Hudbay Minerals Inc. (HBM) Q2 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Welcome to the Hudbay's Q2 2015 conference call. At this time, all participants are in a listen only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded today, July 30th, 2015. It is now my pleasure to introduce your host, Ms. Jackie Allison, Director, Investor Relations. Please go ahead.

Thank you, operator. Good morning, and welcome to Hudbay's 2015 second quarter results conference call. Hudbay's financial results were issued yesterday, and are available on our Web site 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. Accompanying David for the Q&A portion of the call will be: David Bryson, our Senior Vice President and Chief Financial Officer; Alan Hair, our Senior Vice President and Chief Operating Officer; Brad Lantz, our Vice President, Business Development and Technical Services; Cashel Meagher of the South America Business Unit; Rob Winton, our Vice President of the Manitoba Business Unit; and Pat Merrin, our Vice President of the Arizona Business Unit. 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 Web site. And now I'll pass the call over to David Garofalo. Dave?

Thanks, Jackie. Good morning, everyone. In the second quarter, with the achievement of commercial production at Constancia at the end of April, and steady performance at our Manitoba operations, we saw production of all of our metals increase substantially when compared to 2014. In particular, copper production increased 270%, which together with increased byproduct production and lower input costs, saw our cash cost decline by 37% to $1.29 per pound of copper. While our operating cash flow improved by 76% when compared to the second quarter of 2014, it would have been multiples higher if we had sold all the metal we produced in the quarter. We ended the second quarter with unsold production of approximately 19,200 tons of copper, 30,300 ounces of gold, and 579,300 ounces of silver. In the second half of 2015, with the benefit of full production, and already improving metallurgical recoveries at Constancia and decreasing input costs, we expect to maintain our company's 2015 production and mine site operating cost guidance. This should also lead to further improvements in cash cost per pound of copper produced. These continued increases in metal production, together with improving transportation logistics in Peru and Manitoba, are expected to drive up revenues and operating cash flow substantially in the second half of the year. At current copper prices, we also expect to be modestly free cash flow positive over the second half of 2015, with improving results in 2016 as we achieve full production at Constancia. At June 30th our total pro forma available and committed liquidity was approximately $437 million, including $143 million in cash, in cash equivalents and $294 million available under our credit facilities. This incorporates the additional $100 million committed by the lenders under our corporate revolving credit facility. We expect to complete documentation related to this expansion of our credit line in the third quarter. In the second half of 2015, we also expect to realize over $100 million in cash flow from the sale of our excess metals inventory and value added tax refunds from the Peruvian government. At Constancia mining operations are progressing as planned and cost optimization is underway. Plant performance was a primary focus during the second quarter in response to normal ramp up challenges related to ore blending and recoveries. Better coordination amongst the various operating teams has resulted in progress, and recoveries are now in line with our expectations. Daily ore throughput continues to meet ramp up milestones. So far in July, daily ore throughput has averaged approximately 80,000 tons, and copper recoveries have averaged approximately 75%. Cost performance has also been good with combined unit operating costs since the beginning of May up $9.22, which compares to 2015 guidance range at $10.90 per ton. Commissioning of the moly flotation circuit started late in the second quarter and ramp of production is planned during the third quarter. Turning now to our Manitoba operations. Ore processed in the second quarter of 2015 was 3% higher year-over-year due mainly to an increase in production at Lalor, offset partly by the decrease at 777 mine. Compared to the second quarter of 2014, zinc and gold grades were higher, and copper and silver grades were lower, due to normal mine sequencing. Combined Manitoba unit operating costs increased by 25% year-over-year due to the higher proportion of overall production coming from Snow Lake, which is high unit cost, and lower production at the 777 mine. The collective agreements with each of the seven labor units representing employees in our Manitoba business unit expired on December 31, 2014. We have signed new three-year agreements with six of our seven unions, but our mechanics have been on strike since May 2nd. Operations are continuing under a comprehensive contingency plan during the strike. Last quarter we released assay results for the first seven drill holes of our 14-hole phase one copper-gold zone drill program at Lalor. The assay results from the remaining 7 drill holes continue to confirm a high grade thick core down the middle of the main zone, with decreasing grade and thicknesses towards the contacts, as well as separate hanging wall and foot wall mineralization. The phase two exploration ramp extension to the north is progressing well, and is expected to be completed by the end of August. This will allow the 8,500 meter drill program to start in September. To view the remaining drill results, please refer to the appendix in this Q2 conference call presentation or to our second quarter 2015 news release which has a link to the Lalor plan view and vertical composite section. Having achieved commercial production at Constancia, our focus is to optimize production and cost performance at all our operations and to continue realizing returns from the investment in our four producing mines. We expect to generate free cash from our business in the second half of this year, even at current metal prices. By proceeding with the phase two exploration drilling program in the copper-gold zone at Lalor, which is expected to start in September, we will generate additional information to support our comprehensive mining and processing plant for Snow Lake. We should see increased production from Lalor in the next two to three years. At our Rosemont project, we will continue our permitting efforts in advance to technical work required to take the project forward. We believe that Rosemont will provide an attractive opportunity to compound the returns from our four existing mines. With that, operator, we'd be pleased to take questions.

Thank you. [Operator Instructions] We'll pause for just a moment to allow everyone the opportunity to signal for questions. Our first question comes from Brett Levy of CRT Capital. Please go ahead. Mr. Levy, please go ahead. Please go ahead, your line is now open.

It's Brett Levy. Can you guys talk about like any outlook for curtailments in any copper production globally that you guys are seeing that would sort of offset the current pricing environment?

Well our view is actually the market is pretty much in balance and we think that the pricing in copper right now is out of equilibrium. We think that the equilibrium price for copper in a balanced market should be somewhere in the $2.60 to $2.80 range, and we already are starting to see some evidence of copper production curtailment. Freeport made some announcements earlier this week about curtailing production, and I think that might be the leading edge of the wave of seniors curtailing production, particularly if copper prices stay at these levels because it is biting into some of the higher marginal cost production in the high end of the curve.

And in terms of like your own plans, is there anything that you would do to curtail at Constancia in any way sort of beyond the unexpected delays, or, you know. I don't know, I'm just -- I'm looking for signs that you could ever see like above $3 copper anytime soon.

Our view is $3 copper price is probably a couple of years away. We think the market is going to be broadly imbalanced for the next couple of years. And we think copper prices, quite frankly, may be range bound in that environment. And again, we think the equilibrium price for copper is probably somewhere around $2.60 to $2.80 in that type of environment. In terms of our own business, we continue to ramp up production. As you saw this quarter, we saw a significant decrease in our unit cost, so our margins are actually intact, even in a more depressed copper price environment due to declining input costs, weaker Canadian dollar, weaker probings proven solely, but the economies of scale that comes from ramping up our production volumes as well.

And then is 1.25 the sort of all-in C3 cash cost that you guys are still seeing at Constancia?

We expect Constancia's cash cost over the balance of the year will be broadly in line with what you saw in the second quarter, if not lower.

But to be clear, the cash cost target there was more comparable to sort of more of a C1 style. It's not exactly the same just given the need to reconcile to the financial statements, but C3 would include some other components relative to what was in there. It's more comparable I think to how some of our peers disclose.

Thank you. The next question comes from David Charles, Dundee. Please go ahead.

Yeah, I suppose I have two questions. Could you give us an update on the logistical issues that you had down at Constancia with the trucking and when you think you will solve these issues if they haven't been resolved to some extent already? And I just want to understand the logic behind highlighting the fact that if there were significantly lower copper price or unexpected demands on capital spending, you may need to raise more financing. I suppose what exactly is unexpected demands for capital in a sense that you might be looking at?

David, it’s Alan here. I’ll answer the Constancia [con] transport logistics. There are a number of issues at play here. Obviously we had a very good ramp up at the plant, so for just a lot of concentrate very quickly. And this initially wasn’t matched by haulage contract as we had to address some performance issues there. But the situation was obviously compounded. I think it was widely publicized the situation in Tia Maria and number of road and port blockades that slowed things down to begin with there, and obviously impacted our ability to get materials to the port. Another factor at play is there is currently -- this is good news in the long-term, major road upgrades underway on the stretch of road between Espinar and the [Matarani] Condorama. Unfortunately they’ve slipped quite severely schedule wise and they’re causing actual road blockages to do the road repairs for a big chunk of the day. So what that meant is it increased our overall transport cycle times. Rather than a cycle time of two days to the port, we now have to -- or we’re now budgeting on three days. So we do have a full recovery plan in place in terms of just increasing the number of trucks to take into account these situations. And we’ve built in considerable contingency because Peru is Peru and even in the last couple of days, and completely unrelated to anything to with Hudbay at Tia Maria, there is some road blockades on the road to Matarani associated with the [Mayas Sequis] dam proposal. So we think that we’ve now built in adequate contingency in terms of the number of trucks that we’ve got available that we’re confident that we’ll have the inventory drawn down before yearend.

And with respect to your other question, David, it’s David Bryson. I think you’re referring to a passage in the liquidity discussion in our MD&A. And not that I’d want to suggest that any of our disclosure is boilerplate, but I think you’d find that that reference has been in there each quarter probably for a couple of years now. And it’s just an acknowledgement that in sort of dramatically lower copper prices than where we are today, we have to adjust our plans. But I think, as we said, we feel that our current liquidity situation is adequate to meet most plausible copper price environments, assuming the business performs as we expect it to.

And maybe, just so I understand as well, as far as the shipments of material from Constancia, going back to the first question, do you think that you might be able to get those shipments done by the end of the third quarter or do you think it’s really only feasible to get it done by the end of the fourth quarter?

Given that we’re talking about pulling back down some 40,000 tonnes of inventory on site, David, and to have a reasonable plan for doing that, we’re forecasting by the end of the fourth quarter.

Thank you. The next question comes from Stefan Ioannou of Haywood Securities. Please go ahead.

Sure, Great to see the ramp up at Constancia going so well. Maybe just further on Dave’s question there, on the last bit on just the inventory buildup. Out of the 73,000 tonnes of unsold copper con, how much of that is at Constancia versus Manitoba related?

I’d say sort of about, you know kind of 2/3 to 3/4 of that would relate to Peru, Stefan.

And then just maybe just switching over to the exploration, some really numbers there in Lalor deep. You know, I mean you could just provide maybe a little more color going forward on what the sort of longer term plan is there? And also, is there similar activity going on at depth at 777 right now or is it more focused on Lalor depth?

I think we’ll throw that one over to Brad.

It’s Brad, Stefan. Really the results at Lalor just really confirmed what we’d seen from our surface drilling, which obviously, as you can see, the results are really high grade. So we’re just in the final throws of completing the exploration ramp, so it’s going to be finished at the end of August. And then we have an 8,500 meter drill program going on that will happen between September and December of this year, which would incorporate 17 holes with two drills. So really our focus is let’s look down plunge. Our surface drilling had given us indications that there is something down plunge, so this program will help just confirm and define that a little better. So, very encouraging results though at Lalor. At 777, we have been drilling the WarBaby and obviously the results are just have not been as encouraging. We just recently completed two holes. They are currently being logged. We will do some bore hole pulsing, and again current plan is to do a couple more holes, but really results to date at 777 have not been that encouraging.

I’d just add to that, I mean we've obviously been drilling in other areas in 777, not just WarBaby. I mean, as Brad indicated, I mean it very much looks as if 777 is now approaching the end of its life in terms of ability to extend the reserves any further.

Thank you. The next question comes from Ian Parkinson of GMP Securities. Please go ahead.

I hate to harp on this logistic stuff, but one more question. What price protection mechanisms are in place right now for this large inventory, if there are any at all?

We don't have any in place in terms of active hedging of the position. I think given where copper prices are at, I think our own view is that there's probably a bias towards higher prices, just given how much the market feels like it's sort of capitulating. So, you know, we continue to monitor that in our provisional pricing exposure, but we don't have any substantive hedging right now.

And I mean, David, do you expect that to continue if it does take say another six months to draw down this inventory? Do you expect it just to be exposed to the market forces as they be?

That's our current plan.

And any changes Manitoba wise as far as rail availability, unit availability? Has it picked up in recent weeks?

Well as you've seen, the Manitoba copper sales again lagged production a little bit. It wasn't as significant in previous quarters. We're expecting the delivery of substantial new fleet of released railcars over the next couple of months. It's taken some time to actually get delivery of those cars to the specifications that we require, but we're starting to see them arrive. And so that gives us the confidence that we should be able to get that excess Manitoba inventory drawn down before the end of the year as well.

So just from a modeling basis then, but the revenues should be sort of more skewed towards Q4 versus Q3 at this point?

Probably.

The next question comes from Matthew Fields, Bank of America. Please go ahead.

Just looking ahead at your capital structure, your revolver has that 3X maintenance covenant I believe once Constancia has had four quarters of commercial production. Given the low price environment, and sort of you know prudence as necessary it seems, how would you think about redoing that or sort of holistically redoing the capital structure?

Matthew, I think our view is that by the time that kicks in we should be okay with respect to the trailing run rate on consolidated EBITDAs Constancia ramps up even at current prices. So, you know, we're not overly concerned about that. I think from a more sort of macro perspective, you know, sort of looking at the capital structure, what we might do with the existing bonds, is going to partly be a function of how things progress with Rosemont, and you know sort of the timing of sort of any decision to proceed there and the manner of financing that. So a little early to say at this point, but certainly we wouldn't be looking to do anything in 2015.

And then just sort of a follow-up on that. Is a delay in Rosemont permitting you know sort of mean that you're more likely to address the bonds early, or sort of more likely to keep them in place from your point of view?

I think it's going to depend on the market conditions. You know, as you know, the first call is October of 2016, but that's at 1.04 and change. So, we're going to continue to monitor opportunities, but we certainly don't feel pressure to do anything with the bonds from a sort of a run rate basis. We think that you know sort of we can comfortably work within the existing indenture.

And then switching gears a little bit. Can you just talk a little bit about the New Britannia mill refurbishment and paced back fall costs and the timing of that?

I think we had indicated previously, we've currently got a comprehensive set of studies going on to address the incorporation of New Britannia into the overall Snow Lake picture. There's quite a few moving parts and we want to make sure we get them all connecting properly. So we're looking to have some insight to those numbers by the first quarter of next year.

The next question comes from Alex Terentiew of Raymond James. Please go ahead.

I apologize, I joined the call a bit late, so I may have missed something here, but a few questions. The first is costs in Manitoba came in at 89 bucks a tonne, you know a little bit higher than guidance and obviously about what you had in Q1. Are these higher costs related to the machinist union strike or should we expect to see costs come down in the rest of the year?

I think the point worth bearing in mind there, the guidance is based over the whole year, and we've got Lalor still progressively ramping up quarter-on-quarter. So that's likely the most significant issue in play. We still expect to be within guidance for the year.

Second question, copper recoveries at Constancia, you know, it was 75% in June so making progress there. You still have good confidence, I believe you said on the last conference call, the target was to get to the upper 80s by the end of this year. Is that still a plan?

Yes, that's still the plan.

And the last one just on Rosemont. There's been, in the press, a bit more lately of protest against Resolution. That's obviously not your project, but Resolution copper seems to be picking up. Are you seeing any increased activity around Rosemont or more of the just normal activities that the project has faced over the past few years?

I think we'll let Pat answer that one.

Good morning, Alex. I think we're seeing the same level of activity we have seen in the past. I think most people see the projects as quite separate, so I think things for us are business as usual.

Thank you. The next question comes from Oscar Cabrera of Bank of America Merrill Lynch. Please go ahead.

Apologies too, I joined the conference late. Wondering if you had already commented on the logistics issues. I'm pretty sure you have. But I was more interested in hearing color around the blockades that you referred to that were unrelated to Constancia.

Sorry, Oscar. I mean the blockades we referred to were not associated with Constancia directly. The issues when there was a lot of activity, a lot protest against the Tia Maria project. And more recently there's been a couple of incidents in the last few days, again not related to Hudbay in any way, and not related to mining, around an irrigation dam project.

Great. No, that clarifies that. And just, given the weaker copper environment, I'd just like to -- and you know, the fact that you increased your lines of credit, could you offer some context or color around whether you're thinking on the deployment of capital around the Lalor as well as potential startup of construction in Rosemont much later in 2016 and 2017.

Sorry, Oscar. Do you mean in terms of return on capital criteria and things like that?

Exactly. And more so than timing, Dave, just around yeah, returns on capital, has that changed your perspective on that?

No, no I mean we're still targeting internal rates of return at the project level unlevered of around 15% after tax. We're still using $3 long-term copper to make our investment decisions, whether they're internal or external opportunities. And I think, you know, the ability to move forward on Rosemont has more to do with making that investment case and obviously the permitting than anything else.

Right, that's exactly what I was after, Dave.

Thank you. The next question comes from Ralph Profiti of Credit Suisse. Please go ahead.

Thanks for taking my question and apologies for joining the call late. But with respect to these logistical issues in Peru at Constancia, I do see that Las Bambas signed a transportation agreement, which is sort of a combination road and rail. And then you have Hudbay, mitigating the risk by increasing the size of the truck fleet. Can you remind me where we are with respect to Hudbay's own study on you know sort of that bimodal transportation, and if moving to a deal such as what's going on at Las Bambas, would mitigate some of these risks even better?

I think it would be fair to say that ultimately we would like to consider something like that. But because of the uncertainty around the timelines associated with that and the Las Bambas project, we felt it more prudent to do our own thing for the time being until we see exactly how things are going to shake down. Perhaps a higher priority for us right now is to get the, I suppose it's the administrative issues solved so we can actually share the Las Bambas road. It's a more preferable route and it's just a few -- a bit of bureaucracy that we have to outcome. So that would be our first priority, and then obviously we'd be looking to see where things land with the bimodal option further down the road.

Thank you. The next question comes from Orest Wowkodaw of Scotia Bank. Please go ahead.

David, just curious, with Constancia now appearing to be over the hump in terms of a very smooth ramp up to date, and with Rosemont still sort of tied up in permitting, do you see any chance of an opportunity to add another asset or assets into the portfolio that might actually bridge Constancia and Rosemont?

I would say the herd’s pretty thin in that regard. There are not a lot of operating assets available, in our view that would enhance the quality of our portfolio. We continue to look. On the development side, everything else that we’ve looked at, in the jurisdictions we’re focused on, tend to be more long dated in nature. And so there is really no urgency to own them. We’re better off, as we’ve said in the past, building relationships with juniors and funding their exploration programs, allowing them to de-risk the assets within their existing vehicle. So we continue to look for opportunities like that. So I don’t see a lot of opportunity out there that would improve the quality of our portfolio, or even match the quality of what we’ve built over the last five years.

And let’s assume, Rosemont continues in permitting for a bit. Do you see any opportunity maybe to restore some of the dividend?

I would say ahead of a decision on Rosemont, any dividends we’d contemplate would be nominal. I think our focus more would be on deleveraging the balance sheet, through shrinking our net debt and putting us in an excellent position to finance Rosemont internally from cash flow in our existing resources. But, over time, as Rosemont achieves completion, our scope to increase the dividend dramatically is there, for sure. And it is still a focus of our capital structure.

Thank you. [Operator Instructions] The next question comes from Greg Barnes, TD Securities. Please go ahead.

Alan, the recoveries at Constancia, I know you say the tracking the feasibility study, it does feel like it’s lagging a bit. What have you done to get to 75% and what do you need to do to get to the higher recoveries that you talk in the feasibility study?

I think it’s likely better that I throw that one over to Cashel there, Greg.

Okay.

Sure. Hello, Greg. Cashel here. Certainly early on it was just the physical nature of the plant and getting familiar with the ore and the operators and getting the team coordinated. Then it was working through to get from that level to the next level where we’re at in the high 70s, low 80s we’re sort of tracking in the past half of this month. It was working out sort of the proper ore blend, recognizing we’re into a transition state with some oxide intermixed in the supergene. And so it’s about getting those blends properly coordinated and getting proper managerial coordination with the mine and the mill. Going forward, the next part of the optimization process to get us up to the high 80, between 85 and 89 recovery as stated in the feasibility study, we’ll be working on more refinement of the blending of the ores and segregation of the ores. And then we will -- we have also got programs where we’re encouraged with different types of reagents and different sort of working more individually with the flotation cells themselves. So that’s sort of the process we’re going. From what I understand, that’s a normal process. Learning the ore, learning the ore body, and the sequencing as such. With these types of ore bodies, obviously the start of the mining through the supergene, when you have a little bit of oxide it’s more complicated versus the life of mine plan which will be sustained mostly with the hypogene and that’s what the testing of course showed very good results there. But this learning stage we’ve been going through. So we’re working on the next stage, which brings us up into the mid to high 80s, which is the design. And we feel we’re tracking well against our progress to be able to accomplish that this year.

So nothing in there, Cashel, that’s taking you by surprise that’s causing any particular problems and nothing that looks like it's going to prevent you from getting to the high 80s?

I think what it was is -- yes, I think basically what we thought was, is we were tracking extremely well early on and we thought we were going to get some gains in our contingency we built into the ramp up. But because of just normal idiosyncrasies of this ore body, it ate up some of that contingency. So we’re tracking where we said we were going to, but we were hoping to knock it out of the park, but we’re still doing okay. So, nothing majorly -- no major issues, and so this next part of the optimization process is designed to get us up to the next stage.

Thank you. There are no further questions. I’d like to turn the call back to David Garofalo.

I appropriate everybody has a very crowded calendar this morning. I saw a number of people that had to leap off other calls to join ours, and I really appreciate the effort. But if there is any aspect of this that you missed, please feel free to call any of us, Jackie, David, Alan, myself, if you have any follow-up questions. We’ll be available to you over the course of the day. Anyways, have a good week.

Ladies and gentlemen, this does conclude the conference call for today. You may now disconnect your line and have a great day.