Earnings Transcript for HOC.L - Q4 Fiscal Year 2016

Executives: Ramon Barua - CFO

Analysts: James Bell - BofA Merrill Lynch Dan Major - UBS Dan Shaw - Morgan Stanley

Ramon Barua: Hello, everyone. Thank you very much for attending Hochschild's 2016 results. First of all, let me tell you that Ignacio couldn't be here, unfortunately, today; he's had a runner's related injury. He's doing fine. He should be up and running again pretty quickly. So, he sends his regards, to everyone. I think this year, we have a fantastic set of results, driven primarily by the first full year of production of our Inmaculada mine. In 2016, it was the record production ever at Hochschild Mining, which produced 35.5 million silver equivalent ounces. This year, 2017 our intention and our guidance is to beat that record, and produce 37 million silver equivalent ounces. Costs performed also much better than expected. I think, we reviewed guidance twice during the year. We started with a guidance of $12 to $13 in of all in sustaining costs. We reviewed that to $12 to $12.5. We reviewed that again to $11 to $11.5; and we ended in $11.2. From a cost perspective, I think it was also a fantastic year. Notably, it's the fifth consecutive year in which we have been able to reduce all in sustaining costs. We started, in 2012, with around $21.7, and every year we've been able to drop that number. Those cash flows have allowed us to reduce debt also quite aggressively. We'll show you some charts. But really the headline there the headline there is that, right before Inmaculada started production in June 2015, we had a net debt to EBITDA ratio of 5.8 times. Since then, we have also been able to repay that debt quite quickly and we have a ratio, today, of 0.6 times. So, investment grade levels very much early improvement on that front. Then, we're going to talk also in this presentation a lot about Brownfield. As, Brownfield has become our main source of growth going forward. We're very pleased with the strategy. For the first time, also in the history of the Company, we not only have a five-year mine plan, but we also have a five-year exploration plan, with very defined targets and, of course, with a full financing of that plan. We'll talk a lot about that, and where are the targets on each mine, and what are we thinking on doing, going forward. We have announced a dividend, we're not forgetting about that. Again, the first priority of the Company remains repaying debt continuous through the Brownfield program, but also returning cash flow to shareholders. So, during the first half of the year, we announced $7 million of dividend. We're announcing $7 million more. That brings the dividend to a dividend yield of approximately 0.8% or 0.9%, and it represents very close to 30% of net income. This is the summary of our P&L. Again, revenue significantly increased. There's a little bit of an increase due to prices, 5% or 6%. But most of the increase is related to higher production of gold and higher production of silver. Cost of sales, unit costs very much under control. Higher depreciation related, of course, due to the fact that we are now fully depreciating the investment in Inmaculada; driving gross profit to 29%, compared to only 13% in 2015. Admin expenses have been going up by $10 million. But this has to do almost exclusively, due to the fact that there are some extraordinary bonuses for staff that are related to the performance of the share price. They are evaluated every three years, so we have to mark to market the three-year programs every year. They are very much in the money after the 2016 increase in our share price, and that is reflected in our admin expenses. Selling expenses coming down substantially, mainly having to do with the fact that export taxes were eliminated in Argentina. Exploration very much in line with what we had last year. We're going to talk also about increases in our exploration budget from those $9 million to around $25 million, which is the budgeted amount for 2017. Within others, which is also a very important number there, we have the Patagonian port credit. It's a credit we were receiving in Argentina for exporting through this remote port, but it's a credit that we will no longer have, going forward, unfortunately. Financial cost $29 million. Again, the largest number there comes from the interest that we pay on our senior notes. The senior notes are due in 2021. But there is something very important. Although they mature on that date and that year, we have a call feature, and we can start calling those bonds, partially or in full, starting in January of next year. So, in less than a year, we'll have the ability to fully call on those bonds. Again, we're paying a coupon of around 7.75%. We will have cash on hand at that time. For the balance, we could take on short-term lines in Peru. Right now, we have around $175 million of short term lines in Peru, for which we pay around 1%. Once we call those bonds they are going to be material savings north of $20 million per year, that are going to start going through the P&L of the Company. We reach a net profit of $69.3 million; $53.2 attributable to our shareholders, after discounting the portion that we do not own in Argentina, representing $0.11 per share. The EBITDA, also very important number, reached almost $330 million for the year. A big improvement from the $139 million that we achieved in 2015. I like this chart very much because it shows the waterfall of our cash flow. You can see how important Inmaculada is now for us; Arcata, also with very positive generation; as well as San Jose. Pallancata is all about transitioning to Pablo and we'll talk also about that. But you should expect, going forward, that Pallancata represents a much more important percentage of our cash flows. Hedges. We lost in hedges around $19 million. Important to note that going forward we have no hedges at all. Admin expenses, we already talk about that. That basically has to do with our corporate offices. We repaid $127 million in debt. We paid $26 million on interest. We paid $18 million to McEwen. Remember, last year we took around $36 million out of Argentina, approximately half of that corresponds to a portion that McEwen mining owns. We paid $7 million at the half year. We paid some taxes and there have been some important improvement in working capital as well. The Patagonian port credit, important to note, it's around also $18 million/$19 million. We have not collected that amount during this year, it is -- sorry, during 2016; it's expected to be collected starting 2017. Hopefully, we'll start collecting it in the next coming months. So, we ended up the year with $140 million in cash. In terms of cost, again, we're very proud to say that underlying costs are very much under control, both in 2016 and in 2017. We'll see the projection later. This only evaluates our performance compared to the previous year. There is a higher cost in Inmaculada, basically due to a fact that, in 2015, we had some free material that came out from the mine development and that was capitalized at that time. In the case of Arcata, there was an important reduction. We have been doing lots of initiatives in Arcata that have to do with improving the mine cycle. We have been improving also --we have increased the length of the bars that we use for blowing the mineral during the production cycle. We have changed the supplier of energy. You will see within the exceptional items that there's a penalty that we had to pay upfront, in order to change the supplier. But that is resulting in important cost savings going forward. Pallancata. You see the costs are relatively high and they went higher, because the production is relatively low. We have started to do investing in mining infrastructure to access Pablo, so that has a particularly high impact in the all-in sustaining cost. But the expectations in Pablo going forward is that the all-in sustaining cost is going to be highly, highly competitive. Hopefully, challenging or approaching levels of Inmaculada. So, the total number -- sorry, and San Jose was particularly benefited again by the elimination of export taxes and by the Patagonian port credit. We've lost the Patagonian port credit, so going forward we should expect that a little bit over $1 should be added to that all-in sustaining cost. But overall, the $11.2, I believe, is a fantastic number. It's highly competitive and, again, it has continued a five-year trend of further lowering costs at our operations. In terms of sustaining CapEx the guidance that we're giving is between $120 million and $130 million, which is very much in line with what we had last year. The biggest difference is that we're spending less in Inmaculada. In 2015, we needed to continue investing in finishing the plant. That is completed now. The $45 million of 2017 does include $15 million for increasing the tailings dam capacity at that operation. In Pallancata you can also see an important number of $25 million. Of course, most of it has to do with building a new ramp and accessing the Pablo vein. At the bottom of the slide, you see the new brownfield number. Again, as I mentioned, we're increasing it quite substantially. You can see that most of that amount is expected to be invested in Inmaculada. We have some charts to show you where we are planning on spending that

Q - James Bell: James Bell, BofA Merrill Lynch. Just a couple of quick questions, firstly on the debt, can you talk about what the targeted interest rates you're looking at, and what split you'd expect to be, in terms of are you going to look at doing another bond, or are you going to look at just using your local credit lines? Then, secondly, just remind us what your conversion rates are and resources historically, and what you think you can get to now that you've recut your current resource package?

Ramon Barua: No, in terms of the debt, we have $300 million of debt, the bond is actually $295 million, but we will need to pay $103.875, so that's another $10 million let's call it, $305 million. We have right now $140 million in cash. The idea is that this year probably at these similar prices we are going to be generating probably between $75 million and $100 million of free cash flow that we could add to that number. In general, our expectation could be that around two thirds of that money of that debt, could be repaid with existing cash, and one third with additional debt. Now, given that during 2018, we expect again to generate important cash flows, hopefully short term debt will be enough. Short term debt, again, we are playing close to 1% in Peru. That will be the top alternative. In the meantime, hopefully there will be some more projects to invest. In which case, we'll have to figure how we finance that. If we were to access longer credit lines in Peru or internationally, we have been quoted recently for five-year debt around LIBOR plus 2, LIBOR plus 2.5, so that would be around my expectation if we wanted to do anything further. Conversion rates, historically all the way from inferred and measure indicated into reserves, has been between 60% and 70%, I would say. Our expectation going forward is probably going to end towards the higher end of that range.

Dan Major: Hi, Dan Major from UBS. A couple of questions. In terms of your $25 million exploration budget, where do you see the biggest risks around that, I think particularly with respect to permitting, in terms of being able to deploy that capital? The second is around a bit more detail on the reduction in your resources, how much of that was price-orientated, and how much of it, you said it was as small amount, can you give us a sense of the percentage on that? Then just a quick reminder now earnings have normalized where you expect effective tax rate across the Group to come out at in 2017 and medium term?

Ramon Barua: Sure. You're totally right on exploration. Permitting is going to be certainly the most challenging part. There are certain areas of our plan that are already permitted, the permits fall now in two different categories

Dan Major: Effective tax rate.

Ramon Barua: The effective tax rate, well, you know in Peru we're paying around 30% taxes, that's the nominal rate; in Argentina it's around 35%. But there are two different impacts. The first one is that in the case of Peru we're paying royalties, we have always been paying royalties. But around six years ago, when Humala became President of Peru, I don't know if you remember what -- we, as an industry, renegotiated royalties. At that time, it was agreed that the royalties instead of being a flat rate and a percentage of sales, it changed to being a percentage of the operating income. The larger the operating income a company had, he needed to pay a higher rate. Right now, with Inmaculada performing so well, we are having a very good operating income and, thus, we are paying the highest rate. That number, in Peru we have paid around between $7 million and $7.5 million of royalties in Peru, which brings the overall tax rate to a relatively higher level. Note that in Peru we have also losses accumulated, and we are allowed to bring forward a depreciation in Peru. This, 2016 and 2017, our expectation is that we will pay zero taxes in Peru. The royalties we do have to pay, and in Argentina we don't have that benefit. We've had that benefit in the past, we've brought some of the depreciation forward. Right now, the expectation is that, in Argentina, we pay around $30 million in taxes during 2017, of income taxes.

Dan Major: Sorry, just to be clear on that, so you're paying, you expect to pay $30 million of cash tax in Argentina?

Ramon Barua: In Argentina; zero in Peru; and we expect to pay in Peru only the royalties amount, which is around $7 million to $7.5 million.

Dan Major: Okay, but you still get a P&L tax charge, correct?

Ramon Barua: Of course.

Dan Major: What's the effective rate on that?

Ramon Barua: The effective rate for 2016, correct me if I'm wrong Charlie, somewhere between 20% and 30%. Sorry to give you such a large range, but we will clarify on that.

Unidentified Analyst: Great, thank you. Two questions, the first one on San Jose. What inflation and peso assumptions are you using for your cost guidance, just with how much it's moving around right now? Then secondly, at Pallancata, at Pablo, there's multiple veins. In terms of the widths of those multiple veins, as you look to convert that into reserves, how do you see the grade transferring across?

Ramon Barua: Yes. First, in terms of inflation and devaluation in Argentina, in our cost guidance, we're assuming a zero impact. I think the number for both of them is around 25% inflation and devaluation. But should there be a higher devaluation than inflation, it should be a benefit to us; and, of course, the oppose is also true. In the case of Pablo, the grade, I would say, should be very accurate and should be a very good reflection of what we expect the production rate to be. The grades in certain areas are just impressive. Curiously enough, it's not a net, the veins in Pablo are relatively wide all in all. Having said that, the veins that are narrower but they're still at a very good width, have the highest grade and the veins that are, especially the main Pablo vein, which is much wider, has a relative lower grade than the others. So, that's why we expect that the grade is going to transition very well into production.

Unidentified Analyst: Two questions. Just one on the dividend, I know you say that paying down debt is a priority, but once you've addressed that bond, are you looking at a different policy? It seems like the dividend to date was just a flat nominal amount. Maybe just comment on that?

Ramon Barua: Sure. We talk a lot about dividends, of course, at a Board level. But what we see, Ian, is that there is a lot of volatility in in our cash flow from operations, of course, as a result from the volatility of gold and silver. So, it's really hard for us to make very long term projections, but our first goal is going to be again fully repaying the debt, continuing with the Brownfield project. Continue paying dividends, I would say what we have been paying, now I think it's a good reference. It's not a policy, but it's a good reference. What I can tell you is that the Board keeps very much in mind the fact of how important it is for shareholders to receive its dividend. The intention is to maintain the policy not [Indiscernible] the policy, to maintain the payment without having a very explicit policy. But what I can tell you is that if we continue in this line of showing positive results, in all likelihood, the payment of dividends will certainly continue.

Unidentified Analyst : And then just secondly on your Brownfield exploration that's picking up, maybe just looking at the profile over the next few years to get to the 2020 target of 10 years for resource, how much does that figure need to go up by?

Ramon Barua: It's very interesting what you are asking, but here, the plan that we have put together is a plan that will also ramp up tend to ramp up towards the end of the period. The reason is because there is a lot of permitting work that needs to happen upfront. For example, very explicitly during 2017, it shouldn't be precisely one fifth of that goal. On the contrary, I would say, we should start, especially given that it is such an aggressive number, that we need to go find mineral in areas we are relatively outside of our existing mines. Thus, requiring new and different permits than the ones that we have already in place.

Unidentified Analyst : But maybe just to push you on that, what's the absolute figure you need to spend to get to that 2020 target? I know you gave some ranges in the Capital Markets Day last year, but maybe just flesh that out a bit more.

Ramon Barua: We believe that this $25 million, if we can maintain that number consistent during the next five years, that would be enough to obtain the potential resources that we need for the goal. Once we discover those potential resources, converting them into inferred and measured and indicated will require additional budgets. Those additional budgets will be related to, of course, the timing and the quality of those potential resources. But, all in all the estimation that we have given is that we should be spending around $0.30 per ounce of silver discovered and incorporated into inferred resources.

Dan Shaw: Dan Shaw, Morgan Stanley. Just one question on Pallancata. You said the target there is to get to 2,400 tonnes per day by the end of the year. Obviously, there's still a little bit of extra spare capacity there to take you up to 3,000 tonnes. Could you talk about what needs to happen to get up to that level? Thanks.

Ramon Barua: Yes. What needs to happen is we need to have the accesses of the mine. The bottleneck is going to be the mine. We started with 2,000 tonnes, but as Pablo has started to expand and you saw that chart on Pablo that there are several other veins, so if we can access them in parallel as long as we can access them in parallel, the restriction will be the access to the mine; that's why we're building especially a new ramp for this area, at a cost of around [$15 million], to try to broaden that bottleneck and allow for a production in parallel. I think that the goal is going to be 3,000 tonnes per day. For this year, we have brought it up to 2,400 tonnes. It seems that a higher number could be possible in the following years, but so far, we have not fine-tuned that number. But there is certainly the possibility, because we are doing everything possible to expand bottlenecks, to make sure that we reach that capacity. The bottleneck, again, is at the mine.

Dan Shaw: And just one follow up. If I understood you correctly, the -- well, not all of the resource that's been increased at the Pablo is in permitted areas, is that correct? Can you give us an idea of how much sits within areas that are already permitted, and how much is outside that, or is that different to --?

Ramon Barua: Very broadly, I would say half and half. Yes, it's very curious because it doesn't show in that map, but where you see where we have our environmental impact study, because this is in an area where, as I showed you in Pallancata -- let me show you very quickly. Now, in the case of Pallancata, we had like secured, let's call it, all this area in terms of permit, and Pablo is right at the limit. The permits are cutting Pablo at around here. Also, the Pablo vein is in very good shape, I would say most of the Pablo vein is in very good shape. But these areas of the Pablo Piso, especially higher grade areas, need the permit -- for the permit to be updated. The things that we're working with the government are potentially that, because we're talking this is 5,000 meters above sea level, 200/300 meters underground, in the middle of nowhere, why is there a reason to have a super-complicated update of the permit? Of course, they understand that very well and they are working with us in trying to improve the permit. But even if they don't improve the permitting process, with the areas that are already permitted, it gives us enough room to achieve our production goals, as we have stated them. Hopefully, they -- if we receive the permits further, that will help, for example, in trying to expand capacity earlier on.

Dan Shaw: Thank you.

Unidentified Analyst: Just a quick question on medium-term capital structure of the business. Obviously, the immediate goal is to pay down the bond early, as early as possible. But in the context of net debt EBITDA 0.6 times, is there -- how do you think about medium-term capital structure of the business? Is there a comfortable level of net debt EBITDA that you target, or is it really just focusing on reducing net and paying for brownfield exploration?

Ramon Barua: Important question. Look, in terms of capital structure, we believe that we would prefer to have the lowest amount of debt possible. If we don't have a very specific use for that debt, then we don't see much point on having it. The problem, again, is the volatility of our cash flows. That prevents us from having a too aggressive amount of debt in the balance sheet. Of course, smaller amounts like keeping $50 million or $100 million in debt in the balance sheet, that's certainly fine. That can certainly work, especially if the debt is coming at such a low cost as the one that we describe. But certainly, nothing material, and we're not targeting a very specific goal in terms of capital structure or leverage ratios. It will be different if we have a project that we want to invest in, like it was the case of Inmaculada. For the case of Inmaculada, we decided to take on a lot of leverage, of course, and some part of equity. But that was because we felt very confident that this was a world-class project. So, we were prepared [indiscernible] project sitting on our backyard, with risks relatively managed. We know, you know, we know the authorities; we know the area; we have infrastructure. We know the geology of the place very well. So, we felt comfortable in taking that risk. Going forward, it has to be the same case. If it's a super-high quality project, then we'll probably also take advantage of the debt market. If not, there will, these things will need to be financed with either equity or cash flow. Cash flow, primarily, because we'll have an excess on that front.

Dan Major: Dan, UBS. A follow up on Dan's question, just around permitting again. After the $25 million exploration budget, if you assume, like, what's the split of actually permitted areas you can spend, and how much of that do you need to receive the permits to spend up to that amount?

Ramon Barua: Yes, it's a very good question. Unfortunately, it also has different degrees, because there are areas, for example, where we don't have the permit, but the permit is expected to be received in the next two or three months. There are others in which the permit is expected to receive up to a year. So, when we did the budget for this year, what we think is that we can spend that $25 million. What areas are permitted and which are not, let me show you, for example, what I have in mind. This is, we'll start with Pallancata. In the case of, sorry, Inmaculada. In the case of Inmaculada, one of the largest objectives is to explore the Millet vein. The expectation is that the permit is received in Q4 of this year. In the case of Pablo, this area, Explorador Marco, as I mentioned, that is fully permitted. We can go at it right now. But for this area, for example, Palca Cochaloma, probably it's going to be either Q4 or Q1 of next year. This area, we don't have it permitted. That is probably going to be pushed, have a larger potential of being pushed towards next year. In the case of Arcata, as I mentioned, at the core of our plan, we don't need the permit, because we are going to be exploring from underground with these parallel drill holes. So, that is in good shape. And in the case of Argentina, there is no major problem with permits. Again, it's a combination. Some of the areas we already have permits. In others, we don't need it. In others, we're expecting those in the second half of the year, with the risk of having to push them to early 2017. There are others where we believe it's a longer shot to have it this year. We still have it in the budget, but we're pushing really hard, as I mentioned, working hand in hand with the government, to try to bring them forward. It's in everybody's benefit to do it, actually; you're harming no one by bringing that forward. So, it doesn't make any sense. That's the plan.

Dan Major: Okay. So maybe 70%?

Ramon Barua: Let's call it 70%, that's fine. All right? Well, thank you very much for -- sorry, questions on the phone.

Operator: [Operator Instructions]. There are no questions on the line at this time.

Ramon Barua: Well, thank you very much for attending. Thank you very much for your questions and interest in the Company. We have a nice plan in place. Hopefully, update you with more positive results going forward. Thank you.