Turquoise Hill Resources Ltd.
Q1 2018 Earnings Call Transcript

Published: 9 May 2018

[Operator:]

Good day, ladies and gentlemen, and welcome to the Turquoise Hill Resources First Quarter 2018 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 is being recorded. I would like to introduce your host for today’s conference, Mr. Tony Shaffer. Sir, please go ahead.

[Tony Shaffer:]

Thank you, operator. Welcome to our financial results conference call. Yesterday, we released our first quarter results press release, MD&A and financial statements. These items are available on our website and on SEDAR. With me today is our CEO, Jeff Tygesen; Luke Colton, our CFO; and Brendan Lane, Vice President of Development and Operations. We’ll take your questions at the conclusion of our prepared remarks. Please refer to the forward-looking statements included in our press release and MD&A. I’d now like to turn the call over to Jeff.

[Jeffery Tygesen:]

Thanks Tony. During the first quarter, Oyu Tolgoi continue to make progress on multiple fronts with underground development and open-pit production. As the open-pit transitions to Phase 4, we are beginning to see higher gold grades and improved recoveries. Due to the hardness of Phase 4 ore, we expect throughput to be a bit lower this year than 2017, when the concentrator mainly process softer Phase 6 ore. Before I move on, I want to comment on Oyu Tolgoi safety performance during the quarter, where they had an AIFR of 0.21 for 200,000 hours of work. This includes both the open-pit operations and underground project. We are extremely proud of Oyu Tolgoi safety accomplishments and how they are sharing our approach to the safety with other Mongolian businesses. Good safety practices should be shared. Moving to underground development during first quarter, Oyu Tolgoi saw their best lateral development rate since project restarted in 2016, with an almost 20% increase in total equivalent kilometers completed over the fourth quarter. In March, the team has their highest development month. We are seeing development momentum build and this should continue with the completion of Shaft 5 fan commissioning, which is expected soon. Following the completion of Shaft 2 sinking in January, the installation of structural steel inside the shaft began during the quarter. Fit out of Shaft is expected to take place throughout the year, and when complete, we expect to see further increases in lateral development rates. During the quarter, Oyu Tolgoi spend a little over $270 million in underground expansion, resulting in total spend since January 2016 of approximately $1.4 billion. At the end of the quarter, Oyu Tolgoi had committed more than 60% of the direct project contracts and procurement packages. We continue to expect production from first draw bell in mid-2020 and first sustainable production in 2021. Brendan will go into more detail later in the call on underground development. Moving to open-pit operations, first quarter production was as expected. Due to planned concentrator maintenance in January, mill throughput was down over the fourth quarter. The impact of maintenance was partially offset by increases in recovery, particularly for gold. As the higher grade Phase 4 ore became a bigger part of mill feed, we started seeing increased gold production. Gold grades and production are expected to increase throughout 2018, particularly in the second-half of the year. Copper grades and production are expected to be fairly consistent. I would now like to provide a bit of context on our first quarter announcements. In mid-February, we announced, the Governor of Mongolian cancelled the power sector cooperation agreement or the PSCA, between the government and Oyu Tolgoi. This disagreement was put in place at the request of the government to explore possible SouthGobi power plant site locations and see if a third-party supplier would provide power to Oyu Tolgoi. The cancellation of the PSCA as it relates to the building of power plants has resulted in the restart of the four-year timeframe for Oyu Tolgoi to source power domestically. We’re working with Rio Tinto to evaluate all viable power options, including building a power plant at Oyu Tolgoi. I would expect a decision on the path forward in the next four to six months. In mid-March, Oyu Tolgoi received an information requests from the Mongolian Anti-Corruption Authority or the ACA, to provide financial information relating to Oyu Tolgoi, which we are advised they continue to comply with. Their requests relate to an investigation of our possible abuses of power by authorized government officials during the negotiation of the 2009 investment agreement. While we cannot make any assurances that the scope of the investigation will not change, there was nothing in the information requests to suggest that Oyu Tolgoi is the subject of the investigation and to date, we have received no information suggesting otherwise. Up to now Turquoise Hill has not been contacted by the Mongolian ACA. The Swiss Attorney General’s Office or indeed by any regulator about this issue. We have received several questions on the investment agreement. The IA was authorized by the Mongolian Parliament concluded after sixteen months of negotiation and reviewed by numerous constituencies within the Mongolian government. We have been operating in good faith under the terms of the investment agreement since 2009, and we believe not only that is a valid and binding agreement, but it has proven beneficial to all parties. The Investment Agreement has provided a framework that has allowed for the development of the underground project in a manner that has given rise to significant long-term benefits to Mongolia. The country has and continues to benefit from Oyu Tolgoi’s open-pit operations and underground development, including but not limited to, employment. Current direct employment is roughly 14,000 people. Indirect has been estimated at 50,000. Between 2010 and 2017, Oyu Tolgoi paid approximately $1.8 billion in taxes and royalty. Oyu Tolgoi spent more than $2.2 billion on Mongolian procurement from 2010 to 2017. Over that same time period, Oyu Tolgoi spent more than $7 billion in Mongolia, overall, the benefits are significant. All combined, the Investment Agreement has led to economic development and sustainability in Mongolia. In summary, underground development continues to advance and we’re making good progress. As open-pit operations move further into Phase 4, we expect to see increasing gold grades and production. Our copper grades and production should be fairly consistent. With that, I’m going to turn the call over to Luke to discuss the financial highlights.

[Luke Colton:]

Thanks, Jeff, and hello to, everyone, listening in. Revenue for the quarter was $246 million, which is an increase of approximately 3% over the first quarter 2017. This reflects higher copper and gold prices, partially offset by lower concentrate sales volumes. Copper prices in the quarter averaged $3.16 a pound, that’s an increase of 19% compared to the first quarter 2017. Average gold prices for the quarter increased about 9% from the first quarter of 2017. Concentrate volumes sold decreased by approximately 14% over the first quarter 2017, impacted primarily by the force majeure declaration in January 2018. Gross margin for the quarter was 31%, up from 18% in the first quarter 2017, driven primarily by a 13% reduction in cost of sales, combined with a 3% higher sales revenue. The decrease in cost of sales reflect silver volumes of concentrate sold and reduced depreciation and depletion due to certain long-lived assets reaching the end of their depreciable lives. Finance cost of $24 million or net of amounts capitalized on the underground of $68 million. Income attributable to Turquoise Hill shareholders in the quarter was $86 million. Cash from operating activities in the quarter was $19 million, compared to $86 million in the first quarter of 2017. The reduction was primarily driven by significant movements in working capital impacted by the force majeure, partially offset by higher copper prices. We expect the force majeure-related impact upon sales and working capital to be made up over the next few quarters. Capital expenditure on a cash basis was $286 million in the quarter, compared to $148 million in the first quarter of 2017. This includes $271 million for the underground project. Since January 1, 2016, the total amount spent on underground development is $1.4 billion. In addition, Oyu Tolgoi had further capital commitments of $1.2 billion as of March 31, 2018. The net realizable value of copper and gold stockpiles at the end of the quarter was $110 million, an increase of $11 million compared to the end of 2017. The increase in the stockpiles net realizable value in the quarter was primarily driven by an improved short to medium-term price outlook. A net reversal to the income statement of $10 million was consequently included within operating expenses. This includes a $3 million charge related to the materials and supplies provisions. In the quarter, the total deferred tax assets recognized increased by $32 million to $506 million. This was the main driver of an income statement credit for income and other taxes of $26 million in the quarter. The increase in deferred tax assets, primarily reflects additional Mongolian operating losses and interest charges incurred by Oyu Tolgoi during the first quarter of 2018 combined with an increase to the long-term consensus copper price assumptions. At 31 of March, 2018, Turquoise Hill’s cash balance was $1.5 billion, compared to $1.4 billion at the end of 2017. Total operating costs at OT were $177 million in Q1 2018, compared to $168 million in Q1 2017, mainly due to higher open-pit concentrator maintenance costs. C1 costs for the quarter were $1.76 per pound of copper produced, a decrease from $1.85 per pound in the first quarter of 2017. This is due primarily to lower realization costs and higher gold sales. That concludes my comments. And I’ll turn the call over to Brendan.

[Brendan Lane:]

Thanks, Luke. First of all, safety performance was again encouraging with excellent results in the open-pit and underground during the quarter and an AIFR of 0.21. In the concentrator, the first quarter 2018 saw feed drop in quarter four 2017, with no maintenance occurring in January and another second outage is planned in the second-half of the year. However, after the mill maintenance, good production rates occurred for the rest of the quarter within above planned results achieved. We’re seeing promising results for the high-intensity blasting practices helping mill throughput with a harder price for ore in the quarter. And the plan will be to continue mining the ore with that practice on the Phase 4. Mining also continued from Phase 6 during the quarter. This will decrease going forward as we move to a majority of the higher gold areas in Phase 4, as planned, in the second-half of the year. Moving to the underground, overall development continues to advance and the workforce is still mobilizing according to plan. Currently, the stockpiled workforce is approximately 89% Mongolian. The total project workforce has mobilized over 6,600 people to site since notice to precede, but the daily average onsite during March is being over 4,000. Construction of the new campus is now more than 75% complete at the end of March, including the occupancy of eight buildings. When fully complete, the new camp will be a large-scale accommodation facility with more than 1,800 rooms and catering for over 5,000 people. Underground development continued during the quarter with a notable development of just over 900 equivalent meters in March and now total of 10.3 equivalent kilometers considered since project restart. The main focus area for the project continues to be critical headings development, Shaft 5 exhaust fan commissioning, Shaft 2 infrastructure works. In addition, the construction of an underground open new mine drive facilities and a central heating plant expansion. Of these key activities, the work around Shafts 2 and 5 are important enablers of increased underground development activity in terms of both equipment and people and support the next step ops in mining development. The Shaft 3 structure steel insulations have started multiple fronts in the shaft, Shaft 5 sinking completed in the quarter. Shaft 5 will be a dedicated exhaust ventilation shaft and is fitted with three service fans that provide extra capacity to exhaust air from the mine. And we’ll have two ventilation take up points, including one at the bottom of the shaft. Insulation of all three Shaft 5 exhaust fans is mechanically complete along with electrical and instrumentation, and commissioning is occurring over the coming days. But the increased ventilation progressively more equipment and personnel will be able to operate the underground, enhanced increased development activities are expected to occur. Additionally, during the quarter, the conveyor to service development continued and earthworks commenced by Shafts 3 and 4 with the sinking package expected to be finalized over the next few months. Finally, we remain on target for the first drill point blast in mid-2020 and sustainable production in early 2021. That concludes my comments. I will now turn it back to Jeff.

[Jeffery Tygesen:]

Thanks, Brendan. To summarize first quarter, lateral development and maintenance continues to build. The completion of Shaft 5 fan commission is expected soon. Early works for Shafts 3 and 4 have commenced. As the concentrator process has increased amounts of Phase 4 ore, we expect gold production to increase throughout the year. The open-pit continues to generate operating cash flow. That concludes our prepared remarks. Michele, we are ready to take questions.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from the line of Ralph Profiti with Eight Capital. Your line is open. Please go ahead.

[Yasir Siddiqi:]

Hi, good morning, guys. This is Yasir Siddiqi on behalf of Ralph Profiti. Can you guys talk about the impact of rising commodity prices, especially energy on your operating and capital costs?

[Jeffery Tygesen:]

Thank you for your question. The impact of increased commodity prices that were your question?

[Yasir Siddiqi:]

Especially energy to oil and gas oil prices increasing?

[Jeffery Tygesen:]

So there will be some impact. There wasn’t a significant impact in the first quarter. The main increase is really, we’re in the maintenance base for the first quarter with some additional maintenance being undertaken at both the open-pit and the concentrator.

[Yasir Siddiqi:]

Okay. And just one more question. Is there any seasonal impact to the pace of underground development work? Could we see the pace accelerates further as we head into the summer month? Thanks.

[Jeffery Tygesen:]

Could you repeat that? It faded in and out on the second question. I think you said something to do with seasonal impact on the underground development?

[Yasir Siddiqi:]

On the pace of underground, yes, does it get easier as we move into the summer months?

[Jeffery Tygesen:]

We don’t see a lot of seasonal impact on the underground, but we did in January in the open-pit, where we had some severe weather. But the underground has been fairly isolated. One thing, we’re doing with Shaft 2 with that becoming an intake shaft in the near future. As we have plans to install heaters to make sure the – during the winter months, the error could be as low as minus 30 to minus 35. So we are putting those in place, so there will be minimal impact.

[Yasir Siddiqi:]

Okay. Thank you.

[Operator:]

Thank you. And our question comes from the line of Craig Hutchison with TD Securities. Your line is open. Please go ahead.

[Craig Hutchison:]

Hi, guys. The CapEx for the open-pit was only $15 million in Q1. I think, your guidance is $150 million. Do you expect a significant pickup over the back-half of this year?

[Jeffery Tygesen:]

Yes. So there were a few delays in the first quarter. There were some capital spares meant to be purchased in Q1 that were actually delayed till later in the year. So we’re not changing the full-year guidance, Craig, we think we’ll still hit it.

[Craig Hutchison:]

Okay. And on OpEx guidance, the open-pit, I think it was $700 million. Do you think it will still be sort of in line with that or do you think you guys can come below that?

[Jeffery Tygesen:]

We’re still forecasting to be in line with that.

[Craig Hutchison:]

Okay. And, Jeff, you mentioned about, obviously, gold grades, you’re going to pickup in latter half of this year. You also touched on recoveries. What’s your sort of target do you think you can get for recoveries as you move into the higher grade Phase 4 ore?

[Jeffery Tygesen:]

So we’re – as we mentioned, the second-half is in the lower part of Phase 4 for A. The expectation for gold recoveries that we had in Phase 2 were in the 70s, so I would think that we would be comparable to those.

[Craig Hutchison:]

Okay, great. And then, I guess, political risk is obviously on the rise as we seen some announcements here at the couple former PM’s have been arrested. Can you just talk about what the charges are there? And what your understanding of why these guys have been charged related to the Investment Agreement?

[Jeffery Tygesen:]

Well, the official word that I’ve heard is, they’ve been detained for questioning, I don’t know if they officially been charged. The statement by the Mongolian authorities is, they’re investigating abuse of power by the members of the government. But anymore detail than that, I don’t have. Their investigation is still ongoing.

[Craig Hutchison:]

Okay. Okay, guys. Thanks. That’s it for me. Thanks.

[Operator:]

Thank you. And our next question comes from the line of [indiscernible] with CIBC. Your line is open. Please go ahead.

[Unidentified Analyst:]

Hi, good morning. Thank you for taking my question. So the Mongolian workforce seems to continue performing well. And I know Rio Tinto just recently made a cost review. But would you – if this continues, would you expect another cost or CapEx revision anytime soon?

[Jeffery Tygesen:]

So last year, there was a schedule and cost review undertaken and the project was roughly about 10% complete at that time. And the high-level summary of that was that scope, cost and schedule are still long planned. Within the Rio Tinto organization for large-scale projects, they have – I don’t want to call it an annual review, but a regular review depending on the duration of the project and the scale. There’s another one scheduled for this year. There’s – and another one scheduled for next year. The exact timing should be determined as far as the close up dates for that review. But at this stage of the project, the forecast is still to hit the milestones in the feasibility study and the capital estimate.

[Unidentified Analyst:]

Okay. And you mentioned the – in your MD&A that they – Rio provided some high-level overview of that cost review. So at this point that you mentioned are those – are this at this point, right, or do you have any other key takeaways from their review?

[Jeffery Tygesen:]

So in the beginning of the project, we mobilized a workforce that’s now, as Brendan mentioned, over 6,000 for the underground project. A lot of those folks had to go through training. So compared to the original plan in order to maximize Mongolian content, we took the time and the effort to do more training upfront, which had a little bit slower in the first 3-ish months. But as mentioned earlier on the call, the underground teams are matching the schedule in the technical report and have their highest quarter ever. And with Shaft 5 commissioning, we expect those underground development rates to continue to go up.

[Unidentified Analyst:]

Okay, thank you for that. And just a quick clarification on the Mongolian Tax Authority Assessment. So we’re currently in that 60-working day period, correct?

[Jeffery Tygesen:]

That’s correct.

[Unidentified Analyst:]

Okay. Thank you.

[Operator:]

Thank you. And our next question comes from the line of Mark Llanes with Credit Suisse. Your line is open. Please go ahead.

[Mark Llanes:]

Hi, I’m on the call for Anita Soni. Just had a couple of questions on the Phase 4A higher grade ore from gold. So are we – how can we see that come on line in Q3 And how long do we – how long can we expect those grades to persist? Thank you.

[Jeffery Tygesen:]

After 2017, this has been in line here. We’ll see an increase…

[Luke Colton:]

2018.

[Jeffery Tygesen:]

…2019, we’ll see an increase in Q3, but mining fact will be felt in quarter four and particularly right towards the end of the year for this year’s production.

[Mark Llanes:]

All right, okay. And also just a follow-up question on Rio Tinto’s cost and schedule review. I know that you spent, I believe, $1.4 billion in CapEx to date. In terms of where you are in the – your project plan in terms of percentage of completion, was that CapEx spent to date above or below budget?

[Jeffery Tygesen:]

I think that’s tracking behind budget at the moment.

[Mark Llanes:]

All right. Okay. Thank you very much.

[Operator:]

Thank you. And our next question comes from the line of Dalton Baretto with Canaccord. Your line is open. Please go ahead.

[Dalton Baretto:]

Hey, good morning, guys. I’d just like to follow-up on Craig’s question there with regards to this anti-corruption investigation. Jeff, you talked about the abuses of power being sort of the general charge. Give us a sense for how the Investment Agreement ties into that?

[Jeffery Tygesen:]

I don’t have the details from what Mongolian authorities are looking into. What we received is a request for information around their view of possible – I want to say possible abuse of power.

[Dalton Baretto:]

Okay. But are these abuses of power claims predicated on the Investment Agreement process?

[Jeffery Tygesen:]

Well, there have been a few people and you’ve read in the headlines, a few people detained and they span different timeframes. And the statements made by the Mongolian officials is representatives of the government and abuses of power. So one was in office around 2009, another was an employee of Mongolian company around 2015. So I don’t know exactly what they’re looking at as far as that times – time span, but the first one was referenced to the Investment Agreement in 2009. As I mentioned and it’s in our MD&A, the Investment Agreement originally when set out in 2008, the expectation was that a group of people were authorized by parliament to negotiate on behalf of the government. And the expectation is they would have this agreement done in 2.5 months. The overall timeframe to finalize that agreement going through multiple different groups within the government, including a working group in parliament in total took 16 months because of the scale of the Oyu Tolgoi project. So it wasn’t one person, it was a lot of different people looking at and assessing the agreement. And then in the end, the Minerals Council reviewed and approved the technical portions of that agreement and then we ended up having signing by all parties. So, in my view, it was thoroughly reviewed by a lot of people on both sides to make sure the Investment Agreement benefited all parties.

[Dalton Baretto:]

Okay. And maybe on just a slightly different note. I understand there’s a government committee that’s been tasked with actually repealing the Investment Agreement, this is sort of par for the course every time, it’s a new government. Have you guys heard anything back from that yet from that review?

[Jeffery Tygesen:]

No, no, there’s no doubt, since the Investment Agreement was finally signed, it’s fair to say whenever there has been a new government that there has been a request by different members of parliament to review the agreement to make sure that there’s a good understanding. So I look at that is another way for this new government, which has been in place since September of last year to improve their understanding and confidence level in the agreement. But as you pointed out, it’s not a whole lot different than what’s been done over the past – since 2009. And I would expect going forward with a change in government when they occur where there would probably have members asked for a review just to make sure that the agreement is being met.

[Dalton Baretto:]

Okay. And then just maybe one last one for me. These Rio Tinto projects and schedule reviews that, it sounds like they’re going to happen annually. Are those the mechanism, I guess, within which decisions around expansions will be made, or if that could be a completely separate process?

[Jeffery Tygesen:]

This schedule and cost reviews are specific to just the scope of work. And it wouldn’t include options to as we have in our tech report for the different scenarios of the different deposits and/or concentrator expenses, that would be a separate process.

[Dalton Baretto:]

Okay. And what’s the current thinking around those now? Is there discussion around maybe started to look at those opportunities, or is it still kind of the base case?

[Jeffery Tygesen:]

Well, as we’ve talked before, the number one driver and value option is to complete Lift 1. And as Lift 1 gets closer and closer to production, there will be groups looking at the optionality of if you go South for the timing of Lift 2. So the number one goal for everybody right now is to focus on getting to Lift 1, where a big chunk of the value is sitting.

[Dalton Baretto:]

Okay, perfect. Thanks, guys. That’s all for me.

[Operator:]

Thank you. And I’m showing no further questions. And I’d like to turn the conference back over to Jeff Tygesen for any further remarks.

[Jeffery Tygesen:]

Thank you for joining us today. I just like to make one last comment that we continue to advance underground development towards production in the near future and Oyu Tolgoi realizing its full potential.

[Operator:]

Ladies and gentlemen, thank you for participating in today’s conference.