Turquoise Hill Resources Ltd.
Q3 2017 Earnings Call Transcript

Published: 3 Nov 2017

[Operator:]

Good day, ladies and gentlemen and welcome to the Turquoise Hill Resources Q3 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 follow at that time. [Operator Instructions] As a reminder, this conference maybe be recorded. I would like to introduce your host for today's conference, Tony Shaffer. You may begin.

[Tony Shaffer:]

Thank you, operator. Welcome to our financial results conference call. Yesterday, we released our third 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, Jeff Tygesen; Luke Colton, 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.

[Jeff Tygesen:]

Thanks, Tony. Before I begin, I want to welcome Luke Colton, our new CFO. He started on October 9 and has been inundating himself with Turquoise Hill. Luke joins us from Richards Bay Minerals, which is one of Rio Tinto's key IOT operations in South Africa where he was CFO. For today, I want to start with safety. Through the end of September, Oyu Tolgoi's All Injury Frequency Rate of 0.25 for 200,000 hours worked. This is an impressive result, particularly with the addition of about 2500 people to our underground workforce so far this year. The Management of Oyu Tolgoi is meticulously training new workforce about the mine safety culture. Open pit operation had an impressive third quarter. During the quarter, Oyu Tolgoi set records for open pit material mining and concentrated throughput. We are track for 40 million tons of throughput this year and it's possible we could achieve that number. Revenue for the quarter was almost $250 million, an increase of more than 20% over the second quarter. Improved copper and gold prices were one reason for the increase as well as the almost 30% improvement in gold production over the second quarter. The increased gold production was due to higher head grades and better recovery. Operating cash flow for the quarter was approximately $95 million and through the third quarter, Oyu Tolgoi has generated almost $235 million for 2017. We started the year expecting zero positive operating cash flow, so the outcome has been very stellar. Obviously, a strong price environment helps the operating improvements Oyu Tolgoi has made and continues to make contributes to better cash flow. For reference since 2014 Oyu Tolgoi has generated over to $2 billion in operating cash flow. As part of our site visit in September, we announced that we expect more gold production in 2018 than forecasted in 2016 technical report due to the splitting of Phase 4 into two sections. We released our 2018 production and financial guidance in mid-December, but we expect the additional gold in 2018 could be approximately 100,000 ounces. The additional gold is simply the result of bringing production forward from future years. Moving to underground developments, good progress was made during the quarter with lateral development, the sinking of Shafts 2 and 5, and convey-to-surface development. Brendan will cover this in greater detail later in the call, but I wanted to mention a few the highlight. The 3500 ton per day development crusher was commissioned during the quarter and is fully operational. Also during the quarter, the third deployment of crews was fully deployed and crews four and five are in training are expected to be fully deployed during the fourth quarter. There is a lot of focus on Shaft 2 development including further mass excavation and final sinking before the 2018 fit out. Shaft 2 is key to future increases in lateral development. Underground CapEx through the end of third quarter was more than $525 million. As referenced during the September site visit, Rio Tinto is undertaking a schedule and cost, which is normal for large scale project. We continue to expect first draw bell mid-2020 and sustainable first production in 2021. The four key areas for the third quarter are open pit operations continue to fire on all cylinders and set operational records. Strong copper and gold prices are having a positive impact on revenue and cash flow. Underground development continues to progress and our targets for sustainable production are unchanged. The development team is focused on advancing Shaft 2 in order to increase future lateral development rate. With that, I am going to turn the call over to Luke to discuss the financial highlights of the quarter.

[Luke Colton:]

Thanks Jeff and thanks for the welcome. Revenue for the quarter was $247 million, which is an increase of approximately 21% over the second quarter of 2017 and this reflects the higher copper and gold prices. Average copper prices in the quarter increased by about 12% versus Q2 from $258 a pound to $290 a pound. Average gold prices for the quarter increased by about 2% from the second quarter, averaging 1,287 per ounce, Concentrate sold increased approximately 3% over the second quarter. The gross margin for the quarter was approximately 20%, that's up 7% in the second quarter driven by higher sales revenue. Cost of sales included an adjustment of $3 million for a reversal of provision against concentrate inventory, reflecting improved spot prices at the end of the quarter. Finance cost of $37 million are net of amount capitalized on underground construction of $53 million. Income attributable to Turquoise Hill shareholders in Q3 was $65 million. Cash from operating activities of $95 million compares to $51 million in the second quarter, again reflecting a higher average selling price for gold and copper. Capital expenditure on a cash basis was $234 million in the quarter, that compared to $205 million in the second quarter and includes $206 million for the underground project. Since the 1 January, 2016, the total amount spent on underground development is $754 million, with capital commitments at 30 September of $1.1 billion. Cash used in investing activities was $3 million in the quarter, compared with cash generated from investing activities of $35 million in the second quarter. The variance is due to higher levels of underground cash capital expenditure, together with higher cash generated from operating activities in the quarter, which leads to a lower amount of capital expenditure needing to be funded by amounts withdrawn from the related party receivable. The net realizable value of copper, gold stockpiles at the end of the quarter was $60 million. This is a decrease of $30 from the second quarter and is due primarily to reduced copper and gold grades in the remaining stockpile. This is because higher grade stockpile door was processed during the quarter, thereby negatively impacting the value of the residual medium grade stockpile. This resulted in a charge to the income statement of $25 million and is included within operating expenses for the quarter. This also include the $5 million charge related to the materials and supplies provision. In the quarter, we increased the total deferred tax asset from $368 million to US$446 million. This was the main driver for an income statement credit for income and other taxes of $71 million. The increase primarily reflects additional Mongolian operating losses and interest charges incurred by Oyu Tolgoi in the third quarter 2017. At September 30, 2017 Turquoise Hill's cash balance was $1.5 billion compared with $1.4 billion at the end of the previous quarter. C1 costs in the quarter are $1.83 per pound compared to $1.92 per pound in the second quarter. That's mainly due to higher gold sales revenues. This concludes my comments and I'll turn the call over to Brendan.

[Brendan Lane:]

Thanks Luke. During the third quarter, the concentrate continue to process all from both 6, 4A and stockpile. As noted, during the previous calls, Phase 6 is a challenging ore requiring complex blending to make shipping specifications. Mix blending will continue for the remainder of 2017 and for a small part early 2018. Also, as previously noted, Phase 6 has the advantage of being a softer ore, enabling a higher throughput in the plant compared to ore from Phase 4. The combination of the softer ore being fed to the mill, higher concentrator availability and utilization has led to another quarterly record for Oyu Tolgoi throughput, which ran at an annualized rate for 42 million tons per annum for the quarter. The concentrator has operated above expectations at this point of the year, achieving a nine-month annualized rate of over $40 million tons per annum. During fourth quarter, we will continue to mine Phase 6 as an ore source while we move towards 2018 and a return to a majority of [indiscernible] southwest ores of Phase 4A. Phase 4A ore is expected to contribute to slight improvement gold rate right in the fourth quarter and then significantly higher gold rates in the second half of 2018. Moving to the underground, overall development continues to advance and the workforces continue to grow with over 5,000 people currently working on the project. During the third quarter, the new Shaft 1 development crusher was commissioned to work and now steadily operate at over 3,000 tons per day and provides full crushing capacity to support the lateral development phase of the underground is currently scheduled there. The next increase of crushing capacity is expected at the end of 2018 for an additional 6,000 ton per day crusher will be integrated with the overall Shaft 2 fit out. During this last quarter, crusher commissioning required moving back and forth between all the new crushers and also the native stockpile and then re-handle development tons. For these complexities, overall lateral development rate was maintained at approximately 1.4 equipment kilometres. During this time and the total development since project restart grew to 5.4 per kilometer. During the fourth quarter, we expect to see a step-up in development with up to five effective crews fully operating for yearend compared to the three that were fully in service at the end of September. Crew 4 has actually already commenced operation in the full quarter while Crew 5 is still considered in training mode. During the third quarter, Shaft 2 continue sinking and reached the top of the main service chamber that has a flow at level 12 pit. This Shaft 2 service level requires further mass activation to complete before sinking resumes. It will provide future expanded underground access by two connected drifts east and west. It will include a material receiving and lie down area, personnel on and offloading and light vehicle parking as well as allowing for the delivery of the larger phases of equipment. Compared to Shaft 1, the Shaft 2 level will enable a significant and efficient step up in underground personnel and material delivery capability, thereby supporting an increase in lateral development. Making to the shaft bottom at 1284, where shaft dewatering facilities will be located, we still expect it to be completed in 2017 with the shaft fit out plans occur over 2018. Shaft 5 sinking rates continue to see improvements during the quarter and we still expect to reach at final depth in early 2018, subsequently contributing to increased underground ventilation. Finally, we remain on target for the first draw bell in mid-2020 and sustainable production in early 2021. That concludes my comments and I'll now turn back to Jeff.

[Jeff Tygesen:]

Thanks Brendon. To summarize the third quarter, open pit operations operated at full steam and set a number of records. The concentrators are on pace to have a stellar year. From a cash flow perspective, operations this year are much better than expected. For underground development continues to advance, lateral development is progressing well. The sinking of Shafts 2 and 5 continue to move deeper. We maintained our expectation for first trough around mid-2020 and first sustainable production in early 2021. That concludes our remarks. Glenda, we're ready to take questions.

[Operator:]

Thank you. [Operator instructions] And our first question comes from the line of Ralph Profiti from Eight Capital. Your line is now open.

[Ralph Profiti:]

Good day. Thanks for taking my question. Jeff, I'm just wondering how much flexibility there is in the principal repayment schedule and the project financing and if it's tied to the net cash flows of the project, could the Rio Tinto CapEx and timeline review push those payments back or even potentially bring them forward?

[Jeff Tygesen:]

Ralph, this is Jeff. I am still regaining your questions, there are several of them in there, but the gest of it is our current plans and we discussed this during our site tour is we have a fixed repayment schedule and that's our plan today. There is flexibility to move forward on that, but as of today, we'll continue with that plan.

[Ralph Profiti:]

Okay. Thanks.

[Jeff Tygesen:]

And this is a matter detail we're currently in a period where we're interest-only and it's a gradual ramp up starting in 2022 and then ending in 2027.

[Ralph Profiti:]

Okay. Got it. Maybe something for Brendan. I'd like to get a little more color on the critical path item in underground construction. It sounds like it's centered around the different packages in Shaft number 2. Is that the case and if not, how much times slack is built into the Shaft 2 schedule before that becomes the critical path item?

[Brendan Lane:]

The critical path is the lateral development underground and the lateral development goes through several stages of stepping up and the next critical path item is for the completion of Shaft 2 to enable the step up and that's expected to occur over 2018 and we should see a price that we should see another step up, but eventually if we had additional crews and additional capacity and there are further milestones further out with primary crushers and the other price. But in terms of 2018 the focus is around that Shaft 2 development.

[Ralph Profiti:]

Okay. Great. Very helpful. Thanks all.

[Operator:]

Thank you. And our next question comes from the line of Matt Murphy from Macquarie. Your line is now open.

[Matt Murphy:]

Hi. Just a question on the progression of underground CapEx. Looks like the spend year-to-date is $527 million or so and you'd initially guided to $825 million to $925 million. Just wondering do you still think you might hit that guidance and if not, how much is a function the slight slow ramp-up in procurement etcetera versus things working out cheaper than you had initially figured on?

[Luke Colton:]

So, we are at this point it's looking like will be somewhere around the low end of the guidance. So somewhere around the $825 million.

[Jeff Tygesen:]

Matt, this is Jeff. Just to add to that, we've been ramping up through the year and as Brenden mentioned we now have 5,000 people on the project for the underground. So, it's always been planned to be more heavily weighted for Q4 and as Luke mentioned we're looking to be around the low end. But it's also a timing issue of when do the invoices come in towards end of year or do they make it in time for the cutoff. So, if it wasn’t for yearend we will be meeting that, but it's a timing issue as well, but it's affecting the work as I said full steam ahead. Recently was on site just around Shaft 2 there were 1800 people, just on the surface working on the facilities to support Shaft 2. So, there's a lot of activity going on from the underground perspective.

[Matt Murphy:]

Okay. Thanks. And just as a follow up, so the Rio Tinto schedule and cost review, are you expecting at some point then to make a public statement about that or would it only be if it's diverting from prior expectations?

[Jeff Tygesen:]

It would be -- if there is a diversion from the base plan like I said earlier it's normal to have these reviews, it's still being finalized at this point hasn’t been completed yet, but if there is a difference we will announce that.

[Matt Murphy:]

And do you think that would be in year 2018 guidance announcement or just in terms of timing would it be like a this year event or next year, thanks?

[Jeff Tygesen:]

Just to talk on that, it's the timing of finishing the review is late this year. So, it could be into early next year.

[Matt Murphy:]

Okay. That's great. Thanks.

[Operator:]

Thank you. And our next question comes from the line of Craig Hutchison from TD Securities. Your line is now open.

[Craig Hutchison:]

Good morning, guys. Are you just starting to see any cost pressure on the CapEx side with the recoveries you're seeing in base metals and in oil prices?

[Jeff Tygesen:]

This is Jeff, Craig. From my review today, we're not seeing that a great deal primarily because the bulk of what we're doing in the open pit in operation has to do with labor. It actually has a little bit of a benefit with respect to fuel prices. But as of today, we're not seeing a whole lot of pressure on the underground project.

[Craig Hutchison:]

So, it's not difficult to source sponsor for the project?

[Jeff Tygesen:]

No in fact an update to be provided at the site tour we're seeing around for the underground project 85% to 88% Mongolian content, which is an improvement from what the original plan was. So very pleased with the capability of the Mongolian contractors and their skill set.

[Craig Hutchison:]

And maybe just one question, the inventory write down, I think it was $25 million in the quarter and I think Luke mentioned, that had to do I think taking some of the higher grade out of stock pile. Was that a non-cash charge, because it does -- seems to appear in your all-in sustaining cash costs. How do we view that cost?

[Jeff Tygesen:]

It is a non-cash charge.

[Craig Hutchison:]

Okay. Did you include it your all-in sustaining cash costs?

[Jeff Tygesen:]

Let me just double check. Yes, it does get out at back end. So, the $276 million versus the $227 million you can see the two -- the primary reason for the variance is actually that $25 million write off.

[Craig Hutchison:]

Okay. So that's not a cash component, right? Okay. That's it for me guys. Thanks.

[Operator:]

Thank you. And our next question comes from the line of James Bruce from SailingStone Capital. Your line is now open.

[James Bruce:]

Hi guys. Congratulations on a strong performance in the open pit. Pleasing to see that you beat your expectations. I just had a couple of questions on the underground project, but a lot better understanding and it's a comment in the MD&A that lateral development was in-line with the 2016 technical report. And so, I was just wondering to understand if development rights in the fourth quarter this year are similar to the third quarter and it seems like they’ll be better because you get more crews coming, but I think it will be by the end of this year, maybe 10% ahead of development versus the 2016 technical report. Is that the correct way to think about it?

[Brendan Lane:]

No, I wouldn't say that would be 10% ahead by the end of the quarter, we would expect that was going to be continuing to match close to plan but it's going to depend on how the new crews ramp up. We've just started the fourth crew very early in the fourth quarter and the fifth crew is still got to be added. So, it depends on how those crews perform during that fourth quarter, but we don't have any expectations to get ahead of plan in the fourth quarter.

[James Bruce:]

It looks, even if I assumed that the fourth quarter was the same as the third quarter this year. So, you didn't have the 1400 meters, that would get you up to 2,800 meters and it looks like in the technical report the 2016 and 2017 plan was for only 6,250 meters or thereabout and that's how you're getting the 10% hedge number. Is there something different versus the technical report or I am just trying to understand what's the different better the two is?

[Brendan Lane:]

I don't have the exact number for the fourth quarter James. I'll have to get back to you on that.

[James Bruce:]

All right. and the follow-up is also just then regarding the CapEx and the technical report versus the actual CapEx that we've seen to date in the technical report 2016 and 2017 CapEx was expected to be just shy of $2 billion. To date if you're tracking well underneath that and even if I go to the low-end of your 2017 CapEx guidance you will expend a $ billion. So, it looks like the project is at least on the timeframe point of view the same as the 2016 technical report, but the CapEx is about half what you're expecting from the 2016 report, again is that the right way to think about this project?

[Jeff Tygesen:]

James, this is Jeff. Thanks for your question. As I've referenced before, we did have a slower ramp up in 2016 when we kicked off the project to maximize the Mongolian content specifically Mongolian contractors, which it moved into 2017 as well and as referenced before is currently through Q3 we are on plan for lateral development, which is the critical path. We think we're going to meet the plan and as we talked and referenced on Slide Shaft 2 is the key to advancing more crews for the underground. That will occur in 2018. So, I wouldn't want to take the correlation of what we did yesterday and multiply that and go forward, but we're still targeting for mid-2020 and the 5.3.

[James Bruce:]

But today versus the technical report, the CapEx spend has been half what you expected it to be and you're saying the lateral development is in line with what you expected the technical report to be.

[Jeff Tygesen:]

As we've referenced before, the productivity of those crews for crew one and two, so it's on the early portions as far as meter per month on the ramp up of part of it's a function of crushing capability, which we just installed a large crusher. So those crews are more productive. We haven't really got into the footprint that much and that's where we expect slower development rates just because there are small fracture, but the project team is still forecasting that 2020.

[James Bruce:]

All. We'll look forward to the update when it comes and we'll talk about it more then. Thanks Jeff.

[Jeff Tygesen:]

Yeah. Thanks for dialing in so early.

[Operator:]

Thank you. [Operator instructions] And our next question comes from the line of [Nick]. Your line is now open.

[Unidentified Analyst:]

Hi guys. I had similar sorts of questions to a couple ones that have gone before. So, I'm basically trying to start a similar thing a different why. So, you've spent just the year $525 million or so if I've that right on the underground CapEx through the first three quarters and that's versus some expected amount of money it sounds like was maybe a bit more than that, but not that much more than that because you were always going to have higher spend in Q4. But how much work have you actually got done in the first three quarters and is that about the amount you expected to get done last or more. So, I'm not asking you to extrapolate at all. I'm just asking first three quarters of this year did you get the amount of work overall than that you expect at all or more or less?

[Jeff Tygesen:]

Thanks for your question Nick. The four major components for the work projects or work package are lateral development, which is key and we're on plan with that. Shaft 5 was originally scheduled to complete late this year and now into early 2018 and that's four increased ventilation, but because the crews have been doing more with the same number of pieces or crews. They've made up for that ventilation gap. So, Shaft 5 is not impact -- that slower timing does not impact the development rates. The convey-to-surface is another major work package. It's not on the critical path as we pointed out during the site visit. The box cut on the surface through the unconsolidated material they had a little bit of material slot and that required a little bit of delay to rehab that. They’ve now remediated that and they're back to developing decline. The latest forecast I heard was that they'll be back on plan first half of next year, but that's not due to be complete until 2020 with the fit out of the conveyer until 2022. But Shaft 2 is the focus. All hands-on deck on Shaft 2 it should be finished sinking this year and the fit out be occurring through 2018, which gives us the next step up as I mentioned before and the capability for more crushing and moving material. So, I would say for the most part, we are on plan for critical items and they're all progressing.

[Unidentified Analyst:]

Okay. It would seem like you're actually saying as of right now, maybe you can catch up a bit, but as of right now, you've got slightly less work done as of September 30 than at the start of the year, you though you would have?

[Jeff Tygesen:]

That's the original plan and it all started with last year…

[Unidentified Analyst:]

Compared to whenever you guide like $25 million to $925 million as gotten was a bit off to the original plan.

[Jeff Tygesen:]

Correct.

[Unidentified Analyst:]

Okay. And Shaft 2 how many months do you think you slipped since the start of the year since you gave 2017 guidance?

[Jeff Tygesen:]

I think Shaft 2 is on schedule and the sinking will be finished this year and the fit out for next year. The sinking -- just to go back to clarify, the sinking for Shaft 2 we didn't have that many meters to go down vertically, but because every time we had to stop at an access level or production level, it seems so if there is more actual volume of rock moved in the mass expedition than the shaft sinking.

[Unidentified Analyst:]

Okay. Okay. Thanks a lot.

[Jeff Tygesen:]

It is one of the masses in Shaft 2, the 1202 level under there.

[Unidentified Analyst:]

Okay. Okay. And if the crews three, four, five perform in line with the earlier crews, then lateral development is going to accelerate ahead of plan, but whether that actually happens or not is somewhat to be determined?

[Jeff Tygesen:]

My expectation based on the performance of Crews one and two is don't do what one and two are, we just get to multiply by five instead of by two.

[Unidentified Analyst:]

Okay. So, you think they can perform in line with the first couple if not the first couple were kind of high-graded.

[Jeff Tygesen:]

No. Well we did have the benefit of some people returning from Phase 1 when they're developing the underground, but as I said, the capability of the Mongolia workforces always impresses me and Crew Q3 actually moved into a production rate ahead of what they were anticipating during the training phase. So, all my expectation is those crews four and five will do as well.

[Unidentified Analyst:]

Okay. Sounds good, great. Thank you. Thank you for taking my question.

[Operator:]

Thank you. And our next question comes from the line of Orest Wowkodaw with Scotia Capital. Your line is now open.

[Orest Wowkodaw:]

Hi. Good morning, thanks for taking my question. Most of my questions have been answered, but I do have one small question around the OT administration costs, they’ve been tracking quite a bit lower than in previous years. I realize some of that is related to just the management fee which I guess is based on the spending, but even if we back out the lower management fee, it still seems like the sight, other administration seems to be tracking quite a bit lower than in previous years. Is that -- should we anticipate that as kind of a run rate at current levels moving forward or is that likely to ramp back up, thank you?

[Luke Colton:]

Yes. So, there has been a decrease in the OT admin expenses. It is the result of some cost saving initiatives that OT has undertaken and it is primarily driven by labor reductions for the operations as well as the reduce support costs from Rio Tinto as you've previously highlighted. So, I'm not aware of any reason why they wouldn't be able to sustain those cost savings.

[Orest Wowkodaw:]

Okay. Thank you very much.

[Operator:]

Thank you. And that does conclude our Q&A session. I would like to turn the call back over to Jeff Tygesen, CEO for closing remarks.

[Jeff Tygesen:]

Thank you for joining us today. We continue to advance underground production and Oyu Tolgoi realizing its full potential.

[Operator:]

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