Hudbay Minerals Inc. (HBM) Q2 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Hudbay’s Second Quarter 2012 Results Conference Call. [Operator Instructions] I would like to remind everyone that this conference is being recorded today, August 15, 2012, at 10 a.m. Eastern Time. I will now turn the call over to John Vincic, Vice President of Investor Relations and Corporate Communications. Please go ahead, sir.

Thank you, operator. Good morning. And welcome to Hudbay’s 2012 second quarter results conference call. The company’s financial results were issued yesterday and are available on our website at www.hudbayminerals.com. A corresponding PowerPoint presentation is also available and we encourage you to refer to it during this call. Our presenter today is David Garofalo, Hudbay’s President and Chief Executive Officer. David will be joined by David Bryson, our Senior Vice President and Chief Financial Officer; Alan Hair, our Senior Vice President and Chief Operating Officer; Cashel Meagher, our Vice President, South America Business Unit; and Brad Lantz, our Vice President, Manitoba Business Unit, for the Q&A portion of the call. Please note, that comments made on today’s call may contain forward-looking information and this information by its nature is subject to risks and uncertainties, and as such, actual results may differ materially from the views expressed today. For further information on these risks and uncertainties, please consult the company’s relevant filings on SEDAR and EDGAR. These documents are also available on our website. Lastly, please be reminded that currency amounts discussed on today’s call are all in Canadian dollars unless we indicate otherwise. And now, I’ll pass the call over to David Garofalo. Dave?

Thanks, John. John and I are here with the rest of our senior management team in Flin Flon to celebrate 3 auspicious events. Yesterday we marked first ore production at Lalor with our work force and had a fairly major celebration, moved the crew over to Reed where we celebrated the commencement of full scale construction there as well, and today we’ll be marking first ore, at the 777 North expansion, so it’s been a week of celebration, and I want to take this opportunity to thank our workforce in northern Manitoba, Brad Lantz and his team, for their excellent work and delivering these projects on time and on budget. In the quarter, Hudbay continued to generate steady cash flow from our reliable operating mines, which continue to perform within expectations. It also puts us on track to meet our production targets for the sixth consecutive year. As a result, our production and operating cost guidance remains unchanged for the full year. We also marked a number of significant growth milestones, accelerating our goal of becoming a leading mid-tier diversified metals producer with long-life, low-cost operations in investment-grade countries. Last week, our board approved the development and construction of the $1.5 billion Constancia copper project in Peru. In conjunction with that, we also entered into Precious Metals Stream Transaction with Silver Wheaton for upfront deposit payments of $750 million and are currently arranging a new $600 million credit facility. At our Lalor project near Snow Lake, Manitoba, we reached a major milestone, as I said, with first ore production just this past Sunday in fact, and the project remains on time and on budget. Lalor is now poised to reach early production of 1,200 tonnes of ore per day using the vent raise [ph]. Progress at Lalor is truly remarkable when you consider the deposit was discovered only 5 years ago. Development of our joint venture Reed copper project is also progressing on schedule, significant surface infrastructure is in place or on order and the portal area is approximately 70% complete. First production at Reed remains on track for late 2013. And finally, our 777 North expansion is also on track and on budget. This expansion will allow us to access the Northern portion of the 777 mine by ramp, giving us a new means of egress and enabling establishment of underground drill platforms. First ore should be drawn from 777 North this fall. Total revenue for the second quarter of 2012 was $189.9 million, $57 million lower than the same quarter in 2011 as a result of lower realized metal prices and lower concentrate sales volumes. Year-to-date, revenues was $376.9 million, $47.3 million lower than the same period in 2011 as a result of lower prices. Operating cash flow was $66.1 million in the second quarter of 2012, a $4.3 million increase compared with the same period last year. Cash flows this quarter included a current tax recovery of $18.2 million to reflect the reduction of prior taxes owing as a result of accelerated depreciation of prior year tax pools related to the new mine status ruling at the Lalor mine. Year-to-date operating cash flows were $108.4 million, reflecting an increase of $4.7 million from the same period in 2011 for the same reasons. Our cash and cash equivalents decreased to $710.1 million at the end of the quarter. This decrease was expected and was mainly driven by $175.8 million in year-to-date capital expenditures, primarily relating to our Lalor and Constancia projects. We expect to fund our 3 mine development projects over the next 3 years through a combination of cash on hand, funds from our stream agreements and credit facilities and cash flow from operations. Our operating team continued to work safely and efficiently, which led to another productive quarter. We maintained our track record achieving good cost control and exemplary safety performance at our operations, as all of our mines and processing facilities achieved targeted cost per tonne. Trout Lake, however, exceeded expectations, even as we permanently shut down the mine after 30 years of operation. At Lalor, development and construction of our fully-owned Lalor project is advancing well. Our cost remained on budget. To date, we’ve invested approximately $277 million on the project and have entered into additional $91 million in commitments for the project out of a total project commitment of $704 million. During the quarter, the main ventilation shaft sinking was completed, mine air flow ventilation is now available on the 810 and 840 meter level breakthroughs. We removed the vent shaft services for sinking to enable the company to hoist up to 1,500 tonnes of ore and waste per day this month. The ore will be processed at the nearby Snow Lake concentrator until late 2014, when we expect to begin production from the main shaft and new concentrator in late 2014. The first full year of production from the main production shaft is expected in 2015. Basic engineering for the new concentrator is 80% complete. We have placed orders for the surface crusher and the SAG and ball mills. Site geotechnical work is complete and the company is finalizing the final site leveling required for the concentrator footprint. The main production shaft is currently sunk to the 200 meter level and is 20% complete relative to its planned depth of 985 meters. All other surface infrastructure is essentially complete and underground development is well-advanced. The installation of a new copper circuit, the Snow Lake concentrator is currently underway and commissioning is planned for September to facilitate processing of Lalor ore. Underground development and construction work has been ongoing on the 795-, 810-, 825- and 840-meter levels. At Constancia, front-end engineering and design work is now complete. The principal beneficiation concession or construction permit was granted in June 2012 and other required permits are expected in the ordinary course. Site activity to date has included the completion of a 660-bed construction camp, mobilization of the EPCM and civil works contractors, and the ongoing construction of homes for the 14 families that are scheduled to be moved from the project site later this year. The remaining 22 families are planned to be relocated next year. As noted in last week’s announcement, Constancia’s development schedule contemplates 9 quarters of construction with initial production late 2014 and full production commencing in the second quarter of 2015. This timeline to completion is shorter than previously forecast and reflects the progress that has been made in the past year at the project in front-end engineering, design, permitting and community relations. Out of the total project capital cost estimate of USD 1.5 billion, we have fixed price orders and supplier commitments for approximately USD 252 million in project equipment, including grinding mills and mobile equipment. We have spent USD 91 million of total estimated capital costs of project as at June 30, 2012. On the exploration front, our focus at Constancia will be on expanding Pampacancha and drilling there is underway. Two drills are concentrating on infill drilling, as well as testing the extension of the deposit to the north and the west. The exploration program has been modified to an expected 18,000 meters for 2012, due to the continued requirement for geotechnical drilling to support detailed engineering. At the Chilloroya South prospect, we expect to begin testing gold and porphyry copper targets this month. This exploration program will also concentrate on previously identified high priority targets within the mining concessions. The Chilloroya community has ratified an exploration agreement with Hudbay that allows us to access these exploration prospects for drilling over the next 3 years. At our 70% owned Reed copper project, just 120 kilometers east of Flin Flon, Manitoba, our focus is on the preparation of the project site for portal development. The project is on schedule, as we began the trench excavation in June 2012. We also completed the SAG leveling for the mechanical shop and warehouse office, changehouse and parking lot pads, as well as camp expansions to accommodate the workforce through the development stage of the project. Materials and equipment from the Trout Lake mine have begun arriving at site, and we’ve ordered new mobile equipment and compressors for delivery in the third quarter of this year. Tenders for the mechanical shop and warehouse have also been issued. Initial production at the Reed copper project is expected by the fourth quarter of 2013, and ramp-up to full production of approximately 1,300 tonnes per day is anticipated for the first quarter of 2014. Our transformation to a leading mid-tier diversified producer with long-life, low-cost operations in investment-grade countries is underway, and is being accelerated by the progress we’ve made to date in Constancia. Production in all of our key metals is anticipated to grow considerably in 2015, with 420% growth in copper, 35% growth in zinc and 125% growth in precious metals. Advancing Constancia, while meeting our corporate objective and maintaining and growing per share metrics is important. The Precious Metals Stream Transaction of the term loan we announced last week are not dilutive to our shareholders and are critical to helping us meet this important objective. On a final note, after more than 30 years of service, we closed our Trout Lake mine at the end of June. Trout Lake’s enduring legacy is one that makes all of us proud, and I would like to thank all of the men and women that made it one of Hudbay’s most successful mines in our history. Thanks for your time today, and operator, we are pleased to take questions.

[Operator Instructions] Your first question today comes from Tom Meyer with Scotiabank.

My first question is on the zinc plant, and as it relates to the timing of purchased concentrate deliveries. Was that delay into 2013 related to the shutdown or is that a question of concentrate availability?

You are talking about the zinc concentrates that we are purchasing?

Correct.

Yes. We did have some delays this year, but I think now that’s been finalized. Actually we are going to meet full commitments in 2012, and in fact I think inventory in Flin Flon right now is around 25,000 to 27,000 tonnes. So, [indiscernible] mine is going to see some good production performance over the last half of 2012, and we will probably run some of that inventory into 2013 also.

Okay. But that delay as stated in the release, was it related to the shutdown or just getting the contracts signed?

It’s been the supply from the contracts, yes. There was no delay due to the shutdown.

Okay. And then on Constancia, I know we talked about this on the conference call last week. But what is the status of the power tariff agreement and potential on timing on sorting that out? And then also, I haven’t heard any commentary yet on plans to secure off takes?

Well, why don’t we let Cashel handle the power agreements. Cash?

Yes. Sure. Tom, we went out to tender and we are evaluating the bids that came back. We are happy to say there were several competitive bids that came back that were within our expectations. We believe within the next month, we will close the PPA agreement for the project.

And -- it’s David. Tom, with respect to concentrate off take for Constancia, we have had a number of discussions with smelters and have seen a very strong interest from smelters in the off take from Constancia, we are continuing to work through that and sort of trying to ensure that we leverage the opportunities associated with the smelter interest in that off take.

Is there a timing as to when you would like to have an agreement in place?

For the off take, it’s obviously not something that’s urgent, as to say, we believe that the material that’s going to be coming out of Constancia is high-quality material with relatively low impurities. And so we don’t see urgency to putting that in place that I would think that sort of by mid to late 2013, we want to have that sorted out.

Your next question comes from Alex Terentiew with Raymond James.

Couple of questions. One, just following on Tom’s question there on the off take, so, am I just correct in understanding that with your $600 million credit facility that you are looking to get -- the syndicate of banks there, you don’t expect there to be any requirement to get an off take first before you go down that route?

No. That’s correct. The financing that we are doing is really more of a corporate loan transaction with the banking syndicate that is not related to off take. We had discussed previously some of the work that we had done on the project financing front, which had been related to off take. That option remains open to us, but for the time being, we think that the corporate loan is better fit for the project’s overall financing requirements, so we may come back to project financing as an option for longer-term debt financing of the project once we are closer to completion.

Okay. Great. Second question, copper, gold sales this quarter were all above production during the quarter. Did you have any concentrate inventories remaining to sell or should we expect sales to more closely reflect production going forward?

We’d expect sales to be pretty consistent with the production going forward. I mean, given that we are moving concentrate in 10,000-tonne lots. It can be a little bit lumpy from quarter-to-quarter, but we didn’t have significant amount of excess inventory at the end of the quarter.

Okay. Last question is on taxes. There seems to be a lot of moving parts in that area. Can you give us some guidance on what sort of tax rate we should expect for the next -- or for basically the rest of this year?

Sure. On a run rate basis, when we don’t have some of these unusual deferred tax items floating around, which under IFRS seems to be increasingly common, but on a normalized basis, our marginal tax rate on our Manitoba producing operations is just around 40% combined income in mining tax. But our effective tax rate in what I describe is a normal quarter. We’ll tend to be up closer to the 50, maybe sort of the low 50% range just because of some foreign expenses where we don’t recognize deferred tax recovery on those expenses, and also, the fact that some of our expenses, for example, corporate expenses, are not deductible for Manitoba mining tax purposes. So the short answer to a short question, I’d say that in a normal quarter, we’d expect to see effective tax rates in the -- probably in the low 50% range as we go forward. But it is going to bounce around from quarter-to-quarter depending on the composition of our income.

Your next question comes from Greg Barnes with TD Securities.

David Bryson, I guess, how are you going to account for Lalor between now and the shaft coming into full production 2015?

Yes. Good question, Greg. We’re still working through that as we start to initiate production. What we have not yet determined is whether or not the initial workings for Lalor are going to be sort of their own mine for initial production and commercial production purposes or whether or not sort of all of the Lalor assets will be treated as sort of one mine, which would push commercial production out into late 2014, early 2015. We haven’t resolved that yet and are still working through the analysis on that.

And just, I might add Greg, the $704 million budget that we have for Lalor did not include any pre-commercial production revenue, that was a gross number.

Yes. Right. Okay. So, for us the next year is still a question mark, whether we include Lalor in earnings or not?

Yes. I think by the time we get to the next quarter. I expect we’re going to have a decision made on that, but we just -- as we’re sort of working through the ramp up process, we are getting information that will help us to be able to make that decision.

Okay. Just a second question, David. On the Precious Metals stream, I think there is a fair amount of confusion about how we account for that in terms of deferred revenue and taxes. Do you want to try and explain that?

So the accounting for the stream transaction in our profit and loss statement, we will set up the upfront deposit payments as deferred revenue on the right hand side of the balance sheet. And then we will amortize that into revenues over the life of mine. And so essentially we’ll take payable gold and silver that we expect to deliver to Silver Wheaton and then determine an average sort of deferred revenue amount per ounce of each metal. So at this point, we expect that deferred revenue for 777 that we’ll be recognizing -- will be between $800 and $900 per ounce and the silver to be between $10 -- or $15 and $20 per ounce. So to take gold as an example. When we sell an ounce of gold to Silver Wheaton, we will receive $400 in cash that would be booked as revenue and then an additional $800 to $900 of non-cash revenue to amortize down the deferred revenue. So that’s what will happen on the revenue line of our P&L. From a tax perspective in Canada, the -- while we are amortizing the deposit for contractual purposes, which will be shorter than amortization of the deferred revenue for accounting purposes, we’d expect to fully amortize the deferred revenue in 4, 5 years. I am sorry, expect to amortize the deposit in 4, 5 years. Prior to that point in time, we will pay tax for income tax and mining tax purposes based on the spot price of the metal, so $1,600 an ounce at the moment. Once we’ve amortized the deposit contractually, then we will only pay tax at the fixed cash price, $400 an ounce that we will receive. In Peru, because of the different tax regimes, the tax that we’ll pay in Peru is based on spot price throughout the Constancia mine life, and we won’t see that drop-off to the $590 an ounce silver that we will see upon repayment of the deposit in Canada.

Okay. Yes. Effectively on the taxes though, what will be recognized as revenue for 777, for example, will be the $400 cash plus $800 to $900 deferred, so the differential and taxes will be only on that $1,200 to $1,600 price really?

Yes. We’ll have additional taxes owing with respect to the $1,600, even though for P&L purposes, we’ll be recognizing $1,200 to $1,300 an ounce of revenue.

In the early years.

In the early years.

Yes, the confusion stems from the fact, Greg, that the amortization for accounting purposes and the amortization of loan contractually are 2 different periods.

Yes. I know. I understand that. Are you going to breakout for us then going forward what is deferred revenue, what is real revenue, I guess?

I expect -- we’re going to be working through the disclosure of that and sort of looking at how some of our peers that have active streams that go through that. But, yes, I expect that we’ll provide enough disclosure to allow people to understand what the deferred revenue amount is that we’re recognizing in earnings.

Your next question comes from Matt Murphy with UBS Securities.

Can you talk about what is happening with the Snow Lake circuit for Lalor?

Matt, right now, we’ve got authorized, I think, $3 million for the copper circuit at the Snow Lake concentrator. It looks like we are going to come in slightly less than that. So the week of September 6, we are going to commission coppers in circuit in the Snow Lake concentrator that will enable us to process Lalor’s ore for the next 2.5 years and some copper ore we’ve got stockpiled there from Chisel.

Okay. So its -- sorry, just to be clear the initial ore from Lalor is zinc ore, but you are running it through the copper circuit or am I getting that right?

Total order from Lalor 2012 ore [ph] is from the base metal end stand [ph], and it’s dominantly zinc, it does contain some copper, some gold and silver credit, so we will recover some of that material over the next -- at the end of this year and in 2013. But during the time, before the new concentrator is built, we will be into lenses where we do have higher copper base metal and also higher gold and silver.

Okay. And do you have any idea what the operating costs are going to be at Snow Lake would the revamp done?

The operating cost in the Snow Lake again are in the NDNA [ph]. So you can see those. What’s going to happen though, Matt, is we are going to increase production days. Right now the concentrator basically runs at 50% when we start up in September, we’re going to go to a 5-day week and by the end of the year, expecting in December, we’re going to go to 7 days, 24 hours a day. So we’ll certainly maximize concentrator at that point in time. So my guess is around $20. We’ve probably -- again I’m just giving you a guess, I’m not sure exactly what that number is but it will certainly come down from what it is.

Yes. Okay. Thanks. And then, just wondering on the new mine status at Lalor. Does that fully put to bed any idea of possibly driving ore up the Chisel ramp?

While right now, again the vent shaft has the capability to hoist 1,500 tonnes and should more than handle us. It might just upgrade nicely what the Snow Lake concentrator can handle. So if we were to take ore up the ramp, we would wound up stock piling it. And so I think the matchup between the vent hoist and what the concentrator can take till the new one is built suits us quite well.

And we do have so the capability of bringing waste up the ramp. It doesn’t prevent us, the new mine status doesn’t prevent us from using it for waste development.

The next question comes from Patrick Morton with RBC.

Can you just remind me a bit about the concentrate transport plans at Constancia?

Cashel?

Yes. The EIA contemplated in permits to us to truck concentrate. So in 30 or 40 tonne increments, we’ll be trucking concentrate from Constancia to the Port of Matarani. In the future, there is opportunity and option to load at the rail-head in Imata, which would reduce the trucks, obviously on the road, but right now our intention is to start up and to truck from Constancia to the Port of Matarani. So the whole 475 kilometers.

Okay. Great. And any update on progress with the debt facilities, $600 million?

Yes. We’re continuing to work through that and having good progress, so sort of no fixed timeline at this point for closing, but I think we see the process is still well on track.

The next question comes from Steve Bonnyman with BMO Capital Markets.

A question on Lalor, you’ve now got these run [ph] rates hoisting in place for 1,500 tonnes a day. What percentage of that will really be ore, and how much of it will be hauling development work? Can you give us some guidance on what real ore feed from Lalor we can look at prior to the production shaft being commercialized?

It’s Brad, Steve. Really the plan this year was to hoist roughly 90,000 tonnes of ore. The rest of that hoisting time again would be taken up by development waste. We start to increase in 2013 up to 2014. So the idea is to maximize the Snow Lake concentrator, roughly 1,500 tonnes a day. So as David mentioned earlier, we certainly got capacity to truck waste up. So it’s going to be a combination of development ore, as you mentioned and chance that we have some longhole stoping starting in 2013.

So you figure about 90,000 tonnes, you said this year?

Correct.

And for 2013, order of magnitude?

1,200 tonnes a day on average, I would say for the year.

[Operator Instructions] Our next question is a follow-up from Patrick Morton with RBC.

Just any update on plans for the gold plant at Lalor?

We haven’t done a metallurgical testing recently. Again focus has been to get the work done that’s planned right now, Patrick, but some of the definition drilling that we’ve been completing against some [indiscernible] underground axis, we’ve crunched [ph] closer to the ore body is giving us some positive results and again we’re waiting to get again that underground drill based just to quantify the gold, how minable, how much is there so. I think that’s still a potential good news topic to come for the future but that’s really where we’re at right now, need little more underground information.

We certainly accommodated that possibility in the year [ph], the footprint design for the concentrator, but it’s not critical path. We’re looking probably at the earliest really acquiring [ph] that plant by about 2016. So we do have the luxury of some time to complete some more met testing and make a commitment. But it’s clearly as we get deeper and precious metal content increases measurably at the gold plant, it will make some sense at some point.

The next question comes from Oscar Cabrera with Bank of America.

Just 2 quick questions on your release, you talk about perhaps higher grade at 777. I was just wondering if you maintained your guidance and so what can we expect for the second half of 2012 for the mine, please?

This is Brad, Oscar. Again, I would suggest that we would stay at guidance at 777. At times, you may run higher quarters in coppers and purchase metals, but on the year, I would think we would maintain our guidance at 777.

Okay. And then second question, you mentioned you had strong or you’ve had strong interest from smelters in terms of off take agreements. In your decision to do a precious metal stream, did you ever consider doing like an off take agreement with a smelter as opposed to a precious metal stream?

We have looked at sort of various financing options for Constancia related to off take, Oscar, and those options remain available to us. And we’ll continue to explore them but we see those as optimization opportunities relative to the stream and the $600 million credit facility that we disclosed last week.

That does conclude our question-and-answer period. I’ll now hand the call back over to David Garofalo for closing comments.

Well, thank you for your attention, and I hope you enjoy the rest of your summer. Of course, we remain available, if you have any follow-up questions one-on-one. Thank you.

Ladies and gentlemen, that does conclude our conference call for today. Thank you for your participation. You may now disconnect your lines.