Hudbay Minerals Inc. (HBM) Q1 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the HudBay Minerals First Quarter 2012 Results Conference Call. At this time, all lines are in a listen-only-mode. Later, we will conduct a question-and-answer session and instructions will be provided. [Operator instructions] I would like to remind everyone this conference is being recorded today Thursday, May 10, 2012 at 10:00 a.m. Eastern Time. And I would now like to turn the conference over to Mr. John Vincic, VP Investor Relations and Corporate Communications. Please go ahead, sir.

Thank you, operator. Good morning and welcome to HudBay’s 2012 first 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 Tom Goodman, Senior Vice President and Chief Operating Officer; David Bryson, our Senior Vice President and Chief Financial Officer; Alan Hair, our Senior Vice President, Business Development and Technical Services; Cashel Meagher, our VP for South America 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 at EDGAR. These documents are also available on our website. And lastly, please be reminded that currency amounts discussed on today’s call are all in Canadian dollars unless we indicate otherwise. And now, I would like to pass the call over to David Garofalo. Dave?

Thanks, John. Good morning everyone. We began 2012 exactly where we left off last year with another solid quarter of operating results in the first quarter. And we remain on track to meet our full year 2012 guidance. This would represent the sixth consecutive year that our experienced operating team has met its targets. Earnings per share in the quarter $0.05 which included a total of $0.06 per share in non-cash items, which we did not view as part of our core operations. Our operating cash flow was $42.2 million which was a slight increase compared to the same period last year. 2012 also marks the beginning of a transformation for our company as we prepare to close 2 higher-cost mature operations and transition to low-cost, long-life Lalor and Constancia mines. And the smaller but potentially highly profitable re-mine. At Lalor, project construction development are advancing on track and on budget with first ore production on schedule for mid-2012, and anticipate full production for late 2014. Basic engineering for the concentrator is well underway and the company has placed orders for the surface crusher and sag and ball mills. Front-end engineering and design work at Constancia is almost finished. We also recently announced its Initial resource of the higher grade Pampacancha deposit, which is expected to improve the economics of the Constancia project by adding higher grade mineralization into the mine plan early into the mine life. The anticipated project schedule currently remains unchanged with first production expected in 2015 and full production in 2016. At Reed, we completed site clearing and leveling for the trench, portal and lay down storage area and we set up a construction office trailer on site. Last month, we completed an entire site clearing and a new access road from Provincial Highway 39. Initial production by the third quarter of 2013 and full production by the first quarter of 2014 remains on schedule. From a financial perspective, Hudbay continued steady predictable performance. Our revenues increased to $187 million in the first quarter of 2012 compared to $177.3 million in 2011. The increase reflects higher sales volumes that contain Copper and Gold metal and copper concentrate compared to the same period in 2011. In 2011 we had an increase in concentrate inventory, whereas in 2012 our sales essentially matched production. Operating cash flow was $42.2 million or $0.25 per share in the first quarter of 2012 and $41.9 million, $0.27 per share in the same period in 2011. Offsetting the higher concentrate sales volumes, were lower realized prices compared to 2011, as well as $6 million in past service pension obligations associated with the settlement of our new 3-year collective bargaining agreement in Manitoba. Our capital expenditures increased to $78.5 million during the quarter because of higher capitalized expenditures of Lalor and Constancia, partly offset by reduced sustaining CapEx and the sale of Phoenix project in third quarter of 2011. We also had a $47 million increase in accounts receivable during the quarter due the timing of shipments and customer mix. We expect a large part of this increase to averse in the second quarter as all of these associated amounts were received in April. As a result, we ended the quarter with approximately $771 million in cash and cash equivalence. And including undrawn credit lines, we had $1 billion of available liquidity and no debt. One of the hallmarks of Hudbay is our strong operating culture and our team’s ability to work safely and efficiently while maintaining overall productivity. During the first quarter of 2012, we maintained our track record of achieving good cost control and exemplary safety performance at our operations. The Flin Flon concentrating costs decreased by 4% compared to the same period in 2011 largely due to increase through put. At the mine site, unit operating costs are typically higher during the first and fourth quarters due to seasonal heating requirements. Operating costs per ton of ore at the Triple 7 mine were 10% higher compared to the same period in 2011, primarily due to additional ground support requirements and timing of maintenance. Development and construction at our fully owned Lalor project is advancing well. We’ve invested approximately $245 million to date. An additional $98.5 million has been placed in fixed price orders. During the quarter, we completed development work on the 795, 810 and 825 meter levels, as well as the undercut and development for the ventilation shaft breakthrough. We are currently ramping to be at the 40 meter level and the base of main ventilation shaft. Lalor’s development and construction work is focused on initial production up to ventilation shaft which remains on track for mid-2012. The ventilation shaft is now sunk to approximately 700 meters and is expected to reach its ultimate depth of 840 meters by July 2012. Basic engineering for the concentrator is well underway and we’ve placed orders for the surface crusher and the sag and ball mills. Anticipated full production at Lalor remains on track for late 2014. We’ve also made good progress from our surface exploration drill program at Lalor where we discovered new mineralization occurrences away from the main deposit. We are continuing our underground drilling which we began in January to delineate the first ore production zone which has helped confirm the location of the ore body. This allows for the development of the detailed mine plan and sequencing. Overall results to date have been as expected in terms of the location, width and grades of the mineralization. We have laid down a multi-year underground drilling program for Lalor that we believe will add additional resources to this ore-large and growing deposit. We will update you as the results are compiled and collected. We have narrowly completed our front-end engineering design work at our Constancia project, which has brought about significant changes in the previous project design. The first of which is an annual ore production capacity increase of 15% to 28.2 million tons per year and the second is an expected increase in the in-pit reserve to incorporate additional economic mineralization. The increase in reserve along with plans to incorporate the higher grade Pampacancha Resource expected to be included into a new mine plan by the middle of this year. Dam construction and relocation activities have begun. And so have our value engineering initiatives with optimization efforts focused on areas such as camp accommodation, water management and tailings empowerment. We have placed fixed price orders for over $200 million in project expenditures including grinding mills and mobile equipment. During the first quarter of 2012, we invested $32 million in CapEx in Constancia project, at over total project CapEx of $1.5 billion. The anticipated project schedule currently remains unchanged with first production expected in 2015 and full production in 2016. By mid-2012, Hudbay expects to present its board of directors with a formal project recommendation including any financing plans. On the exploration front. Our focus at Constancia will be on expanding the Pampacancha Resource and explore and other targets through our planned 30,000 meter drill program. We have some promising targets that we identify through Geophysics work, which indicated a strong and large anomaly directed to the West of Pampacancha and drilling will resume in the second quarter of 2012. Drilling at the Chilloroya South prospect area will begin this month with another 2 drills. This area demonstrated some interesting intersections from previous explorations which concentrated on pore free copper targets, scar targets and terminal line pressure targets. At our Reed copper project, just 120 kilometers East of Flin Flon, Manitoba, site clearing and leveling for the trench, portal and lay down storage area was completed in mid-March, and the construction office trailer has been setup at site. Last month we completed entire site clearing and new access road from Provincial Highway 39. Initial production is expected by the third quarter of 2013 and is anticipate to ramp up to full production of approximately 1,300 tons per day by the first quarter of 2014. As we transition toward becoming a company with lower cost and longer-life assets, our focused for the balance of this year, as well as on the continued development of Lalor, Constancia and Reed, which is expected to provide a 255% increase in copper production, 135% increase in precious metal production and a 65% increase in Zinc production over the next 4 years. And as I mentioned early, we plan to incorporate the higher grade Pampacancha Resource with an expected increase at the in-pit reserve at Constancia into a new mine plant by the middle of this year which could add even more production growth. Our production and reserve growth will provide Hudbay investors with leverage to all of the key metals we produce on a per share basis. In the first quarter we announced an increase in our copper equivalent, proven and probable reserves, measured and indicated resources and inferred resources over the past year by 5%, 31% and 9% respectively. Our precious metal equivalent proven and probable reserves, measured and indicated resources and inferred resources increased over the past year to 3.5 million ounces, 1.6 million ounces and 3.6 million ounces respectively. Exploration success in the Flin Flon Greenstone Belt is our tried and true formula and we are actively exploring there as well, as at Constancia where we are capitalizing on exploration opportunities near the main pit. We are also making investments in Chile, in Columbia and continue to develop our firm systems of investments in junior miners in order to build our pipeline of early stage exploration opportunities. As at March 31, we have minority equity positions in 18 companies with a market value of approximately $100 million. This strategy has borne much success since its inception in July 2010 and we consider our portfolio one of the best firm systems in the mid cure space. Our track record of exploration development and operational expertise that we continue to demonstrate. Manitoba, well positions us to deliver per share value creation for shareholders as we expand our footprint across the Americas. And with that operator, I’d be pleased to take questions.

Thank you. Ladies and Gentlemen we will now conduct the question-and-answer session. [Operator instructions] One moment please for your first question. Your first question today comes from the line of David Charles of GMP Securities.

David this is a toffee question, but I just wanted to get some color from you. We’ve seen in the last little while issues with permitted projects in South America. Just the other day we saw El Morro which was basically suspended by the Chilean superior court if I’m not mistaken or Supreme Court. Can you give us some color as to what HudBay is doing in South America at Constancia to ensure that you won’t face any of the issues that either in Peru or that other companies are experiencing in Peru or Chile?

Let me start and I’m going to hand it over to Cashel because I’m sure he’ll have some critical input there. I think what’s very important for projects in Latin America, Peru in particular, is to have very strong relationships with the local communities and that - if you don’t have that, if you don’t have these select mining agreements in place, generally that creates a vacuum for external interests to get involved. We’ve been very successful since we acquired Constancia in that regard. We’ve signed life mine arrangements with 2 affected communities, providing them benefits, employment guarantees over the life of the mine and in doing so I think that helps guarantee peace for our project. Cashel, did you want to supplement that response at all?

Sure, David. There are 5 levels of governments in Peru. We’re active engaging all 5 levels of governments. We have what we call an institutional relations department. As David mentioned, we’ve just recently come to these 2 major agreements with the local communities and we are in discussions now with what they call the next ring or the donut around those with where you see us places like Conga and some of the other problems in Peru you get increasingly greater risk with the outside communities looking at the inner communities and seeing what they had. So we have relationships, good relationships with all these people and we just continue with large efforts in engaging them and that’s the process. The process is in Peru if you don’t know you’re going to have a problem you find out because they’ve stopped your operation or they’ve stopped your project. So we have quite an extensive department in both institutional relations and community relations to be able to engage those. And in those cases you gave the examples why the governments thought or sort of is reviewing the permits in those 2 examples is because we interpret that those companies didn’t have the necessary relationships with the communities nearby.

Excellent. Maybe if I could, just one other question. In this quarter you’ve made commitments on equipment at Constancia totaling about $230 million. I’m just wondering, you’ve seen one of your peers in Toronto recently come up with a CapEx number for their project and one of the things they did was a very significant amount of peer reviews. I’m just wondering, as you move forward with Constancia, do you have plans to go through a very detailed peer review process early on in the whole process so that you’re increasingly comfortable with the CapEx number that you have?

Let me hand it over to Alan here first and then again we’ll have Cashel supplement his response.

Hi, David, it’s Alan Hair here. I think it’s fair to say that we’ve actually gone through quite an extensive review process of the CapEx number to date already and that’s why we’re confident with the number that we published last month. And that’s also been validated through the offset financing process by the independent engineer as well as the parties that we employ to validate the numbers. I don’t know if Cashel wants to add anything.

No, that’s it. We absolutely like our peers we’re going through third party validation on the process. I think that’s standard for the industry now and I don’t think it’s anything novel.

And I maybe add, obviously STRACON who are responsible for design of the plant have built very similar plants and at both Phu Kham and Lumwana and are confident around the costing there and as I think you’re aware that was a lead partner the strategic alliance with STRACON GyM, a major Peruvian contractor and that’s where we get confidence in the other significant cost component which is the civil earthworks and pre-stripping and early mining stage because we’re using those numbers and have worked closely with them to develop the numbers. So I’d say that the numbers are all real and have been very much developed in the local environment.

The one thing I would add, David, is our contingency, effective contingency when you exclude the items we’ve already fixed the price on is about 14% on average, which is considerably higher than some of the other CapEx systems I’ve seen from some of our competitors. And it’s certainly not a blanket 14% where cost pressures are most acute. Our contingency is considerably higher than that average.

That’s excellent. I just wanted to get your up to date color on that so that I was completely up to date on your views.

Your next question today comes from the line of George Topping of Stifel Nicolaus.

Just following on that line of questioning with the high CapEx inflation on 7 power in 2015 and Peru and the politics as well, would you look at deferring Constancia to invest more in Canada?

Well, I think we have actually fairly rational growth profile here. None of our projects are best of farm projects. They’re not multiples of our market Cap. We have a very diversified development stage portfolio. So and I would add that the technical risk associated with our project is considerably lower than some of the other projects that are in the pipeline with some of our competitors as well. We have significant infrastructure advantages and these are out of the box type of projects from a technological standpoint. So I feel like we have a relatively low risk profile when you compare us to some of the other projects out there. So and then you have to add on top of that we’ve completed our feed work at Constancia. We procured over $200 million. We have considerable cost deal. We have very healthy contingencies as I said to David on the previous question. So I feel like we have a very robust project in Constancia we’ll be bringing forward to our board and making a recommendation on the middle of the year and we’re well capitalized. We have a very conservative dollar chain. I think the complaint about how they a 1.5 years, 2 years ago we weren’t spending the money fast enough. So the worm has turned here considerably to hear that kind of question. But it’s a fair question, George but I feel like we’ve got a very rational growth strategy going forward and we’re steadily executing against that.

[Operator instructions] Your next question today comes from the line of Pierre Vaillancourt of Macquarie.

I was wondering if you could just elaborate a little bit on your Lalor drilling program. Just what are some of the key objectives there as you make progress underground?

I’m going to hand it over to Brad.

Hi, Pierre. Well, 2 programs I guess. We have a surface program on the go right now, Pierre, where we’re drilling explorationals from surface on the copper gold zone that we discovered east of Lalor. So we’ve got one drill up there now and underground we have one drill doing some definition drilling and really the program was a 7,000 meter program which we’re about halfway through. So it was the delineator first order we’re going to mine the rich sink lens #10. We have turned around and drilled zone 21 and there’s multiple lenses when you drill actually through the footwall. So really again the program has just confirmed where the lenses were, so we can place our infrastructure development and really design and plan our first order that’s coming out this summer.

Okay. So you essentially think you’ve identified the zinc potential there at this point and it’s more confirmatory in regards to that?

Yes, absolutely.

Okay. And then so the copper gold drilling from surface, just remind me, when are you going to be doing that from underground?

It’s going to be several years off right now. Again the copper gold zone is down plunge and very, very far to the north. So the way the development program looks and what we schedule is it will probably be around late 2015 or so when we would have underground access, Pierre, to drill from there.

Your next question today comes from the line of Patrick Morton of RBC.

Two quick ones. I hope I didn’t miss this in the disclosure, but could you just give me the background on these inventory write downs and what’s the source and what that will be like going forward?

Hey, Patrick, it’s David Bryson. What happened there was similar to something we had in the third quarter as well with the cost allocation model that we’re using to allocate cost between copper and zinc and you see this in the core product cost disclosure that we provide with the softening in zinc prices at the end of the quarter. We wrote down some of the zinc metal inventory to a net realizable value. Essentially that’s a timing issue. It takes cost from the next quarter and pulls it into this quarter. And that’s the reason why we’ve sort of flagged it in our disclosure when it’s risen. But that’s all it is.

Great, thanks. And then the other one was regarding markets and the debt financing, markets are moving sideways and down right now. Does that change your discussions at all with the lenders? Has their views or concerns increased in any way?

I think that we’re really focused on debt financing and we think with the balance sheet and the cash flow generation that we have we’ve got ample capacity to take on debt to support the construction of Lalor and Constancia. So we’ve maintained very good dialogue with the agencies and I would say we’re actually fairly encouraged by the state of the debt capital markets and some of the other red transactions that we’re seeing right now.

Your next question today comes from the line of Gary Lampard of Canaccord Genuity.

My question was about the debt as well. Would you be able to update us as to your current thinking of how you’re going to go about that? Are you looking at anything in addition to some sort of a off take length financing? Some sort of a more regular debt beside that?

Hi, Gary. Yes, we are considering other alternatives. I think as we’ve said in the past we’re looking for about $500 million or so give or take of the off take length financing and we’re continuing to pursue that. We think that there’s a nice piece of financing to be done there. But we think that the balance sheet, the cash flow generation, certainly the cash flow that we would see coming from projects like Lalor and Constancia certainly supports more debt than that. And so we are considering alternatives but haven’t made any hard commitments at this point.

Okay. So looking at $500 million, that probably is enough but would you be interested in getting a cushion of a few hundred million dollars more than that just to cover yourself against potential commodity price weakness?

Yes. If the capital was there on attractive terms I think that we’d certainly consider pursuing that.

[Operator instructions] Mr. Garofalo, there are no further questions at this time. Please continue.

Well, thank you for your time and attention this morning and please feel free to call us if you have any other follow up questions.

Thank you. Ladies and gentlemen, this does conclude the conference call for today. We thank you for your participation and you may now disconnect your line.