing is, within the first two years of production, the RM project will significantly revamp HBM's copper production profile. It's expected that HBM's annual CuEq. (read: copper equivalent) production will grow by 1.5x the expected annual production of FY 2019. Have a look at Figure-4 that depicts HBM's production growth profile.

[Note: The green area represents expected production from the RM project].

Figure-4 (Source: Presentation)

Apart from the positive impact on its operational outlook, HBM will also see significant improvement in its financial picture. During the past 12 months, HBM generated ~$538 MM in EBITDA. Once HBM completes the construction of the RM project, it expects to generate an additional ~$400 MM in EBITDA each year, during the first 10 years of its production.

[Note: This expectation is based on the assumption that long-term copper prices would remain at or above $3/lb (discussed in some detail in the following section), and RM's cash costs will lie at or below ~$1.14/lb of copper and also assumes that HBM produces ~127,000 Mt of CuEq. each year]

The long-term outlook for copper prices

The demand for copper is expected to witness a boom over the next decade due to an expected increase in the electric vehicle industry. This is expected to result in an overall supply deficit in the copper market (Figure-5).

Figure-5 (Source: Turquoise Hill Presentation)

At present, the copper prices are already near ~$3/lb. of copper (Figure-6), and if we consider the positive long-term copper outlook, we can expect the global copper prices to remain well above $3/lb. in the long term.

Figure-6 (Source: Infomine)

The financing of mine development

It's expected that during the first 3 years of development of the RM project, ~$1.92 BB will be incurred. Out of this, ~$1.11 BB will have to be borne by HBM. But the question is, will HBM be able to conveniently finance its proportion of the mine development CAPEX? In my view, it will be able to do so. As shown in Figure-7, HBM plans to source finance from its operating cash flows.

Figure-7 (Source: Presentation)

Moreover, it's expected that the initial 3-year mine CAPEX profile would involve expenditure of ~$144 MM, $861 MM, and $768 MM during the first, second, and third year respectively. Since HBM has generated significant operating and free cash flows (Figure-8) during the LTM (read: last twelve months), therefore, financing the mine CAPEX from operating cash flows would not be a problem for the company.

Figure-8 (Source: Presentation)

Nevertheless, an alternate option for HBM is to obtain financing from external sources. If it goes for that option, it is likely to obtain funds at a lower cost of debt. This is so because HBM has significantly reduced its outstanding net debt during the past 3 years and this strategy improves shareholder returns (Figure-9).

Figure-9 (Source: Presentation)

Finally, having recently witnessed a significant upside in share prices, one may consider whether HBM is a buy at current levels, and that question leads us to the next part of our discussion.

Is HBM a suitable buy at the current prices?

To answer that question, we must first consider the 52-week range of the share price. HBM's 52-week price range lies between $3.44 and $8.08. At the time of writing, the share last traded at $6.79, slightly higher than the mid-point value (~$5.76) of the 52-week range. On the surface, HBM looks slightly pricey. Nevertheless, the technical price chart (Figure-10) shows that a suitable short-to-medium term target price may be somewhere around $7.

Figure-10 (Source: Finviz)

I believe, the short-term outlook also supports such price estimate because once HBM receives the mine's Plan of Operations from the US Forest Service, the share price would take another jump. Moreover, we can also expect HBM's share price to witness growth in the long term thanks to the favourable improvement in HBM's mining outlook post-completion of the RM mine.

Conclusion

In the preceding discussion, we have analyzed the impact of the '404 Permit' for HBM's RM project. This permit paves the way for the mine's construction, which is expected in the current year. We have also seen how this project will significantly change the mining dynamics of the company, in terms of prolonged mine life, wherein HBM would deliver significant CuEq. production at a low cost. Not only will this project improve the HBM's copper production profile but also it will help the company to revamp its EBITDA profile. However, it would need support from copper prices. Since copper markets are likely to face a supply deficit over the next decade, I believe copper prices will stay above the $3/lb. mark. Moreover, HBM has a strong cash flow profile that should enable it to fund the mine CAPEX through operating cash flows. Finally, the technical picture and a robust long-term growth outlook suggest that HBM has more upside potential from the current prices.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.