Earnings Call: H2 2018

Mar 7, 2019

Good afternoon, ladies and gentlemen. Welcome to MMG Limited's 2018 annual results presentations. Hosting today's meeting is the company's Chief Executive Officer, Mr. Geoffrey Gao, and Mr. Ross Carroll, the Chief Financial Officer. In a moment, Mr. Gao is going to give us an overview of the company's performance, and then we will follow by a more detailed analysis on company's financial performance and figures by Ross. Jeffrey will come up again to give us and put us in perspective about the company's strategies and 2019 outlook. I will now hand over to Jeffrey. Thank you, Mr. Xiao. Good afternoon, and welcome to the 2018 annual results briefing. I trust many of you have read through our results materials. Today I will discuss the 2017 highlights, our outlook, our strategy going forward. Ross Carroll, our CFO, will also discuss the financial results in detail. We achieved a number of milestones in 2018, but first I will start with safety. Tragically, we had a fatality at our Sepon Mine in May. Despite reducing overall injuries, it was a reminder that we still need to place safety at the forefront of everything we do. Our financial performance was impacted by operational issues at Las Bambas, as well as lower copper and zinc prices in the second half. Despite lower profit, our cash generation was strong. We continued to reduce net debt by a further $733 million in 2018. We achieved commercial production at Dugald River, and I can proudly say we have developed a world top 10 zinc mine in Dugald River and a world top 10 copper mine in Las Bambas over the past three years. This has been complemented by non-core asset sales to ensure we have the right platform to deliver growth and value for our shareholders. Our performance has been recognized by equity markets with MMG's share price having outperformed our peers over the past one, two, and three years. Safety underpins our culture and is our first value. I strongly believe that achieving zero fatalities is possible for MMG, and we are committed to our efforts to ensure our employees go home safely at end of each day. We continue to focus on improving our environmental performance and our commitment and contribution to communities. We know that this is key to maintain support for our future growth plans. As CEO, I will continue to drive strong performance in this area. MMG has a unique market perspective as an international operator with support from China's largest resources company, China Minmetals, as our major shareholder. This insight underpins our views on the fundamentals for copper and zinc. We still see copper and zinc supply and demand gaps emerging in the coming years. Furthermore, current prices remain below the levels we think are needed to incentivize some of the marginal supply required to fill this gap. At the same time, global demand growth will be underpinned by continued urbanization in China and stable growth in both Europe and the U.S. MMG's core commodities of copper and zinc are well-positioned to both contribute to and benefit from the decarbonization of future energy needs. An accelerating market for electric vehicles and developments in battery storage technology. China is at the forefront of this revolution with a strong focus on quality and sustainability. China is also helping other countries to grow through the One Belt, One Road initiative. This is a major economic strategy that connects 64 countries and seven global regions, stretching from China to Europe with a major infrastructure focus. This will deliver strong demand for raw materials, base metals in particular. I wanted to provide you with an update on the current status of our logistics disruptions at Las Bambas and Dugald River. At Las Bambas, our ability to transfer, transport copper concentrate to the port is restricted by a blockade that is located approximately 130 kilometers from the mine. This illegal action is taking place on a stretch of public road and relates to a community claim for compensation for a preexisting easement that was gifted to the community back in 2011. We are currently in discussions with the government and the community members to remove this block as a condition to hold further discussions. To date, this request has not been respected. While production has not been impacted, failure to resolve this issue or any escalation could impact production in the near term. At Dugald River, recent floods in the region caused significant damage to the rail line that we use to transport zinc concentrates. Despite this, we have been able to continue production, making alternate arrangements to truck concentrate to the Port of Townsville. We expect that rail access will be re-established between late April and mid-May, with annual production still expected to be in line with guidance of 165,000 to 175,000 tonnes of zinc. Before handing over to Ross, I want you to run through MMG strategy and objectives. We aim to be valued as one of the world's top miners. To achieve that, we will focus on four key areas. Our greatest asset is our people. At MMG, we strive to provide a safe workplace that promotes collaboration, accountability, and respect. We will get the most out of existing asset base. We have business improvement programs in place across all operations and group functions. Efforts in this area have accelerated. We continue to mine for progress. We are delivering development and growing community investment every day. We are proud to be miners and to be adding to the communities in which we work. And finally, we will pursue value-accretive growth. We have delivered Las Bambas and Dugald River. These are world-class assets that will create significant value for MMG shareholders. Beyond that, we will look for next opportunity through M&A, exploration, and brownfield expansion projects. I would now like to hand over to Ross to take us through the financial results in more detail. Thanks, Jeffrey, and welcome everyone. As slide 11 highlights, although we remain profitable, our financial performance has deteriorated in comparison to last year, mainly as a result of lower production from Las Bambas. This was partially offset by the successful commissioning of Dugald River in May of 2018. Revenue was down by 2%, with lower revenue at Las Bambas being partially offset by Dugald River, Kinsevere, and Rosebery. Underlying EBITDA was down by 8%, and profit after tax attributable to our shareholders was reduced from $144 million to $64.8 million. I will talk about the operating factors that influenced our results on the next slide, because it is important to talk about our depreciation and interest charges. Depreciation increased by approximately $100 million due to the commencement of production at Dugald River, which accounted for $40 million. Additional ore mined at Las Bambas, which was another $40 million, and the accelerated depreciation of some Las Bambas infrastructure, which was $20 million. Our interest expense was largely flat, with the benefits of the early repayment of our outstanding debt being offset by 100 basis point increase in interest rates during the year. Also, we had the interest costs associated with Dugald River as it came into production. Slide 12 looks at the EBITDA bridge between the 2017 and 2018 years. Starting from the left, we have the impact of the first eight months of production at Dugald River, which added $87.2 million. We then have a fairly minor impact of $17.3 million from increased prices, with higher prices for copper and moly being partially offset by lower lead, silver, and precious metal prices. We then had a minor reduction in royalty and selling costs, with the lower sales from Las Bambas being offset by the commencement of production at Dugald and the higher royalty rates in the DRC following the changes to the mining code. Moving to the right, we also have a favorable FX impact of $61 million due to the weakening Australian dollar and the impact it had when restating some of our Australian liabilities. Now, the stock movement. We have a net increase of $71 million coming out of stockpiles, and this occurred because we had high balances of finished goods at Las Bambas and Rosebery at 2017, which were subsequently sold in early 2018. As you can see from the chart, the biggest impact on our earnings was lower production, and this was mainly at Las Bambas, with a negative impact of over $530 million. This was as a result of producing 385,000 tonnes in 2018, compared to the 453,000 tonnes we produced in 2017. Overall, our operating cost performance was quite good, with a negative impact of just $15 million for timing costs arising. Exploration is a small negative impact, as we spent more money on delineation drilling to follow up some discoveries in the DRC, and hopefully that will add to the value of Kinsevere shortly. We had lower corporate costs to the tune of $45 million. As a result of headcount reductions and lower costs associated with our LTI programs. Some shares were forfeited, and there were some different assumptions made around the vesting of the program. Finally, the other category was a positive. In 2018, we had the gain on the sale of the redeemable preference shares. In 2017, we had some hedging losses, so this year it was a plus. Slide 13 seeks to explain the profit that ends up being attributable to MMG shareholders. As you will see in the chart, the starting point is $119.6 million, which corresponds to our 62.5% interest in Las Bambas. We then add the profit of $114.3 million for the other operations, which includes an 8-month contribution from Dugald River. We then deduct exploration and corporate overheads of $83.3 million, and other items includes FX gains and the gain on the redemption of preference shares, which I mentioned. That is a positive relative to what happened in 2017 with the hedging losses. Finally, we have non-LB finance expense of $125.4 million. As I mentioned at the last briefing, the reason why this amount is so high is that MMG borrowed all of its equity for the Las Bambas project from our major shareholder, CMC. So although it relates to Las Bambas, it does not actually sit within the Las Bambas joint venture. Our joint venture partners probably have a similar cost in their own P&L. The non-Las Bambas finance expenses also includes $12.8 million of interest expense for Dugald, now that we have stopped capitalizing interest following the completion of the project. The next slide, 14, gives our shareholders and analysts an indicator of our sensitivity to both commodity prices and exchange rates. While the table highlights our earnings sensitivity, it also closely approximates our cash flow sensitivity, given the limited cash taxes we are currently paying due to carry-forward tax losses and accelerated depreciation benefits. Copper, zinc, and the A dollar/U.S. dollar obviously have the biggest sensitivity, with a $0.10 a pound change in the copper price leading to a $99 million impact on EBIT. A $0.10 change in the zinc price leading to a $52 million impact, and a 10% movement in Australian dollar leading to a $33 million impact. Slide 15 is a new and important slide, which shows the impact of the movement in copper and zinc prices on our free cash flow. Free cash flow, in our definition, is operating cash flow from the business, less CapEx, tax payments, and interest costs. This new chart, along with some additional information in the appendices, will help our analysts and investors to better model MMG's financials. If you look at currently where we are at, it is about $2.95 copper and $1.28 zinc. Based on that sort of pricing mix, we would be looking at free cash flow of around $730 million-$740 million at the end of 2019, if we meet our production and cost targets and pricing stays constant. To slide 16. As Jeffrey mentioned, we paid down our debt by $733 million during the year, and this has helped offset the pressure of rising interest rates. This takes net debt reduction to $2.7 billion since the commissioning of Las Bambas and more recently, Dugald River. Apart from reducing our risk, the reduction in net debt, as well as other balance sheet initiatives, will lead to significant interest savings. Another point to note from this slide is that after having just developed the largest copper and zinc mines globally over the last few years, our capital expenditure will start to plateau at around $400 million-$500 million a year, with the bulk of the spend to be at Las Bambas. Another factor that should be explained from the slide is the proceeds of our sale of the Sepon mine. As investors will note, the sale price of $270 million includes 10% that is deferred for a maximum of two years. After taking this into account, the net cash inflow from the sale was around $115 million. The reason for that was that Sepon's cash on hand that was generated from the 1st of January 2018, which was the effective date of the transaction, was transferred as part of that transaction. There is some more detail on the accounts, if anyone is seeking some further information. Finally, our investors should be aware that our free cash flow in 2018 was impacted by three years of deferred interest payments on our $2.2 billion shareholder loan that we paid early in the second half of 2018. Moving forward, this interest will be paid annually on the facility. Slide 17 highlights our debt maturity profile. 2018 saw us make some prepayments, and we are currently ahead of our loan amortization schedule. I think you can see from this chart that despite some short-term commodity price weakness, with our strong asset base and the low-cost position of Las Bambas, we can comfortably meet our debt commitments in the near term. We have also been very fortunate to have the support of our major shareholder, China Minmetals, which has enabled us to fund the development of two world-class mines. We are confident this support will continue, which is a major benefit to our minority shareholders. In 2018, we renegotiated our loan with CMC that reduced and also fixed interest rates, which is obviously very beneficial when interest rates are rising. I think this slide on business improvement is particularly important, and if anything, the recent weakness in copper and zinc prices has highlighted the need to place such a high priority on business improvement. We need to be able to deliver returns in all commodity cycles. Our investors need to be aware that all mines get older and deeper, and generally, the grade drops. We can't afford to sit still and assume that we can maintain our operating costs. This is why we have accelerated our business improvement efforts in 2019. Following the sale of four non-core assets in the past 18 months, we have needed to lower our overhead costs. This has resulted in a headcount reduction of around 60 roles from our group support and services functions. This, as well as other initiatives, has delivered annualized cost savings of around $30 million a year. At Las Bambas, we have switched our focus from the very successful ramp-up towards optimization and ensuring that we have the best chance to deliver on its vast potential. To that end, we have a series of programs in place across Las Bambas that we expect to deliver savings of $95 million over 2017 and 2018. Now, some examples of these savings have been a 35% reduction in contractor headcount, a 25% reduction in electricity costs, as well as programs to reduce consumption in key consumables such as tires, explosives, fuel, grinding media, and reagents. At our other operations, our operating philosophy is based around maximizing asset utilization, with initiatives focused on de-bottlenecking equipment availability, and consumption rates. These efforts are particularly evident at Rosebery, which is in its 82nd year of production, and it's just set a new record for mining, mill throughput, and zinc equivalent production. This is quite an achievement for a mine at that age. Now to Dugald River, which is our newest asset. As mentioned earlier, we achieved commercial production on the 1st of May 2018. Our team has done a remarkable job to deliver this project ahead of schedule and below budget. Now, this further legitimizes MMG's capability to deliver large projects. As we have transitioned from a development project into ramp-up, you can see that the key productivity measures, mill throughput, and mining rates are either exceeding or approaching their nameplate design capacity. Throughout 2019, the mine will continue to be developed to open up to a steady state number of operating stopes, with the main area of focus to improve management of geotechnical conditions, to minimize ore grade dilution, and also to increase mining rates. Dugald River is going to deliver significant value to our shareholders over the next 25 years. From an MMG perspective, it provides important diversification away from our very large asset, Las Bambas, in a commodity, in zinc, that we believe enjoys a very favorable outlook. Now, as we're all aware, Las Bambas is the key asset in MMG's portfolio. After a fantastic ramp-up, 2018 was a tougher year for us, with production falling to 385,000 tons as a result of some localized geotech instability, lower grades, and plant maintenance and throughput issues. Despite this impressive ramp-up, it should be noted that production at the start of a mine life has benefited from early access to high-grade skarn ore. In 2019, we expect to produce between 385,000 and 405,000 tons, at C1 costs of between $1.15 and $1.25. We should see higher mine tons and better mill throughput offset a slight fall in ore grade. We remain on track to meet our longer-term guidance that Las Bambas will deliver over 2 million tons of copper in its first 5 years of operation. Las Bambas still remains our most highly prospective growth opportunity. Plant de-bottlenecking will continue to improve our mill throughput as the grade declines. However, it is exploration and subsequent development opportunities which we expect to add significant value. There should be some exploration drilling in the second half of the year. Our progress remains slower than we would like due to land access and permitting issues. I will now hand back to Jeffrey to finish the briefing. Thank you. Thanks, Ross. MMG is delivering on a strategy that we see as valued as one of the world's top miners. Of the pure play copper names, we are the fourth largest and the largest copper miner in Asia. On a consolidated basis, our cash costs for copper and zinc are in the bottom half of the global cost curve. As a result, we generate tremendous free cash flow through the cycle. We have a track record of delivery. Growth has been consistent, and we have a strong asset base. In summary, we have a world-class and focused copper and zinc portfolio. We have benefited from China-backed finance and to delivery growth during the down cycle, and are now well-placed to accelerate debt repayment and pursue further growth opportunities. We are extremely positive on the outlook for copper and zinc, and we are well-positioned to benefit from this. We have demonstrated project delivery and operational excellence over a sustained period, and our operating philosophy is based around safety and driving continuous improvement. We are focused on creating long-term value for our shareholders. With that, I would like to open the floor up to questions. Thank you, Mr. Gao, and thank you, Mr. Carroll, for the in-depth analysis on the company performance. Now the floor is open to questions. In addition to people in this venue, we have about 16 people joining us through the dial-in system today, including those from Bloomberg, Deutsche Bank, DBS, Oriental Capital, and CCBI. Now the floor is open to questions. Just a reminder to those who require simultaneous interpretation, you can switch your headphone to channel 1 for English and channel 2 for Mandarin. Yes. Is there questions? You. Yes, sorry. Thank you very much. Chris Shu from Boston Asset Management. Two questions. If I am not mistaken, there was also a road blockade incident in 2016, if I am not mistaken. Is there any difference now versus that time, the two blockade incidents? That is the first question. The second question is regarding the copper price earnings sensitivities for 2019. I noticed that the sensitivity for 2019 seems to be a bit lower than the one you have shown in the past for 2018. That is despite the higher production volume that we expect for this year versus 2018. So what is the reason for the lower sensitivity? Thank you. I'll address the first one. The second one, we'll pass to Ross. In Peru, the community issue, that is operating reality. I'm sorry. Many other companies are facing the similar issues. This time, I should say it's worse because this blockade happened during a state of emergency. Currently we are still working very closely with the government and the community. We are willing to talk to the community. But we rely on the government's action to really restore the order of law and to free the road. Yeah. Thanks, Chris. In regard to the sensitivity, there'd be a couple of reasons for it. Firstly, Sepon would've come out of the analysis. Secondly, if the last time we showed that chart would've been back in August, and at that stage we would've been expecting Las Bambas to produce, I think it was 410,000-420,000 tons at a lower cost. So the margin would've been higher. Now we've got a lower number of tons with a slightly lower margin as the costs have increased. So that'd be the primary reasons for it. Then I think with zinc, obviously it would've changed with Dugald River coming in, be slightly higher. Yeah. Second questions? Any questions? Yes. This gentleman over there. Hi. Can you explain a little bit about the cost inflation in Las Bambas, in the past year and the cost inflation expected this year? Thanks. Yeah. Because I remember, I think, the Glencore report a few years ago when we first purchased the mine, the cash cost. Cash cost supposed to be below one. Can you explain that? Thanks. Yeah. Okay. Yeah. I think there's a couple of reasons for it. Firstly, we can't really stand behind Glencore's numbers, but earlier on in the piece, we did have a C1 cost of below $1, and then last year it was scheduled to go up to about $1.10. Then with lower production, that pushed, I think it's $1.18 was the final number for last year. I think invariably there's always differences between acquisition models and what happens in eventuality. The other thing I would say too is, Peru is a fairly high-cost environment and there's new mines coming on, so there's a lot of pressure on wages cost there. Then even as all mines get older, I'll give you an example, a real example. in 2018, our average haul distances were 12.7 kilometers, and in 2019 it goes up to 14.2. You've got sort of over or close to a 15% increase. Obviously, that means you use more truck time and more fuel. Just generally over time, the costs do increase and I guess that's why we've got such a focus on business improvement. All things going well, we should keep our C1 cost relatively flat at Las Bambas this year. Yes. Thank you, management. I have two question here. I'm Analyst from Citi, Ada. I have two question. First is related to the road blockage. In the past experiences, what did the government do except for declaring emergency status? In the current scenario, what else can the government do because they already declared a emergency of status? The second question is regarding page 17 of the presentation. I notice that we will need to start repaying for the shareholders' loans starting from 2021. Does that mean that we have to start repatriating cash from Las Bambas JV to the holdco in these two years? Does that mean we need to pay more withholding tax to the Peru government? Thank you. Okay. I'll take the first question. I should say, what I just mentioned this time is the case is worse because we had a similar situation before. But before, every time when we got the government declare the state of emergency, then, the road has been restored to normal order. This time is quite complicated. The blockade happened during the state of emergency, and there are a lot of women and children on the blockade. I believe this is the biggest concern for the government to take any action to restore the order. But as I said before, we are still in a close dialogue with the government and also the community. Now, we are still trying to, through the dialogue, using the peaceful way to restore the order of the road. We are hopeful we can have a swifter solution to this. Yeah. Ada, I guess from regards to the financing, you would've noticed from the sensitivity chart that at current pricing, we produce about $730 million of free cash flow. Then our amortization payments on the structured loans are around about $600 million. I think in reality, we're going to have a little bit of trouble meeting that repayment schedule with the major shareholder. But I think I wouldn't be concerned about that because the facility just matured in July and we rolled it over. I think, unless we see a sharp spike in the copper and zinc prices, it's more than likely that payment will be rolled over or perhaps we could pay a little bit off. But I doubt whether we can meet the whole $700 million that's due in 2021. I should add a comment to say, we always say we've got strong support from major shareholders. So I do believe we have enough of flexibility when it gets due, and we can talk to our shareholder about the way to refinance that part. Okay. Is there any questions from our dialing system? No, not for the time being. Yes. Hello, management, I am the analyst from CICC. I have two questions. First one is about taxes. It seems that the effective tax rate is very high, nearly 50%, especially in Las Bambas. What is the reason? The second question is about the output. Due to the sale of Sepon, the copper output will decline this year. Do we have any plan to increase copper output, such as acquisition or extend our capacity? Thank you. Okay. Next question. Yep. I will answer the first question on tax. The reason for the high effective tax rate is that Peru is a very high taxing country, and Brent has got the chart up there now. The effective or the headline tax rate is 33%, but then they have withholding tax that varies from 5% up to 30%. The bulk of our withholding tax is probably 15% on our interest expense. You will see from that chart, there is $58.2 million of withholding tax that is largely a fixed cost. Proportionately, our income dropped this year, but that withholding tax stays relatively fixed or will diminish over time as we reduce our interest payments. Essentially, there is a fixed cost, and it amounts for about 19% increase of effective tax rate. I think we have added this chart to the pack because that did cause some confusion when it came to our profit downgrade or profit announcement back in January. Peru is a very high taxing country, so the only way we can get that down is to pay all the debt back. Okay. I'll take the second question. That's really regarding the growth of the company. We look growth in two parts. One is try to maximizing the current assets value. On that, we got Las Bambas, big exploration potential. Currently, we are doing some de-bottlenecking projects. Also, we are starting the development of Chalcobamba. That will be the second mine pit for Las Bambas. Then in our Africa assets, Kinsevere, we are also working on the study to develop the sulfide part of our resources. All these efforts mainly will extend the mine life or maintain the production. Particularly, for Las Bambas, we told the market that we will deliver 2 million tons of copper in the first 5 years. I think people should be aware the average copper grade for the whole mine life will be getting lower. Currently, at the early stage, we are exploring the higher grade part. So we will try our best to maintain the production. The other side is about we are also looking at very attractive external opportunities. That is something that we always looking. As we obviously said, we don't grow for growth, so we have to make sure that's the right fit for us. Particularly, we'll focus on our existing operational hub, including South America, Africa, and Australia. We will focus on the commodities we believe in the strong fundamental, that's copper and zinc. Thank you. I might just add, too, in regard to Sepon, production would've finished either at the end of this calendar year or early in 2020. On an EBIT basis, we would've lost money even though we generated a bit of cash. The reason why we sold Sepon is not because we wanted our copper production to reduce, but it had a very limited life. Now it's going to switch over to being a small-scale gold producer, which is not our business. So that's why we're happy to let Sepon go, because they have very limited life left. Okay. Just a reminder to those who join us through the dial-in system, should you have questions, just inform our operators. They will put you through to the floor. Yes, sir. Thanks, management. I am James from Zhongtai Finance, and I have two questions. The first question is still about the tax rate. Actually, you can see that the withholding tax was quite lower than 2017. As I remember in the financial statement, it was over $100 million 2017, and in 2018 it was about $60 million. I want to know, how much could we expect in the next few years for this withholding tax? The second question was about the debt repayment schedule. I have noticed that in the financial statement, the total debt within one year maturity was about $790 million. But actually, in the repayment schedule, it was slightly below $700 million. I want to know where that differences comes from. Thank you. I will answer the first question first. With the withholding tax, as I said, it is about $60 or $58 million, and our interest repayments are just over $500 million. It should stay that $60 million a year and drift down slightly, just over time. I must admit, I guess your question on the repayments and what is in short term or current liabilities, we would have to get back to you on that one because I cannot give you that answer off the top of my head. Either Brent or myself will get back to you. Any other questions? Just for those who join us through the dial-in system, if you have a question, you can press hash and then one. Any further questions from the floor? If there is no further question for the time being, is there anything that Jeremy or Ross want to add in addition to what we have discussed? No. No? Okay. If there are no further questions, we will wrap up this meeting. Thanks very much for coming. Thank you.