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Hudbay Minerals Kicked Its Debt Repayment Further Down The

Road - But Is It Far Enough?


Jun. 26, 2017 4:24 PM ET5 comments
by: The Investment Doctor

Summary

HudBay's management team made a good decision by increasing and extending the
maturity of its debt.

The adjusted free cash flow in Q1 was still very low once you isolate the non-
recurring benefits.

The production cost at Constancia will decrease sharply from next year on.

Introduction

I havent been very impressed with the performance of HudBay Minerals (HBM) in the
past few years and when the copper price dropped to just $2 per pound, the companys
chances to survive were very low as its balance sheet contained too much debt.
Fortunately the copper price and the zinc price started to increase, boosting HudBays
cash flows.

HBM data by YCharts


Source: Ycharts

The higher copper price in Q1 provides more room to breathe

HudBays two production hubs are in Peru (copper-focused) and Manitoba (zinc-focused)
and on a consolidated basis, HudBay sold a total of 26,400 tonnes of copper, just over
25,000 ounces of gold, almost 700,000 ounces of silver and almost 27,000 tonnes of zinc
in the first quarter of this year. As you can see on the next image, the copper and gold
price were definitely cooperating during the quarter.

Source: stockcharts.com

Whilst the gold price was higher compared to the end of 2016, it was slightly lower
compared to the first quarter of last year but fortunately the higher copper and zinc prices
made up for the difference.
Source: quarterly report

The companys total revenue in the first quarter remained stable at US$253M (the higher
copper price compensated for the lower copper production volumes), resulting in a gross
profit of just over $49M which is almost twice as high as the gross profit in Q1 2016. Thats
a good result, but we shouldnt forget the majority of this improvement is related to a lower
depreciation charge on the assets.

The operating income also increased to $42M (thanks to a one-time benefit related to an
insurance claim on the Constancia copper mine where the company received
compensation for an incident during the commissioning phase of the plant). Despite this
benefit, HudBay still reported a net loss of $2.3M as its finance expenses remain very
high.

The $50M net debt reduction was caused by one-time benefits

As you know, you cant repay debt with a paper profit, and the real cash flows are what
really matter for HudBay Minerals. HudBay was proud to announce it generated 50M in
free cash flow which reduced its net debt, but unfortunately the adjusted free cash flows
are much weaker than what youd expect.

So lets start with analyzing the operating cash flows. According to HudBay, the total
operating cash flow was $110M. Okay, but almost $30M was caused by working capital
changes and this is per definition non-recurring. Secondly, it looks like the operating cash
flow also included the insurance payment, which also is a non-recurring item. This already
reduces the adjusted operating cash flow to $75M.
Source: financial statements

That would still be a strong result, but theres one important final part of the puzzle: the
interest expenses. Based on the new situation (7.48% on a $1B bond, and 5%+ on a
$130M loan), the average quarterly interest expenses will be approximately $21M (with
Q2 and Q4 being the interest-heavy quarters). After taking this into consideration the fully
adjusted operating cash flow in Q1 was just $54M. Still sufficient to cover the $40M in
capital expenditures, but with an adjusted free cash flow of just $14M in Q1, the
companys net debt of in excess of $1B remains relatively high.

Is the situation hopeless? No, but HudBay will have to be careful and buying time
was an excellent move
A first important improvement of its financial situation will be the Lalor expansion. The new
plant will process ore at a capacity of 4,500 tonnes per day which is 50% higher than the
current milling rate of 3,000 tonnes per day. According to the companys CEO in the
conference call, this will improve the efficiencies and reduce the sustaining capex, which
is positive on both fronts.

Another positive note is HudBays progress at Rosemont. It took the company much
longer than expected, but the Rosemont copper project in Arizona is now finally moving
ahead.

However, Rosemont wont be the holy grail. The Internal Rate of Return at $3 copper is
just over 15%, and I doubt financiers will be falling over themselves to fund the
construction of the project. Never say never though, as I heard Chinese smelters and end-
users have been kicking the tires of some North American projects in an attempt to secure
a stable supply. However, I wouldnt count on Rosemont in the near future.

A third positive achievement will be the inclusion of the higher grade Pampacancha zone
in the Constancia mine plan. HudBay confirmed in its conference call 2017 will be
thepeak year for cash cost and the sustaining cash cost, before significantly declining in
2018 to 2021. This means the (adjusted) operating and free cash flow should increase,
accelerating the net debt reduction.

Source: company presentation

The companys new management did one thing which will very likely have saved the
companys shareholders from additional dilution. In December 2016, when the copper
price was increasing, it refinanced the existing 9.5% debt with two new bonds, raising $1B
with an average cost of debt of 7.48%. This reduced the annual interest expenses by
$20M per year, and kicked the can three years further down the road. Instead of having to
repay $920M in 2020, it now has to repay $400M in 2023 and $600M in 2025. A golden
move, as the company borrowed more cash at a 20% lower cost and thats a job well
done!

Investment thesis

HudBays turnaround has started, and the companys free cash flow in Q1 will help to
reduce the net debt. Although marginal ($14M), the free cash flow is expected to increase
in the next few years as the sustaining capex will decrease whilst a new zone with higher
returns will be mined at Constancia resulting in a substantially lower all-in sustaining cost
per produced pound of copper.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any
positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving
compensation for it (other than from Seeking Alpha). I have no business relationship with
any company whose stock is mentioned in this article.

Comments (5)

ksmith754
I really like HBM and am up 50% since slowly adding. I know this isn't the best metal pick but it has a good run
ahead of it.

26 Jun 2017, 04:41 PM

The Investment Doctor, Marketplace Contributor


Authors reply It's not the best base metal pick, but it probably offers you the most upside in case
copper goes back to $3. Every $0.10 uptick in the copper price will increase the FCF per year by
approximately $20M.

26 Jun 2017, 04:49 PM

The_truth_uncovered
Thanks for this great article! With rising base metal prices in the longer term HBM will hopefully be able to get out
of its debt faster than letting those loans mature. Lets hope management will make sure it takes good care of its
shareholders once the situation starts improving.

Long HBM

26 Jun 2017, 04:46 PM

The Investment Doctor, Marketplace Contributor


Authors reply Once the situation indeed starts to improve, HudBay should also be able to refinance (a
part of) the debt at perhaps even better terms in the early '20s. Buying themselves an additional 3-5 years
was a great decision. Probably the best decision the company has made in years.

26 Jun 2017, 04:50 PM

sliman21
I bet Lundin buys them out.

26 Jun 2017, 05:20 PM

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