Ero Copper Corp. Q4 FY2021 Earnings Call

Thank you for your patience. This is the conference operator. Welcome to the Ero Copper Fourth Quarter and Full-Year 2021 Financial and Operating Results Conference Call. Please note that all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be time for questions. I would now like to turn the conference over to Noel Dunn, Executive Chairman of ERO Copper, for opening remarks. Please proceed.

Thank you and good morning, everyone. The news release announcing Ero's Fourth Quarter and full-year 2021 financial results is available on our website, as are our financial statements and MD&A for the three months and twelve months ended December 31st, 2021. We will be making forward-looking statements on this call that involve risks and uncertainties concerning the businesses, operations, and financial performance of the company. We'd refer you to our most recent AIF available on our website and also on SEDAR and EDGAR for a discussion of the risk factors of our business and their potential impact on future performance. As per usual, unless otherwise noted, all amounts are in U.S. dollars. Joining me on the call today is Makko DeFilippo, the President, Wayne Drier, Chief Financial Officer, and Courtney Lynn, Vice President Corporate Development and Investor Relations. Unfortunately, David Strang, Ero's Co-Founder and Chief Executive Officer, is unable to join us today due to an urgent family matter requiring his attention and travel overseas. Before we discuss Ero's operating and financial performance during the fourth quarter and full-year of 2021, I'd like to touch on important strategic momentum we've built up over the last 18 months and highlight the clear and fully funded pathway now in front of us to double our corporate reduction to approximately 100,000 tonnes per annum and achieve sustainable gold production levels of approximately 60,000 ounces per annum. Our strategy to unlock value from our portfolio has remained consistent over the years and includes: 1. Maintaining high operating margins to organically fund production growth. 2. Delivering year-on-year increases to our underlying resource base across our asset portfolio through ongoing exploration programs. 3. Optimizing newly identified and existing quality growth projects within the portfolio, prioritizing low capital intensity and high returns, highlighted most recently by the team's work at the Boa Esperança Project, as well as the Pilar 3.0 and NX60 initiatives. Lastly, maintaining a balance sheet capable of supporting our growth initiatives across a range of metal price scenarios. Just last month, our Board formally approved the Boa Esperança Project, which we expect to commence construction during the second quarter of this year. Commercial production from the mine is expected during the second half of 2024 with the first full-year production being in 2025. Upon completion, consolidated copper production of the company is expected to reach nearly 100,000 tonnes at first-quarter operating costs. At our operating assets, our new strategic initiatives are well underway, including the Pilar 3.0 and NX60 initiatives, which are expected to continue to generate high returns on invested capital for the company. At the Pilar Mine, exploration successes and optimization efforts in the shallower portions of the mine, paired with the construction of a new external shaft, are expected to increase combined production from the mine to approximately 3 million tonnes per annum compared to the 1.3 million tonnes of ore produced in 2021. At NX Gold, production from the Santo Antônio Vein, combined with the planned production from the Metinya Vein beginning in 2024, is expected to result in sustained gold production of approximately 60,000 ounces per annum. Excess mill capacity at both assets continues to support our focus on value creation through exploration. To support our growth strategy in the coming years, we bolstered our balance sheet earlier this year with a $400 million offering of eight-year senior unsecured notes. We priced the notes prior to the recent increase in market volatility, and as a result, we're happy to lock in a coupon of 6.5%. Our liquidity position is now strong at approximately $550 million on a pro forma basis, including approximately $475 million in cash and $75 million in revolving availability. While recent geopolitical tensions presented a new set of challenges to businesses globally, they've also highlighted a tangible sense of urgency for both government and consumers to transition to renewable energy sources. The benefit to Ero Copper has been positive, with copper prices rising to all-time highs, more than offsetting the impacts of higher consumable pricing and the influences of the recently strengthening BRL on operating costs. As a result, the margins of our business and cash flows are expected to remain strong, further supporting the execution of our strategy in 2022. I will now pass the call over to Makko DeFilippo to provide an overview of our operational performance, and then over to Wayne, who will cover Ero's fourth quarter and record full-year financial performance. As always, our team will be available for questions immediately following the call.

Thank you, Noel. Full-year production results were previously released along with 2022 guidance and our five-year operating outlook earlier in the year. Operating highlights for 2021 included record production of over 45,500 tonnes of copper and production of nearly 38,000 ounces of gold, surpassing the high end of our full-year production guidance ranges. Copper production at the MCSA Mining Complex during the fourth quarter was approximately 11,900 tonnes, representing a 19% increase relative to the third quarter. The increase in copper production was driven primarily by higher mill throughput, which improved during Q4 relative to prior periods due to the successful completion of planned mill maintenance and upgrade activities during Q2 and Q3. In addition, higher mine copper grades during the fourth quarter from our underground operations, particularly at the Vermelhos Mine, combined with higher metallurgical recoveries contributed to increased quarter-on-quarter production. C1 cash costs at the MCSA Mining Complex during the fourth quarter were $0.96 per pound of copper produced, resulting in full-year C1 cash costs of $0.77 per pound, falling at the low end of our annual guidance range. Increased C1 cash costs during the second half of 2021, including during the fourth quarter, reflect a combination of industry-wide inflationary pressures on consumables, combined with increases in the relative proportion of export versus domestic concentrate sales during the fourth quarter. Production at the NX Gold Mine during the fourth quarter was over 8,500 ounces of gold, while tonnes mined and processed increased by approximately 10% over the third quarter. Increases in mine production were offset by lower grades from within the Santo Antônio Vein relative to prior periods. As a result, C1 cash costs and all-in sustaining costs per ounce of gold produced increased modestly relative to prior periods to $582 and $910 per ounce respectively. For the full year, C1 cash costs and all-in sustaining costs at the NX Gold Mine were $525 and $732 per ounce respectively. As noted previously, we are reaffirming our production cost and capital expenditure guidance for 2022. With respect to setting expectations for production cadence on the year at the MCSA Mining Complex, copper production is expected to be equally weighted between the first and second half of the year. While we expect strong mill throughput rates throughout 2022, copper production is expected to be lower during Q1 due to planned stope sequencing of our underground operations and the relative increases in contributions from our Surubim open pit operations. For the NX Gold Mine, we expect production to be slightly weighted to the second half of the year. First-quarter gold production is expected to be in line with that of Q4, as we move development and production activities from the current areas of the mine into higher grade levels of the Santo Antônio Vein, which we will access beginning in the second quarter. Capital expenditures are expected to be weighted to the second half of the year, largely due to the ramp-up of construction activities at Boa Esperança. As Noel mentioned, we anticipate mobilization to occur during the second quarter. At MCSA, our mill expansion project remains on track with long lead item orders placed, including the third ball mill for our concentrator. The construction of the new external shaft at the Pilar Mine, which commenced in Q3 last year, and our cooling project, both part of the Pilar 3.0 initiative, remain on budget and on schedule. An integral component of our overall strategy as a company remains our focus on organic growth through exploration. We are pleased to be hosting an exploration technical session tomorrow at noon Eastern Time via webcast. A new format for us, our goal with this session is to provide additional context on our exploration strategy, further detail our plans for 2022, and outline some of the organic growth opportunities we are pursuing across our portfolio. Webinar details can be found in our March 8th press release, which has been posted to our website. This session will be available for replay for approximately 90 days. With that, I will turn the call over to Wayne to review our fourth quarter and full-year financial results.

Thank you, Makko. And good morning, everyone. The fourth quarter capped a record year of financial results for Ero Copper driven primarily by a record full-year copper production and higher copper prices compared to 2020. Increased copper concentrate sales during the fourth quarter drove an increase in revenues by over $23 million or more than 20% compared to the third quarter to approximately $135 million. Full-year revenues increased by over 50% compared to 2020 to a record $490 million, driven by higher year-on-year copper prices, as well as increased sales of copper concentrate and gold. Other record 2021 financial results included adjusted EBITDA of approximately $332 million, cash flow from operations of approximately $365 million, and adjusted net income per diluted share of $2.37. As a result of our strong operating financial performance, we ended the year with over $230 million in available liquidity, including over $130 million in cash and cash equivalents, and $100 million of undrawn availability under our senior secured credit facility. This represents a quarter-on-quarter increase of $11 million and a year-on-year increase of $156 million. A portion of the year-on-year increase is attributable to the upfront payment of $100 million received in the third quarter in connection with the NX Gold Stream. As we explained on our third quarter call, this upfront payment is amortized as deferred revenue as ounces are delivered under the stream. In 2022, we expect amortization of deferred revenue to total between $13 and $15 million. With respect to our foreign exchange derivative contracts, we reported realized settlements during the fourth quarter of $6.2 million, representing an increase of $1.8 million compared to the third quarter. This increase was related to the opportunistic early settlement of a portion of our foreign exchange derivative contracts to take advantage of the strengthening BRL that happened during the fourth quarter. We expect foreign exchange settlements to continue to amount to between $4 million and $6 million per quarter for the first half of this year, and then decrease substantially in the second half of the year as our contracts' positions expire. As Noel mentioned, subsequent to year-end, we completed an offering of US $400 million of senior unsecured notes due 2030 and concurrently reduced the size of our senior secured credit facility from $150 million to $75 million. We used approximately $50 million from the notes offering to repay the outstanding balance under the senior secured credit facility. The net result is a pro forma year-end available liquidity position of approximately $550 million, representing an increase of roughly $320 million over what was reported at year-end. Based on the 6.5% coupon on the notes, accrued interest on a quarterly basis is expected to be around $6.5 million, with accrued interest in the first quarter of this year expected to be slightly lower at just over $4 million due to the issuance happening in February. Cash interest payments on our bonds of $13 million will be paid semi-annually every August and February. With metal prices going from strength to strength, we have the potential to deliver another year of exceptional financial results in 2022. With that, I'll hand the call back to Noel to share some final comments.

Thank you, Wayne, and everyone who joined the call today. Before we open up the call to Q&A, I'd like to recognize and congratulate my colleagues on an excellent 2021. As we embark on a multi-year phase of growth for the company, the team and balance sheet—as you've seen recognized in this call—has never been stronger. I'm excited to see this demonstrated execution of our strategy and the value we create for our shareholders. I will now turn the call back to the Operator, and we will open up the line for questions.

Thank you. We will now start the question-and-answer session. We will take a moment for callers to join the queue. The first question comes from Karl Blunden with Goldman Sachs. Please proceed.

Good morning. Thanks very much for the time. Obviously, a lot of volatility in the commodity landscape and some of it is benefiting you from a price realization standpoint. I just wanted to focus briefly on your expected project costs for the build-out at Boa. And I wanted to get your take, please, on any exposures you have there that may influence the total cost of the project, whether it's energy costs or other raw materials like steel. Just want to get a sense of your comfort for the budget there.

When we conducted the feasibility study, we updated the project's cost last summer at a time when steel and concrete prices in Brazil were significantly inflated. Those prices have since decreased. It's somewhat of a balancing act. It would be unrealistic for us to claim there’s no inflation in costs or potential costs related to Boa. Certain expenses will inevitably rise, but other factors have turned out to be lower than we anticipated. Overall, it’s too early to determine the final outcome. Let’s take a step back and consider what Boa is. Boa is a project with very low capital intensity and a high return. That was a key reason for selecting it. It has a 42% internal rate of return and requires only a $300 million investment. In the grand scheme of our business, that's relatively minor. We're not dealing with a $3 billion investment that would leave us very exposed to price inflation.

That's very helpful. During the quarter, you had announced some safety incidents. I was curious. It's been a couple of weeks now, what any changes that have been made at the company since then, if that was necessary, and just employee response to any initiatives?

That's a very fair question. It was a significant tragedy for the company. A core tenet of our business is that people should be able to go to work and return home to their families safely every day of the year. We take these rare events very seriously. In each case, in collaboration with all relevant authorities and regulatory agencies in Brazil, we will review the facts and circumstances and audit our own procedures to determine if any changes are needed or if there's a better way to do things. Our focus during these events is on two main areas: the family of the person involved, which is our first priority, and communication with our employees, which is equally important. It's crucial that everyone is informed about what has happened and what is ongoing. We communicated with our workforce immediately, providing them with information very quickly after such an event. Now, it's been about a month since it occurred, and there haven't been ongoing discussions; we must be sensitive to these matters. Our initial analysis shows no changes in our operating procedures around these issues, as we have strong procedures in place. Unfortunately, events do occur, but there have been no changes in that regard or in how we communicate with our personnel. It's unfortunate, and ensuring these incidents do not happen remains a key priority for our business.

Appreciate the update. Thank you.

The next question comes from Jackie Przybylowski with BMO Capital Markets. Please go ahead.

Thank you very much. I'm not accustomed to being second on the list. My first question is about your mill. I noticed you mentioned in the release that you're working on the mill expansion at MCSA. Could you discuss what work you might be undertaking or what considerations you have regarding future mill expansions? I recall David mentioning the possibility of building a second mill in the past. Is there any actual progress being made on those next steps, or is it still in the early stages?

Hey, Jackie, this is Makko. Obviously, we've outlined our five-year guidance for the expansion of our mill to 4.2 million tonnes a year, and that is happening as we articulated here today. We placed the long lead items related to that next phase. But I think, taking a step back and thinking about what we're trying to do, we're always looking at ways to continue to grow our business, to grow production, and to continue delivering high returns. So there's a whole suite of projects that we're evaluating on an ongoing basis as to specifically how it relates to either a further mill expansion or discussions around a potential new mill. I'd say those are part of a wide variety of portfolio projects that we continue to evaluate in the context of prevailing market conditions; also, what we're seeing on the exploration side. And I think it's fair to say that over the past five years and certainly in the future, our goal is to continue to strategically execute on the highest return projects, as we've done and as I think we're demonstrating here in 2022.

Thanks, Makko. And the second question, maybe if I can, I know you guys have touched on this already, so I apologize. If it sounds like I am repeating, but we're getting more questions about cost inflation, and whether it's at the project level or in operating costs, maybe I'll add more on the operating cost side because I think you were just talking about the project side. So on the operating cost side, how much cost inflation are you seeing in terms of labor or fuel or other sources of inflation maybe on the FX side, and is there anything that you guys can really do about that? And I guess. So we're looking in the context of the guidance that you came out with in January, how comfortable are you, I guess still with that range? Thank you.

Great questions, Jackie. Obviously, one is at the conference that we're quite topical last week at the BMO Conference, and we continue to get questions. Look, I think, again from our perspective, we have seen throughout 2021 inflation in Brazil both in terms of labor and key input commodities as alluded to, steel and cement, both up significantly. That was paired with a significant weakening in the second half of 2021 in the BRL, which from a U.S. dollar operating cost perspective, softened that impact. Labor adjustments are annual in Brazil, so that will be carried forward through our guidance period. I think looking more on a forward-looking basis for this year. What can we do to impact those potential impacts on inflation? I think if you look at the key drivers of our operating costs, obviously labor is one, and as I mentioned, that adjustment happened in Q4 of last year. Then on the other ancillary impacts like diesel-related products, we've been getting a lot of questions on diesel prices. Those represent roughly 10% of our variable operating costs. And diesel, as you know, is subsidized in Brazil. So I think the largest single swing factor in our U.S. dollar-denominated operating costs is the BRL. And we have seen strengthening in the BRL here in the first quarter of 2022.

As I said before, we're not naive; you've got to have some inflationary factors. But the reason why we operate a high-margin business is for precisely this reason. We are all going to see some inflation in cost. But at the same time, we're seeing offset by a significant increase in the copper price. And we have one of the highest margins in copper businesses in the world. Therefore, yes, we will have a negative impact, but relative to everybody else, it's going to be rather minimal for us.

And that's great, that's super helpful. Thanks, Noel and Makko, and congrats on a great quarter.

Thank you.

The next question comes from Orest Wowkodaw with Scotiabank. Please go ahead.

Good morning. Following up on Jackie's question about cost inflation, I understand this is a relevant topic, especially since you're starting two significant projects, the Boa Project and the new underground shaft at Pilar. Can you give us an update on whether you've managed to secure a percentage of the costs or equipment? Additionally, are you thinking about locking in the foreign exchange rate, or will you be fully exposed regarding those projects and the associated capital expenditures?

Yeah. Maybe I'll touch on the capital side and then Wayne can touch on the FX. Wayne, don’t touch on that. So on the capital side, orders for our major projects, we've purchased, as we announced, I think it was in Q4, we announced some acceleration of long lead items related to the shaft. So some of those items have been fixed as of Q4, some of the largest items in that capital profile. And then as I mentioned, we just placed down the order for the long lead item for the mill. So those are, at MCSA, some of the chunkier components that CapEx have been fixed at Boa. We're in the process right now. We're just in the last few weeks, all of the aspects—Noel said, it’s a bit too early to comment specifically on Boa in terms of fixing those, but that will happen here in the coming weeks.

And Orest, Wayne here. Just to pick up on the FX piece of that. I mean, I think the approach we're taking at Boa is, we're not signing a single EPC contract there. It'll be a series of work packages, so kind of think of it as sort of a hybrid EPC model. Obviously, some of those work packages may be denominated in BRL particularly around, let's say, earth moving and site clearing. I think once we're in a position where we’ve got visibility on that, we may consider hedging the exposure on that contract per se. But I don't think there's any desire to go out and hedge the entire project or anything like that. I mean, I think the reason we went and did the bond offering a few weeks ago was to provide ourselves the flexibility to basically weather any inflationary or FX—short-term FX movements in the next year to 18 months.

Yeah. Like we said, it's low capital intensity projects; it's a super fast build to get into production in two years, I think you could go in that context and we're sitting here, what, $470 copper and our balance sheet and a strict business school accounting kind of thinking by doing the action deal. For precise the reason that we live in a volatile environment. And so whether it was copper prices being volatile, energy prices being volatile, that's the reason why we did the bond deal, so we can hopefully get through these two years. But the capital intensity of Boa is so small, it's very easy for us to do that. So in a sense, yeah, you can say costs are going to go up, but you have to put that in the context of what's going on with the copper price. And the copper price is dramatically increasing faster, and put it this way, the copper price benefits to us significantly outweigh any inflation that we perceive in some of the costs. And as I said, it's swings and roundabouts because the team has sourcing products from different sources. And so we're winning on some and losing on others; that's why it's a bit hard today to say, oh, it's going to be much more expensive; it's not going to be much more expensive because the guys are working on different solutions. So I think it's a little early to say. And similarly with the energy prices. If you could tell me that the oil price is going to be $125 for the rest of the year, okay, then we can factor that into our numbers. But the issue on oil prices and issues on those inputs is how long are they going to remain at where they are today? And that's very difficult to predict.

Thanks for the color. Just on the diesel costs. I think Makko mentioned it's about 10% of variable OpEx. Can you remind us what was assumed in the guidance this year with respect to the oil price? Like what was the base case that the guidance cost guidance was driven on?

We used the average for last year for us leading up into our guidance period across input costs.

Average of 2021 basically?

Correct. Yeah, average of 2021. And I would additionally note, sir—and just to clarify, the 10% of our total cost structure is diesel and diesel-related products. So that includes reagents, emulsions, the whole lot.

Okay. Thank you very much.

And spot diesel prices you see on your screen at Bloomberg do not—they correlate, but not terribly well to what happens in Brazil. As you can also see on Bloomberg, if you look at that. So the diesel prices lag significantly to what's going on in the spot market. And if you think about the politics in Brazil, that's likely to continue.

Right.

The next question comes from Dalton Barreto with Canaccord Genuity. Please go ahead.

Thanks. Good morning, guys. I realize this may be front running tomorrow's session, but where are we at in terms of drilling out the gaps and bringing some of that into the mine plant at Boa?

That is front running tomorrow session. And we have—our guys have done a really good job on it and they will reveal small news tomorrow, but we're very happy with the results that we have on the gap zone. It's been very productive, shall I say, without stealing their thunder.

Great. Just to expand that, I think across our portfolio, whether you're looking at Para, Vermelhos, NX, Boa, I think the theme here has been continuing in hallmarks of value. And I think Boa is another strong example in that sequence. And we're really excited with the results that we see, and not just in Boa, but also Para, Vermelhos, and NX Gold as well. And we'll talk about them more tomorrow.

Okay, great. Then maybe switching gears, but staying with Boa. You guys have talked in the past about Boa kind of being the regional hub, given a lot of earlier-stage opportunities in the Eastern carge out there. I'm just wondering how active an acquisition program you have on or is that more of a backward thing?

No. Look, I mean, first of all, we're in the western side, but we already are in the process of sinking an acquisition of a nearby property, which I think once you built the Boa mill and you worked your way through the Boa property in fact, there's an underground component of Boa that we will probably talk about too because we keep finding more interesting things at Boa itself. Boa is essentially a hill; that's why it's got such high economic returns is because you mine into a hill, but there is a future of Boa underground as well. But at the same time, playing on the same logic we have in the Curaçá Valley, once you build that mill, you can create a hub-and-spoke type of operation. And there are other properties in the area that we've looked at, and we're talking to people about thinking ahead down the road as to continuing the life of all the production facility in that area. On a wider basis, it is an interesting place. It's still relatively unexplored, certainly on the west. And there's plenty of opportunities there. And so I think you would expect us over the next five years to be seeking to build a much bigger leg to our business in that part of Brazil. I don't think you should think of Boa as being one isolated operation that we build and then we close up and go away. That's just not the way we're thinking about it. We're thinking about it as being a meaningful additional leg to the business.

That's great. Thanks, Noel, that's all for me.

This concludes the question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

Again, thank you to everyone for attending our call today and for your questions. We look forward to speaking to you again in just a few weeks to discuss our first quarter 2022 results. And as ever, if you've got any more questions or queries, please contact us directly, and we're happy to talk about things. Thank you very much.

This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.