Guidance

Jan 21, 2019

Ross Carroll, CFO of MMG here, and thanks for dialing in today for today's call at short notice. Brent, our IR manager, is also with me. We had a few questions regarding last week's profit warning, so we thought we'd offer up the opportunity for a call to discuss it. You will note from our announcement that it is based on unaudited management accounts for the 2018 financial year. We expect net profit after tax of approximately $135 million-$140 million for the year. This includes a second half loss of $50 million-$55 million. Notwithstanding that we included sensitivity analysis for our major variables in the half year results presentation pack, we believe that second half profit after tax may be below market estimates. This call will focus on further explaining our profit drivers. There are a number of factors identified in the release, and I will briefly explain each. Before we discuss these factors, though, we will be releasing our fourth quarter production report to the market this coming Friday, which, as highlighted in our announcement, will detail our fourth quarter operational performance at Las Bambas that was in line with expectations. I want to point out that this profit announcement is not related to any further production issues at Las Bambas or our other operations. We'll also provide the market with production and C1 commentary upon the release on Friday, so I won't be making any comments today regarding these factors. Now to the factors that we mentioned in our exchange release. The most significant factor driving the weaker second half is the impact that weaker commodity prices had on operating EBITDA. In the first half of 2018, we reported EBITDA of $984 million. In the second half, average copper and zinc prices fell by $0.35 and $0.31 per pound, respectively. Investors will note that our earnings sensitivity analysis was provided to the market with our interim results materials. When compared to the first half, copper prices were over 10% lower and zinc prices were over 20% lower. Obviously, we're very levered to the copper and zinc prices and this reduced our second half EBITDA by over $250 million. There have been some offsetting factors such as the weaker AUD, cost savings, and a strong ramp-up at Dugald River, with the net result being that EBITDA in the second half of 2018 will be approximately $220 million-$230 million lower than the first half of 2018. The next factor to draw investors' attention to is the higher depreciation charges that will be incurred in the second half of 2018. We expect that depreciation will be around $100 million higher when compared to the first half. The major drivers of this higher depreciation include the full six-month contribution from Dugald River. This accounted for around $20 million of higher depreciation. Higher mining and milling volumes at Las Bambas in the second half. Compared to the first half, mined ore was 35% higher and milled ore was 9% higher. So higher mined ore and higher processing volumes result in higher depreciation amortization charges. This accounted for around $60 million in higher depreciation in the second half. The final driver of higher depreciation was some accelerated charges that we took on various infrastructure and support facilities that are being relocated to advance the development of the Las Bambas mine. This mine development work should not be viewed by investors as anything outside the ordinary course of our sustaining capital program at Las Bambas, but it has resulted in the shortening of the useful life of some infrastructure assets and support facilities. This led to around $20 million additional depreciation in the second half. The next factor is the impact of higher interest costs. The driver here is 100 basis point increase that we've experienced in the LIBOR rates over the course of 2018. We have about $6 billion of floating rate debt, so 100 basis point increase will lead to an additional interest charge of approximately $60 million on an annual basis. The result here is that our net interest costs are expected to be between $25 million and $30 million higher than the first half of 2018, notwithstanding that we have lower debt levels. Since commercial production at Las Bambas, we've already prepaid $1 billion ahead of the required amortization profile on these debt facilities. Notwithstanding the early debt repayments, we're obviously still highly geared, so this increase in interest rates really hurts us, particularly at a time when commodity prices are low. Final factor impacting our profit after tax for the year is the higher effective tax rate at around 56%. To better explain this, investors should understand that our prima facie corporate tax rate, based on our operating jurisdictions of Peru, Australia, and the DRC, is approximately 32%. In addition to this, we've incurred tax charges in 2018 of approximately a further $70 million, taking our reported tax rate to around 56%. These additional tax charges are largely fixed in nature. That is, they don't move with operating earnings. The lower profit before tax for the full year results in these tax charges becoming a larger proportion of our pre-tax profit, therefore leading to a higher effective tax rate. By far, the largest contributor to this for 2018 is non-creditable withholding tax in Peru, accounting for about $60 million of the $70 million in additional tax expense. This largely relates to withholding tax on our funding arrangements for Las Bambas, for which we are not able to claim a deduction against our corporate tax. Going forward, the level of non-creditable withholding tax will be impacted by the movement in interest rates and absolute debt levels at Las Bambas. So it's unlikely to change materially in the short term. In closing, I would like to highlight that whilst the second half profit results may be lower than some of you anticipated, they are based on production levels in accordance with our guidance and sensitivities that we have largely presented in the past. The low price environment that prevailed in the second half of this year has only further strengthened our focus on reducing costs, driving operational efficiencies, maximizing cash generation, and prioritizing debt reduction so that we are well-positioned to benefit from the eventual upswing in our core commodities prices. We remain positive on the outlook for 2019 and beyond. I will now open up the line for questions. Thank you, Ross. Ladies and gentlemen, we will now begin the question and answer session. If you wish to ask a question, please press star one on your telephone and wait for your name to be announced. If you wish to cancel your request, please press the pound or hash key. Your first question comes from Helen Lau from Argonaut. Please ask your question. Hi. Hello, Ross. Thanks for the explanation. My first question is about the production of Las Bambas in the fourth quarter. Given that the mining rate is higher, does it mean that the fourth quarter copper production should be higher, or it is still lower because of the lower grade or recovery? That is the first question. Secondly, could you please give us some highlight on the production costs, total production costs at Las Bambas and also at Dugald River? That's it. Thank you. Yeah. Thanks for the question, Helen. Firstly, just in regard to LB production, we'll give more details on this on Friday, but I think you'll see that we had a pretty strong quarter in the fourth quarter, and that's enabled us to get within the guidance range. Particularly in regard to costs, both at LB and Dugald River, we'll be disclosing our C1 costs on Friday. Yeah, it's not the level of detail we're going to today. But again, I don't think you'll see there's anything to be concerned about with the costs. Okay. Right. Sure. Okay, sure. That's it. Okay, that's fine for me now. Thank you. Yeah. Thanks, Helen. Your next question comes from Lawrence Lau from BOCI. Please ask your question. Hi, Ross. Thanks for your explanation. I just want to get more clarity about the tax rate, especially higher corporate tax rate for the second half. If I hear correctly, you mentioned that the tax in Peru actually $60 million to $70 million higher in the second half due to some non-creditable withholding tax, something like that. Could you explain in more detail? I think I am keen to know whether the abnormally high tax rate in the second half is something that will continue in the future. Thank you. Yeah. Thanks, Lawrence. Thanks for the question. Lawrence, as we highlighted, the average or the prima facie tax rate in Peru is 33%. It is actually a very high taxing jurisdiction, mainly due to withholding tax. To give you an indication on external debt, we pay withholding tax of 5% on the interest. On intercompany debt, we pay 15% withholding tax. Then for various other charges, that is somewhere between 15% and 30% withholding tax. That is where we come up with the $60 million of withholding tax, which is relevant for the period. Now, it actually comes back to relativities because obviously, say, if your pre-tax profit is $200 million, the $60 million is a higher proportion than whether if your pre-tax profit over in Peru is $400 million. The problem we have is the USD 60 million is largely fixed, but as the operating profit goes up and down, the withholding tax doesn't. So in lower profit periods, the withholding tax increases proportionately. Does that answer your question? I think that helps. Thank you. I think that withholding tax will continue, but if your profitability improves, it will help to make the effective tax rate lower. Yeah, that's right. The other thing that will help us is as we pay down the debt, and assuming interest rates don't rise too much more, the interest expense will be lower, and that's where the bulk of our withholding tax is incurred. Okay, thank you. Thanks. Your next question comes from Ada Gao from Citigroup. Please ask your question. Okay. Hi. Thank you, Ross, very much for the explanation. I have two questions here. First, can you explain a little bit more about your accelerated depreciation methodology, and how much depreciation we should be expecting for Las Bambas in 2019? Secondly, I would like to ask about the debt repayment schedule. How much debt did you pay in second half 2018, and how much, under current situation, would you plan to repay in 2019? Thank you. Yeah. Okay. Yeah. No, thanks, Ada. Thanks for the questions. Ada, the accelerated depreciation is a result of a couple of issues, and this happened before MMG took ownership, but certain amounts of elements of infrastructure were built on top of some high-grade ore at Ferrobamba, in the Ferrobamba pit, including the truck shop and some power lines. Essentially, and we're not exactly sure of when yet, it'll be in probably three or four or five years' time, we will need to move the truck shop and the power lines. That's why we've brought back the operating life in line with that proposed move, and that therefore reduces the amount of time we've got to accelerate to depreciate the assets over. To be honest with you, that's something we inherited, and it just become clear over the last couple of months that we will need to move that infrastructure. The second element is in regarding to debt, and I must admit, I haven't got the exact figures with me, but the debt repayments for the second half were around $170 million-$180 million. Next year, we move into higher amortization schedules, which include the Dugald River debt and the Las Bambas debt. It's around about $550 million. As that debt's repaid, obviously we'll see a drop in interest expense. Thank you, Ross. Just want to clarify, so for next year, the Las Bambas depreciation should be around the same level as in the second half? No. We've taken a bit of a hit, I guess, on the accelerated depreciation. It will depend on how much ore we're moving and how much we're processing, which also comes back to grade as well. So, probably give or take, it is around about the same as what we're seeing in the second half. But that's not an exact science. Yeah. Okay. Thank you. Yeah. Once again, if you wish to ask a question, please press star one on your telephone and wait for your name to be announced. Your next question comes from Han Fu from JP Morgan. Please ask your question. Han, your line is now open. Oh, sorry, I was on mute. Hi, Ross. Thanks a lot for your time and the explanation. I have one question regarding the Las Bambas development. We see that now we have accelerated development on that mine. Is that maybe some alteration of the original designed development plan? Are we trying to develop new fronts on different mining sections? In that sense, do we expect to have more unit production costs for next year and going forward? Thanks for the question, Han. What this is actually we've got some infrastructure in the Ferrobamba pit, which is the only pit we're mining at the moment. Then eventually, over time, we move into Chalcobamba and Sulfobamba. Just the way the mine's worked out, we've discovered that we're going to need to move the truck shop and the power lines earlier than what had been expected. So there will be some sustaining capital that comes with that expenditure. But it doesn't mean any great change to our either production schedule or our operating costs. Okay. Thanks for that. Yeah. Thank you. Your next question comes from Chris Xu from Boswell Asset Management. Please ask your question. Hi, Ross. Hi. I've got a question regarding the sensitivity. As of now, do you see that the sensitivity analysis has to be changed? Is it possible for the company to also maybe provide sensitivities on a net profit basis instead of just EBIT? Because a lot of the uncertainties actually have to do with the taxation. That's the first question. The second question is, could you give us a sense of whether there has been much of a change in terms of CapEx in the second half versus the first half, or maybe versus the full-year guidance? What should we expect going forward? Thank you. Right. Yeah. Thanks, Chris. Just in regard to the sensitivity, we will be updating that when we do our results at the start of March. Because they do vary depending on the production levels. Now, obviously, we're going to have a full year's impact from Dugald River next year. That means, for instance, our zinc sensitivity will increase. The other thing with the sensitivity, it does get a little bit difficult too, because we had a stronger last quarter at Las Bambas, which unfortunately coincided with the weakest prices of the year. It's also, in a perfect world, you'd obviously like to have your higher production when the price is high, but we can't always control that. In regard to CapEx, you'll find our CapEx was higher in the second half than what it was in the first, but it will come in underneath the guidance range. Yeah, we'll talk to that more on Friday. But obviously, during this low price environment, we're trying to manage the CapEx spend. We'll also give some guidance on the CapEx spend on Friday as well, so I don't want to detract from Friday's call. Thanks. Got it. Could you give us a sense of how cash flow has been? Any sort of points that we should pay attention to? Any changes in, I don't know, receivables or maybe inventories and then payables and things like these, working capital? Yeah. I'd probably say there's nothing significant in there. Our cash flow from operations was not as heavily impacted as what our EBITDA was. Which I guess I'm trying to say is the variance between the cash flow from operations from half one to half two is less than what the variance in the EBITDA is. Again, these results are still unaudited and just our management accounts, so we'll provide further clarity on that in March. Got it. Okay. Thank you very much, Ross. Yeah. Thanks, Chris. Your next question is a follow-up question from Helen Lau from Argonaut. Please ask the question. Hi, Ross. About the Dugald River, if I heard it correctly, it is also made a loss. Other than the zinc price decline, what other reasons for that contributed to the loss? No, Dugald River didn't make a loss, Helen, I can assure you of that. But, yeah, obviously that's the sort of level of detail we'll disclose in March. But I can assure you Dugald River was a positive contributor. Okay. Good. But you mentioned, it says that the EBITDA number declined by 200 something, $200 million? Yeah. The EBITDA was down by about $220 million. Yeah. Oh, okay. Right. So that is for the Dugald River. Right. That was mainly because of the zinc price decline. No, the $220 million is for the whole group. For the group. Oh, okay. Yeah. So we got the- Sorry, yeah. USD 250 million of price variance, and then about a USD 30 million offset amongst some other items. Yeah. Okay. Got it. Yep. Sure. Thank you. Once again, if you wish to ask a question, please press star one on your telephone and wait for your name to be announced. Your next question comes from Joy Zhang from Goldman Sachs. Please ask your question. Hi, Ross. Hi, this is Joy. I have just two simple questions. First one, is there any other one-off losses or profits occurred in the second half of 2018? The second thing is still about the tax rate. I know there is some non-deductible expenditures, but is there any indicators that we can link to model as what is kind of a fixed amount for that? Or is there any flexible of the rate that we can Because it is quite difficult for us to estimate the earnings if the tax rate changes a lot. I think probably could you give us more indications how to model the non-deductible ones? Yeah. No. Thanks, Joy. Firstly, there's no other material one-off items. It's a bit of a complicated company. We've got always some pluses and minuses, but nothing material. In regard to, I guess, how you estimate the profit, I must say we have trouble estimating the tax as well, because we're sort of under siege from taxing authorities. But I think the way you should approach it is if you work out your pre-tax profit, multiply it by 32%, will give you the prima facie tax. And then these permanent differences will be about $60 million or $70 million, depending on interest payments or interest expense and the like. Again, the percentage weighting they have is gonna depend on the pre-tax profit that you've calculated. But the $60-$70 million, depending on the pre-tax profit, after all these minority interests, it means that only corporate, right? I guess perhaps to put it a different way, just say our pre-tax profit is $100 million. Therefore, the prima facie tax would be $32 million. But if you've got to add the $60 or $70 million on to the prima facie tax expense, it means if we make $100 million pre-tax profit, that our profit after tax is effectively going to be close enough to zero. Okay. I see. Thanks. Yeah. If you've got any further questions around it, Brent will be happy to answer them. Once again, if you wish to ask a question, please press star one on your telephone and wait for your name to be announced. There are no further questions at this time. Ross, please continue. Well, I'd just like to thank everyone for joining the call. Obviously it's fairly some complicated topics in here, so please feel free to contact the company if you've got any more, any questions. Thanks for dialing in, and we look forward to talking to most of you again on Friday. Thank you.