Sierra Metals Inc.
Q1 2021 Earnings Call Transcript

Published: 7 May 2021

[Operator:]

Good day and thank you for standing by and welcome to the Sierra Metals First Quarter 2021 Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. I would now like to hand the conference over to your speaker for today, Mr. Mike McAllister, Vice President of Investor Relations. Thank you, sir. Please, go ahead.

[Mike McAllister:]

Thank you, operator, and good morning, everyone. Welcome to Sierra Metals first quarter 2021 results conference call. On today's call, we are joined by Luis Marchese, our CEO; Ed Guimaraes, our CFO.

[Luis Marchese:]

Thanks, Mike. Good morning, everyone. Turning now to slide four. Well, I would like to start by stating that above all, the safety of our workers and the communities in which we operate remains paramount to the company. COVID-19 has imposed various direct and indirect challenges to the company and management, which have affected our ability to operate as effectively as expected in 2020 and continuing into 2021. Impacts have included delays in mine development and preparation of areas for mining and consequently lower head grades as we focus on larger and with lower-grade ore bodies as we strive to meet that. This has resulted in lower metal sales resulting from lower grades.

[Ed Guimaraes:]

Thank you Luis and good morning everyone. Turning now to Slide 6. The company had a relatively good first quarter despite the COVID-19-related operational challenges. We reported a 4.5% increase to our consolidated throughput and generated EBITDA of $25 million. We also reported positive free cash flow and net income and we finished the quarter with approximately $74.3 million in cash. These relatively solid results are the product of evolving optimized operations and expansions ramp up, despite the effects of COVID-19 providing solid financial and operational performances which we expect to continue as we progress into 2021. Our revenue mix by metal continues to be led by copper followed by silver and zinc. While we have seen the copper portion reduced in Q1 due to previously disclosed factors, it is expected to continue to take a leading role in the company's metal mix of production and revenue.

[Mike McAllister:]

Thanks, Ed. That ends the presentation portion of this call. As previously mentioned, we are open to discussing other topics of interest that shareholders may have. We would now like to open the call to questions from participants. Operator, please open the lines.

[Operator:]

So our first question comes from the line of Mark Reichman with Noble Capital Markets.

[Mark Reichman:]

Good morning. So the first question is Luis, probably address some of this in his commentary, but I wanted to ask, just what exactly needs to happen and when do you expect to see grade improvements at Yauricocha and Bolivar?

[Luis Marchese:]

Thanks Mark. Thanks for the question. I mean what has happened at both mines Mark is that, we've been with the COVID situation for over a year now and we have been over time prioritizing development and mining to make sure that we had the tonnes to feed the plant. In that process, we have been prioritizing larger ore bodies although with lower grades, okay? So, we are now and we've had in the first quarter the effect of this prioritization. Otherwise, we wouldn't have met the tonnage.

[Mark Reichman:]

So is it fair to say, when comparing first quarter production actuals to the guidance range, I mean it doesn't seem like it should be too much of a stress to achieve the low end of the range. But your ability to gain ground during the remainder of the year that will in part be driven by the trajectory of the impact of COVID. Is that the way to kind of think about it?

[Luis Marchese:]

Yes. Yes. I think that summarizes it.

[Mark Reichman:]

I’ve got a couple of more questions. But I think I’ll just go back into the queue and follow up with you later.

[Luis Marchese:]

Okay. Thank you.

[Operator:]

Your next question comes from the line of Alex Hunchak with CIBC.

[Alex Hunchak:]

Hi, everyone. Thanks for taking my questions. I was also going to ask on the guidance. So it looks like you guys have sort answered that one. But maybe switching to the exploration to Yauricocha. Some nice results out there. Is that something that you guys can add to the resources this year, or is it going to take a bit more drilling than that? And when could we maybe see some of that new zone in the actual mine plan?

[Luis Marchese:]

Thanks for that question, Alex. Yes the areas that we started driving what we call Sierra Yauricocha mill last year to add – to look into this one to 1.5 kilometer stretch with Esperanza and Cachi and start putting some exploration spots there. As a result of that, we have found some continuity right next to the north of Esperanza and that's what we announced in the market in our press release.

[Alex Hunchak:]

Okay. Great. Thank you for that. And then maybe could you also just give a comment maybe on the political situation in Peru and how that might impact your closure going forward? I know it's a bit uncertain still, but how are you guys viewing that going forward?

[Luis Marchese:]

Yeah. Well Peru is really -- mining is very important in Peru. It's 10% of the GDP. 18% of the taxes. 40-whatever-percent of the exports of the country. So it's the elephant in the room in terms of the economy. And it always comes as a topic of discussion with every presidential election. So this is the case now. We have two candidates. One Keiko Fujimori and the other Pedro Castillo. They have also addressed their initiatives around mining and their impact to the country and their view. There are discussions of government take about redistributing the benefits of the mining revenues into the population and the rest. Having said that, Peru is a demography. So there is a -- if -- for the initiatives to move forward, they will have to go through Congress and through a strong debate. Keep in mind that the Congress has already been elected and none of the two candidates have a majority. They have minorities in Congress. So any decision-making in terms of anything, but in particular to mining, which is what we're discussing would have to go through Congress and through a good debate. We are now as you said in the middle of the campaign. So it's a bit uncertain. You know how campaigns are. So let's wait for the result and see what comes out of this. And then eventually we will engage -- the industry will have to engage in a conversation and together with a political adversary.

[Alex Hunchak:]

Okay. That's a good synopsis.

[Luis Marchese:]

Thank you.

[Alex Hunchak:]

And that's it for me. Thanks guys.

[Luis Marchese:]

Thank you, Alex.

[Operator:]

Your next question comes from the line of Lee Cooperman with Omega Family Office.

[Lee Cooperman:]

Let me just say this that I am incredulous that you guys do not voluntarily say something about the strategic review process which was valued as a big deal in early January. So what can you say to update us about the strategic review process?

[Luis Marchese:]

Thank you Mr. Cooperman. Thank you for the question. We can -- okay well I can say is that the strategic review process has also been affected by these unusual times. And it's taking a bit longer than we had expected because of the restrictions on pretty much anything we...

[Lee Cooperman:]

When do you think that you'll have something to say. Well we're not asking what you're going to say, but when do you think you'll conclude the process, if you had to guess?

[Luis Marchese:]

We won't -- difficult to tell. But certainly, we are working on it consistently and we expect this to happen in the next few months. And hopefully come back to the market with good results from this process.

[Lee Cooperman:]

All right. Second question. If the process doesn't yield an attractive enough pricing, I happen to come from the vantage point your stock is significantly mispriced. Year-to-date to give you an example Freeport copper and gold was up 67%. Despite you're -- putting up a sale sign to come, but your stock is only up 13% year-to-date. But after the strategic review process does not provide a price that's attractive, how much debt is the company willing to carry? Because I think we could recapitalize the company at a very favorable price. In other words, I look at the – you look at your EBITDA forecast this year, and look at the tonnage that you're projecting for the next couple of years, I assume your earnings will grow quite substantially, if prices stay at these levels. But is the company prepared to take on debt to buy back stock, or is the company uncomfortable doing that?

[Luis Marchese:]

Thank you. Thank you for the question. Mike, maybe Mike can comment on the on the market situation and the comparison that you just made and then we can comment on the scenario that you are suggesting.

[Mike McAllister:]

Yeah. So the only thing I would say there is – yes see, if you compare us to Freeport then we're down. But it's not really an apples-to-apples comparison. Freeport is more of a pure copper play. We're a diversified producer. If you look at us compared to like Hudbay or some other base metals comparables, we're pretty much in line. With iron ore, we're doing better. And silver peers we're doing good against them as well on a mid-tier level. So while I hear you on the Freeport, we're not a major yet. So, a little ways off. So, it's not really a fair comparison for that. We're more of a –

[Lee Cooperman:]

Well I would observe is none of these companies you're mentioning have put themselves up for sale. Generally, speaking when a company puts itself up for sale, you get a premium because people anticipate a favorable outcome. And I am not interested in selling the company at a discounted price. So when I look at the enterprise value of the company, and I look at our free cash flow seems to me that, we could create a lot of value for the shareholders by recapping the company. In other words, for example, if EBITDA was a couple of hundred million which I think will be next year, and you had debt to EBITDA say two times, that's $400 million plus you'll be in a net cash position. That's two-thirds of the market cap of the company. So it's to me very exciting that we can make our own luck, but anyway I just plant that seed. Am I right in assuming that you're still staying with guidance, which is at current spot prices EBITDA this year of $170 million to $185 million and on consensus prices $155 million to $170 million. Is that still your guidance?

[Ed Guimaraes:]

Thank you. Yes. Yes it's still our guidance.

[Lee Cooperman:]

Okay. Good. Okay. And I assume that you would anticipate – if I said to you prices will remain at current levels, which is the big assumption that we would earn more money in 2022 and 2023 than we're earning currently?

[Ed Guimaraes:]

That's correct.

[Lee Cooperman:]

Okay. Good. Okay. And tell me about the iron ore project, which is going to take up a fair amount of CapEx. What is the return on that CapEx likely to look like or the profitability of the iron ore business?

[Luis Marchese:]

We are going to – thanks for the question. We were very excited about that project which we are bringing into construction now. We are going to release the economics in the next few weeks as we issued EIA for Bolivar including that project. So I cannot claim the economics. But I can tell you some characteristics about this project. We are going to do it at a very reduced capital intensity. We're going to spend as you've seen in the press release $28 million for 0.5 million tonnes of iron ore concentrate. If you compare us with the CapEx intensity of any other iron ore project in the market, we are in the low end. On the other hand, in terms of operating costs, Bolivar is very fortunate that we have a way of road line only 50 miles from the mine. While if you have iron ore project anywhere in line in the world, usually build and infrastructure becomes a major color and a major issue in terms of CapEx. We don't have that because we have the train available. And also we have in Mexico one port, which is the closest one to our operation that has space and facilities and infrastructure to manage the production that we are going to bring from the magnetite. On the other hand, we have quite a good stockpile of ore that we're going to process through these new facilities. And this will drive our own cash operating cost at the mine to the low end. So now our challenge is to bring these to operations as soon as possible and then we are going to add value following our ore resources. So on top of our current metals mix, which is I think extremely strong because we have as you are aware copper, silver, zinc and rest, we're going to add iron ore. So Sierra Metals is going to pretty much become an example of the right metals mix for the future.

[Lee Cooperman:]

Yes. You don't want to answer the question for a few more weeks. But by and large, you have the answer because you would have not gone ahead and improved the CapEx of $28 million without doing the analysis. Is that correct?

[Luis Marchese:]

Absolutely. Yes. But we have to follow the regulations...

[Lee Cooperman:]

Well this is an open mic. You have -- this is open to the public right? So whatever I don't want to go down that path. Just -- do you expect to end the year with more cash than you have presently? In other words, you have $175 million let's say, I'm using as EBITDA. We have CapEx of what $106 million, how much of that $106 million has already been spent this year? In other words, how much additional spending we're looking at? Have you spent any money this year yet of the $106 million?

[Ed Guimaraes:]

Yes. Yes, we have. And we're a little bit behind in Q1, we're about $10 million from what we said in terms of annualized, if you were to take the quarter and annualize that. But to answer your question, yes, we expect there to be a positive free cash flow so -- and add-on to the cash balances. Yes.

[Lee Cooperman:]

Yes. I would expect that you would end the year debt-free. If you took your cash minus your debt that you would be debt free. Is that a bad assumption and too aggressive?

[Ed Guimaraes:]

No. It's going to be closely, but yes it's going to be approximately around that. Might have some, but it's going to be de minimis. It might be less than $10 million.

[Lee Cooperman:]

This is a little bit esoteric, but I am I think the third largest shareholder in the company. And I -- if we don't have a favorable conclusion to the auction process and I'd say do we have a favorable conclusion. I think that the buyer should have to pay materially more than the last sale to buy this business that we should consider substituting debt for equity in the capital structure. In other words, we're in an environment where interest rates are the lowest in history and our equity price is very cheap relative to the underlying asset value. So it seemed to me to be intelligent to substitute debt for equity in the capital structure as long as we feel we're a couple of hundred million dollar EBITDA-type earner, which I suspect you think would probably higher than that going forward? So just expressing a view -- expressing view and I'm happy to discuss that off-line with management. And my last observation. You're going to love this one Mike. Why are we making it so difficult for people to listen to the call? Why are we requiring preregistration and stuff like that? What are we afraid of? I mean, I've been doing this for over 50 years and I don't recall this being done by anybody else. Why are you doing it that way to ask questions you have to preregister?

[Mike McAllister:]

A matter that star provider has scaled back during COVID. And there's not as many operators available. And so if everybody dials in at the last minute they're going to be overwhelmed. And so we're asking people to preregister. And we're hoping that this would go away as things improve.

[Lee Cooperman:]

Got you. Okay. Got you. Thank you for your answer. I appreciate. Good luck. Thanks. Stay healthy. Thank you.

[Operator:]

Your next question comes from the line of Richard Carrigan with Equitec .

[Unidentified Analyst:]

Good morning. You've already answered my questions. But I have one last question. Did we undertake this review process four months ago as a result of some specific expression of interest in the company? That's my only question now.

[Luis Marchese:]

Well, thank you. Thank you for the question. No. It was because we -- the Board discussed the strategic position of the company. And it was the view of the Board that it was a good time and the right opportunity to undertake this process.

[Unidentified Analyst:]

And did I understand you correctly answering an earlier question that the process will probably drag on for another two months perhaps?

[Luis Marchese:]

Well, I cannot preempt that, but we expect that it will go for the next few months.

[Unidentified Analyst:]

Thank you for your time and good luck.

[Luis Marchese:]

Thank you.

[Operator:]

Your next question comes from the line of Jim Young with Midwest Investment.

[Jim Young:]

Yeah, hi. A couple of questions here for you. Number one, regarding these cost trends that you experienced in the quarter, are these expected to remain at these elevated levels for the foreseeable future, or would we expect to see the -- a decline materializing over the next couple of quarters? Thank you. That's my first question.

[Luis Marchese:]

Thank you Jim. Thanks for the question. As the grades go up, Jim we expect the cost per metal produced to go down. But that's a function of how we can be successful on bringing this higher-grade ore into the mix. I think we are getting there in Bolivar who is a bit behind because of all the impacts that they had in the first quarter. Yauricocha it's a bit more difficult because as I said we are in the middle of this second wave in Peru. So it's getting a bit trickier to get into those ores as soon as we would have liked to. Having said that, we are bringing more workforce into the mine and trying to get faster into those grades. So that's a function of how we do and how well we can do in terms of this COVID situation. Let me give you a number that strikes -- that has strikingly in the first quarter. In January, out of the 560 or 570 the people that work in Bolivar, we have -- in the -- through the screening process we got a stop over 150 that were sick with COVID. And in February, we had over 40. So we're talking in the first month over 25% of our workers who are sick of COVID and in the second month another 8%. So this has been a real hit, okay, in Mexico in the first quarter. Now we're seeing way lower numbers, but we are still looking into it. Now in Peru we are seeing more cases. So, we still don't know how this is going to evolve, but we are happy that our screening process is working, okay? But we are certainly -- I'm happy that so many of our workers have been sick out of this disease over the last few months.

[Jim Young:]

Okay. Thank you. And I appreciate your focus on the safety of the employees. The next question would be pertaining -- and this is for Ed, regarding the TCs and RCs. And Ed, I recognize and understand that in the past you aren't able to really comment directly upon Sierra Metals' specific situation, but can you give us a sense as to how much of the benefit from lower TCs and RCs we saw in the first quarter? And can you help us give us a feel for how much additional benefit do you expect in the second quarter, third quarter and fourth quarter of 2021?

[Ed Guimaraes:]

Jim, that's a very good question. And I don't mind going in and elaborating a little bit more on the TC situation especially with the rising metal prices and I could explain a little bit how the TC mechanism works. So, just first off, the first quarter still had TCs and RCs from the previous year negotiated contracts. And that was because of COVID we had delays in fulfilling all of our contractual commitments with our customers, with our off-takers. Typically, these contracts for concentrates are very short term. They're usually one year, in nature. And the reason for that is, many we do -- we do a tender process every year. So, it involves about 20 offtakers, some refiners. And built into these the TCs RCs, if you will, are escalators. And what that means is that when you negotiate a contract, the counterparty wants to or puts in provisions that they participate in the upside of any metal price. So, in the case of -- let's just take copper. Copper has -- a year ago copper was around $2.50. We're currently at $4.70. So, what does that mean to the TC? Your TC would be negotiated at a base price. And that base price for argument's sake, let's just say, was $6,000 per tonne copper price. We're now at over $10,000 per tonne and rising. What this -- the implications on the TC is as the metal price rises, the offtakers can participate by way of an escalator in the form of higher TC. So that -- essentially what I'm saying is that they participate in the upside. We don't get 100% of the upside. It's not like you can just take a benchmark TC for copper for instance of $60. No, that $60 will increase and in the case of copper, it could be significant. If metal prices were to stay where they are now, you could see a significant rise in that TC based on the escalator.

[Jim Young:]

[Ed Guimaraes:]

That's correct. That's industry-wide and it does affect our all-in sustaining costs. Not our cash costs, but are all-in sustaining costs which is essentially out of our control in that we include it in the overall cost number. So -- and that's what we're dealing with there. So, there is some upward pressure definitely on the TCs and RCs. Even though we negotiated much better terms in terms of if you want to take benchmark as -- if you look at benchmark for zinc for instance it is down -- last year's benchmark was about 300. This year I think they were closer to the 140, 150 level. Same thing with copper they were down probably 25% compared to last year. But you now have to factor in this escalator if you will. And that could be significant especially for copper. Copper is on a tear right now. Is it a bad thing? No, it's a good thing. I think we shouldn't -- I'd sooner take this than a copper price of $2.50, but it's important to recognize that we don't participate fully in the upside of metal costs.

[Jim Young:]

And that's just for this

[Ed Guimaraes:]

That's correct. So, these -- because we keep these contracts relatively short-term. So, when we negotiate next year, these escalators they reset to zero. So, if copper was at $4.70 on January 1st, 2022 or whenever we negotiated that contract that escalator -- or that's the base price and then escalators go from there. So, it really doesn't have any impact long-term. It's really just a short-term impact on the TC situation.

[Jim Young:]

And that still look for RCs too?

[Ed Guimaraes:]

No, it's just a TC. It's on the headline. It's on the treatment charge. Normally, these things wouldn't be -- we hardly talk about it because you wouldn't see significant swings in base metal prices like we've seen. I don't recall seeing such a swing over the past 10 years in copper prices.

[Jim Young:]

Okay. And then secondly, I guess, my last issue to just say is that the guidance you gave back on January 18th for EBITDA, I would -- I'm a little curious and a little bit disappointed frankly that you have not eliminated the low end of that range because of -- and I totally recognize and understand that the near-term challenges from COVID the impact on production, the impact on grades a little bit. But it would seem to me that given where the commodity prices are overall at that low end of the range is just way, way out of the question. So, I don't understand why you're not eliminating that low end of the range and updating that guidance for EBITDA for 2021?

[Ed Guimaraes:]

I think it's still premature, Jim. We'll certainly look at it. I think probably in a couple of months when we close off Q2 we'll definitely -- we'll provide a lot more clarity at that point. But now given the costs that we've had in Q1 associated with COVID given this price participation that I've mentioned in terms of not benefiting fully in the price of the metals. It's -- we're comfortable leaving it where it is and we may make further adjustments or refinements to that in the future, but for now we're maintaining assays.

[Jim Young:]

Okay. Thanks very much. That’s all for right now.

[Operator:]

And you have a follow-up question from the line of Mark Reichman with Noble Capital Market.

[Mark Reichman:]

Yes. This is a question for Ed. So capital expenditures for 2021 those were originally forecasted to be $78 million, which included, kind of, a carryover of $10 million from last year. So $37 million was for sustaining, $41 million was for expansion. And now you've got the $28 million for the iron ore processing plant. So do you expect to expand the full budget for the year, or maybe I should just ask could you, kind of, address the spending for the remainder of the year including the $28 million for the processing plant?

[Ed Guimaraes:]

Thank you for the question. And yes with COVID, we have had restrictions and that has affected mine development. It's affected exploration development. And so that was -- we had -- that explained the carryforward into 2021. Could we have a similar carryforward? It's still too early to tell. But if we are restricted in terms of headcount it could have an impact. So including the magnetite we're looking at $106 million, the $78 million plus the $28 million that we just recently announced. Could we fall short of that? Yes. It's too early to say. But there could be where we might have a carryforward into next year. But if we do it's really at the -- it's because of the safety precautions and just having lower headcounts.

[Mark Reichman:]

Yes. So some of that spending will fund some of the improvements that Luis alluded to in my earlier question. So in terms of the -- do you think for your ability to gain ground in the -- for the remainder of the year to -- in terms of production is that more of a function of the sustaining CapEx spending, or will some of that be on expansion as well?

[Ed Guimaraes:]

In terms of maintaining -- because we could easily…

[Mark Reichman:]

It should be all.

[Ed Guimaraes:]

The plant capacity we can go over so that -- it's really -- it's just in the sustaining. The growth really doesn't impact production. It's all-in sustaining. And the good thing is we have the cash to fund the CapEx. So if we can we definitely will spend it. It's really more of a security situation regarding COVID.

[Mark Reichman:]

Okay. Great. Thank you very much.

[Operator:]

And there are no questions at this time.

[Mike McAllister:]

Thank you operator. That concludes today's call. On behalf of the management team, I would like to thank all the participants for joining us today. A replay of the webcast and all materials can be found on our website at sierrametals.com. If there are any further questions or concerns, you may reach out to us after today's call. Our contact information can be found in today's presentation, as well as on the company's website. Thank you operator. Please conclude the call.

[Operator:]

Ladies and gentlemen, thank you for your participation in today's conference call. Today's conference call has concluded. You may now disconnect.