Turquoise Hill Resources Ltd.
Q2 2017 Earnings Call Transcript

Published: 1 Aug 2017

[Operator:]

Good day, ladies and gentlemen and welcome to the Turquoise Hill Resources Q2 2017 Financial Results Conference Call. At this time, all participants are in a listen only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference call maybe be recorded. I would now like to turn the conference over to Tony Shaffer. You may begin.

[Tony Shaffer:]

Thank you, operator. Welcome to our financial results conference call. Yesterday, we released our second quarter 2017 results press release, MD&A and financial statements. These items are available on our website and SEDAR. With me today are our CEO, Jeffrey Tygesen; Owen Thomas, Acting CFO; and Brendan Lane, Vice President of Operations and Development. We'll take your questions after our prepared remarks. This call will include forward-looking statements. Please refer to the forward-looking language included in our press release and the MD&A. I'd now like to turn the call over to Jeff.

[Jeffery Tygesen:]

Thanks, Tony. It's been good to see the copper market moving in a positive direction over the last few weeks and how Turquoise Hill's valuation has benefited alongside the upward moving copper prices. I think this also demonstrates how quickly copper price can move on potential supply constraints. We are even starting to hear $4 copper being discussed. This supports our long term view that copper prices will not remain at current levels with the expected supply gaps anticipated to start around 2019 to 2020. Recently we're actively marketing to investors in June and July and it was good to hear from them their positive sentiment on long term copper prices as well. During the second quarter, Oyu Tolgoi had an excellent safety performance with an All Injury Frequency Rate of 0.27 per 200,000 hours worked. With the ongoing increase in the underground workforce, Oyu Tolgoi has done a fantastic job introducing new employees and contractors to our strong safety culture. Underground development continue to progress. Lateral development advanced at a good rate during the quarter and Shaft 5 saw at second highest month of sinking progress in June. Brendan will provide more detail on underground development later in the call. While we continue to expect production from first draw bell in mid-2020 and sustainable production in 2021. Commissioning of a new pressure is expected to be complete in August allowing for full utilization of the third development crew. We expect lateral development to increase with the introduction of the third crew. Crews 4 and 5 were in training and should be deployed in the second half of the year. For the first half of 2017, Oyu Tolgoi spent more than $320 million on underground development. Going forward, quarterly spend is expected to continue to increase. At the end of June, Oyu Tolgoi had further capital commitments of 1.1 billion beyond spend to date. Lastly, open-pit operations continue to make the best of low grades and recovery challenges. The concentrator is on target to process 40 million ton this year, which we had tremendous achievement in our first Oyu Tolgoi. We expect gold grades and recovery to move up slightly in the second half of 2017. As such, we are maintaining our production guidance for the year. For 2017, Oyu Tolgoi's strategy is to focus on copper in order to maximize copper metal production because copper shared revenue is over 80% when compared to gold. Revenue in the second quarter decreased approximately 14% compared to Q1. For reference, first quarter revenue benefited from higher gold production in the later part of the fourth quarter of 2016. Operating cash flow for the second quarter was more than $50 million than almost a $140 million for the first half of 2017 with Oyu Tolgoi benefiting from strong copper prices. That said, OT has worked extremely hard to control operating cost in order to deliver positive operative cash flow. I would note that since 2014, OT has removed over $200 million in operating costs. I am pleased to make comments about two numbers to remember for Oyu Tolgoi which are 3 and 8. Three years until production from the first draw bell and eight years until significant free cash flow from Oyu Tolgoi. Our definition of free cash flow includes principal and interest payments for project finance and supplemental debt. Based on feedback from investors, we have a very conservative definition on free cash flow. We are told that depending on how we structure long term financing for OT, investors may not include principal repayments in their calculation free cash flow. If that were the case, it would likely result in cash flows in less than eight years. Another major factor in such a calculation be the price of copper. For example the price assumed for 2017 in the technical report for the reserve case showed 215 per pound. Today, we are 280 per pound. Overall, current operations are performing well, despite the low grade this year. 80% of Oyu Tolgoi's long term value resides in the underground. From a near term perspective the most important value driver for Turquoise Hill is to deliver on the underground development timetable and production ramp up schedule. This should enable good cash flow to Turquoise Hill and expect dividends to our shareholders. We are working closely with Rio Tinto to achieve these targets. I am very happy with the concentrator's performance history and what the team at Oyu Tolgoi has achieved. With that I'm going to turn the call over to Owen to discuss the financial aspects of the quarter.

[Owen Thomas:]

Thank you, Jeff. Revenue for the quarter was $204 million, decreased approximately 14% over the first quarter of 2017, reflecting lower concentrate sales and lower copper prices. Average copper prices in the quarter decreased by about 3% from the first quarter from $2.65 per pound to $2.57 per pound. Average gold prices for the quarter increased by about 3% from the first quarter averaging $1,257 per ounce. Concentrate sales decreased approximately 4% over the first quarter. Gross margin for the quarter was approximately 7%, down from 18% in the first quarter, driven by lower sales revenue. Cost of sales included an adjustment of $4 million for reversal of provision against concentrate inventory, reflecting the improved spot prices at the end of the quarter. Finance costs of $41 million are presented net amount capitalized on underground construction of $47 million. Income attributable to Turquoise Hill shareholders in second quarter was $24 million. Cash from operating activities of $51 million reflects the impact of lower sales. Interest paid of $107 million increased payment of project finance interest of $99 million. Payment of project finance interest takes place twice yearly in June and December. Capital expenditure on a cash basis was $205 million in the quarter compared with $148 million in the third quarter and includes $185 million for the underground project. Since January 1, 2016, the total amount spent on underground development is $548 million with capital commitments of $1.1 billion at June 30 of $35 million in the second quarter compared with cash used for investment activities of $83 million in the first quarter. The change reflects increases to amounts withdrawn from the related party receivable. The increased withdrawals were needed in order to fund the higher levels of underground capital expenditure in the quarter and the payment of project finance interest and due to the impact of lower operating cash flows on cash available for reinvestment. The net realizable value of copper gold stockpiles at the end of the quarter was $96 million, an increase of $15 million from the first quarter, due primarily to reduced estimated conversion costs per ton and increased estimated metal recoveries, both of which positively impacted the value of the medium grade stockpiles. And net reversal of the income statement of $40 million was consequently included within operating expenses for the quarter. In the quarter, we increased the total deferred tax assets recognized from $339 million to $368 million. This was the main driver of an income statement credit the income and other taxes of $24 million. The increase primarily reflects additional Mongolian operating losses and interest charges incurred by Oyu Tolgoi in the second quarter of 2017. As June 30, Turquoise Hill's cash balance remained consistent with previous periods at $1.4 billion. C1 costs in the quarter were $1.92 per pound compared to $1.85 per pound in the first quarter, mainly due to lower gold sales revenues in the second quarter. That concludes my comment, and I'm going to turn the call over to Brendan.

[Brendan Lane:]

Thanks Owen. During the second quarter, the concentrate continue to process all from both 6, 4A and stockpile. As noted, during the first quarter results, Phase 6 is a challenging ore and complex blending is required to make shipping specifications. Also given the very low grades of gold expected in 2017, Oyu Tolgoi's object this year has been to maximize copper production and the resulting revenue. We do this by using the highest copper grade available, which is currently Phase 6. Phase 6 also has another advantage of being a soft ore enabling a higher throughput in the plant compared to ore from Phase 4 and significant portions of the stockpiles. Oyu Tolgoi continues to perform well in managing this complex ore blending with offsetting factors such as high arsenic and high pyrite levels as discussed in the previous quarter. In the second half of 2017, we will continue demand Phase 6 as an ore source as we move towards 2018 and a return to a majority of the harder Southwest ores of Phase 4. Phase 4 ore will contribute to slight improvement gold grades in the second half of 2017 and significantly higher gold grades in the second half of 2018. Plant concentrator maintenance during the quarter was carried out successfully by an old Mongolian management team, without injury and encompassing over 20,000 hours to a temporary increase workforce of nearly 400 people. When taking this five day concentrated shutdown into account in the second quarter, the mill performed at 40 million tons per annum rate with around of third of the mill C being the soft ore from Phase 6. This good plant performance is expected to continue through 2017 with the Phase 6 central zone ore. This also provides an indicator of performance when Hugo North Lift 1 block cave eventually becomes the majority of all phase of the concentrator. Moving to the underground, overall development continues to advance and the workforce has continued to grow with over eight million man hours worked on the project today. Kent expansion works continued during the quarter with increased deliveries of modular accommodation blocks ready to be installed and fully complete and Kent will be world class larger scale accommodation facilities with more than 1800 rooms, 18 buildings encoding for over 5000 people. Since the project restart mid-2016, we've completed over four equivalent kilometers of lateral development. The second quarter created two of the three best months of underground developments since project meeting the previous best month in March 2017. During the quarter, important increase development in Ivanhoe move forward including the mechanical completion of the heart of [ph] dewatering system and a new larger underground development crusher. At the end of July, the crusher will in commissioning and is expected to be complete August, allowing for the full utilization of the now deployed third crew. Development to the end of June was effectively carry-up by any two crews. The fourth and fifth crews are expected to follow later in the second half of this year, the training currently in progress. During the second quarter, the Shafts 2, 1220 lighting level massive device and works were completed and sinking activities recommends towards the 1256 level. The Shafts 2, 1220 skip lighting station design included massive device of approximately 18 meters wide, 34 meters long and 22 meters high. Shafts 2 will be a multi-purpose production, service and from insight ventilation shaft moving up to 30,000 tons per day as well of people on equipment. It will be 10 meters in diameter, concrete line and sunk to a depth of 1284 meters. The 60 tons production skips from 1202 and a 150 person service cage operating primarily to the main access level of 1256. A design for simultaneous hosting by simultaneous hosting of ore[indiscernible].Sinking is expected to be complete in 2017 with the concentrator plant with a fit out plant to occur over 2018. Prices improvement initiatives during the second quarter led to increase Shaft 5 sinking rates of around 40% compared to the first quarter. The better thinking rates over the last quarter expected to continue going forward. Shaft 5 is expected to reach its final test in early 2019. We continue to expect that the lateral development rate we are currently seeing will provide a buffer to the longer than expected thinking of Shaft 5. As such, we don't expect this to materially impact the lateral development plan. In the coming quarters, we expect to see a step up in lateral development with July and August being targeted as the largest month since the project restart. Finally, we remain on target for production from the first draw point blast in mid-2020 and sustainable production in early 2021. That concludes my comments, I'll now turn back to Jeff.

[Jeffery Tygesen:]

Thanks Brendan. For the second quarter, open pit operation performed as planned with Oyu Tolgoi focusing on copper production in order to maximize revenue. We expect great and recoveries to increase slightly in the second half of 2017 and we are maintaining our production guidance. The concentrators on pace to have a record year. Underground development continues to advance, lateral development is progressing well, and sinking rates for Shaft 5 to improve significantly. We maintain our expectation of underground production from the first draw bell in mid-2020 and sustainable production in 2021. That concludes our prepared remarks. Lien, we are ready to take questions.

[Operator:]

[Operator Instructions] And your first question is from Ian Grundy with Scotiabank. Your line is open.

[Ian Grundy:]

Hi guys. Just a quick follow up question on interesting comment Jeff made there about free cash flow and principal repayments. What kind of quantum in the first few years of the ramp up, are you assuming for principal repayments on the debt in terms of that statement about free cash flow to shareholders?

[Jeffery Tygesen:]

So the terms of the agreement we have for the project finance have interest only for the first five years. I think that gets us to mid-2021. It ramps up slowly and we end up having it all paid off by year 2027. So the first couple of years are low and then it ramps up to meet the total payment back by 2027.

[Ian Grundy:]

Okay. That's very helpful. And then if the copper market does surprise favorably versus your expectations, I mean if we did end up in closer to a $4 a pound environment, how would you think about using any excess cash, although you get over that time when it go to paying down the project finance faster or would you think about repayments to shareholders or expansions or just if you could give some color to it would be great?

[Jeffery Tygesen:]

$4 copper would be great for everybody. We have a fixed payment schedule currently that would be an option to consider to repay earlier. But one option considered today would probably be looking at any excess cash as a possible dividend earlier. But that would be a good position to be in at $4 copper.

[Ian Grundy:]

Yeah, yeah. I certainly agree. That's it for me. Thank you.

[Jeffery Tygesen:]

Thank you.

[Operator:]

[Operator Instructions] And I am showing no further questions. I would now like to turn the call back to Jeffery Tygesen for any further remarks.

[Jeffery Tygesen:]

Thank you for joining us today. Just a final comment, we continue to invest in the underground and Oyu Tolgoi realizing its full potential.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program and you may all disconnect. Everyone have a great day.