Ero Copper Corp. Q2 FY2023 Earnings Call

Thank you operator. Good morning, and welcome to Ero Copper's second quarter 2023 earnings call. Our operating and financial results were released yesterday afternoon and are available on our website as are our financial statements and MD&A for the three and six months ended June 30, 2023. On the call with me today are David Strang, Ero's Co-founder and Chief Executive Officer; Makko DeFilippo, President and Chief Operating Officer; and Wayne Drier, Chief Financial Officer. We will be making forward-looking statements that involve risks and uncertainties from which actual results may differ materially. We would refer you to our most recent annual information form available on our website SEDAR and EDGAR for a discussion of the risk factors of our business and their potential impact on future performance. As a reminder and unless otherwise noted, all amounts are in US dollars. I will now pass the call over to David Strang.

Thank you, Courtney, and thank you, everybody for joining us today. During the second quarter we continued to navigate a dynamic macroeconomic environment as we observed strengthening fundamentals in global copper demand while at the same time experiencing softer copper prices, driven by global economic concerns. The transition to clean energy has intensified the need by governments and downstream industries to secure critical minerals supply, as evidenced by impressive investments from non-traditional investors across the copper sector. Despite this positive backdrop, we saw lower copper prices during the period as well as a stronger Brazilian real. However, we're able to offset the impact of these changes in the copper price and exchange rate through the strong execution of our full year operating plan. This resulted in a noteworthy increase in copper production of nearly 30% compared to the first quarter. Additionally, our Xavantina operations performed well, contributing to adjusted EBITDA of $49.1 million and adjusted net income attributable to the owners of the company of $22.3 million or $0.24 per share on a fully diluted basis. We also made meaningful progress on our key growth initiatives including the Tucumã project and the Caraíba operations new external shaft. I am pleased to report that we are approaching 50% physical completion at the Tucumã project. Similarly, the pre-sink phase of development for the Caraíba operations new external shaft was successfully completed and we are gearing up for the main shaft sinking later this year. Importantly, we have achieved over 95% visibility on planned capital expenditures at Tucumã and approximately 80% visibility on shaft capital, with total forecasted capital for both projects remaining within 5% of the original estimates. Before I hand over the call to Makko to provide more detail on the progress around our key growth projects, let me give you an overview of our second quarter operating performance and the expected cadence of production during the second half of the year. At our Caraíba operations, we produced 12,004 tonnes of copper in concentrate at C1 cash costs of $1.52 per pound of copper produced. The higher mine tonnage and copper grades at all three of our mines were driven by planned stope sequencing resulting in increased production and lower unit costs compared to the first quarter. While we continued to sell copper concentrate to our domestic smelter during the quarter on a limited and prepaid basis, the associated reduction in concentrate sales costs was offset by continued strengthening of the BRL. As for the cadence of production in the second half of the year, we expect copper production to be slightly lower in the third quarter compared to the second quarter due to slightly lower planned mill throughput volumes and copper grades resulting from stope sequencing. However, we expect mill throughput volumes to increase in the fourth quarter with the anticipated commissioning of the new ball mill and drive quarterly production to its highest level of the year. Putting aside any fluctuations in the BRL exchange rate, we expect these variations in production to be reflected in Caraíba's C1 costs with slightly higher C1 cash costs expected in the third quarter and lower C1 cash costs expected in the fourth quarter. As a result, we are reaffirming our full year copper production guidance of 44,000 to 47,000 tonnes of copper produced at C1 cash costs of between $1.40 to $1.60 per pound of copper produced. Turning to our Xavantina operations. We continue to benefit from strong mine and processed gold grades of over 13 grams per tonne during the quarter. This represents an increase in grade of over 11% quarter-on-quarter and 100% year-on-year, effectively offsetting lower metallurgical recoveries that were impacted by elevated mill inventory at quarter end as well as elevated carbon content in several high-grade stopes mined and processed during the period. Consequently, we produced 12,333 ounces of gold and C1 cash costs of $492 per ounce of gold produced. We are reaffirming Xavantina's 2023 gold production guidance of 50,000 to 53,000 ounces at C1 cash costs of $475 to $575 per ounce of gold produced. With the completion of development to the Matinha vein during the second quarter, we expect higher gold production in the second half of the year as we commence production from this second ore source. Regarding our 2023 capital expenditure guidance, we have increased our range by $15 million to $20 million to reflect proactive investments following a detailed review of major projects and support infrastructure at the Caraíba operations during the second quarter. While the shaft project remains within 5% of budget we have elected to invest in various upgrades in the second half of the year, which Makko will discuss more to support our expanded life-of-mine operating plans. It is worth noting that the non-Caraíba components of our capital expenditure guidance as well as our C1 cash cost guidance remain unchanged. Nevertheless, we are closely monitoring the BRL to US dollar exchange rate, which averaged approximately BRL 4.8 in July. The BRL has since weakened following a higher than expected 50 basis point rate cut by the Brazilian Central Bank, combined with a more dovish tone expressed by the country's policymakers. If the BRL remains at current levels or strengthens again, we may consider adjusting the BRL 5.30 exchange rate assumed in calculating our full year operating cost and capital expenditure guidance ranges. I will now pass the call to Makko to discuss the highlights around our year-to-date project execution, after which Wayne will discuss our financial results for the quarter.

Thank you, David, and good morning, everyone. During the second quarter, we continued to make excellent progress across our portfolio of growth projects. Advancement of critical path work streams at both Tucumã and our shaft project at Caraíba is evident in the updated project photos we have included in our second quarter news release. At Tucumã, as David mentioned, we are approaching 50% physical completion and are on track to achieve first production during the second half of next year. Contractor mobilization hiring of key operational positions and the continuation of our training programs, which are focused on hiring locally, all progressed significantly during the period. And we now have a workforce of over 1,100 people on site. Notable achievements this quarter include the completion of all critical path earthwork activities and completion of all large volume civil work. In addition, we commenced assembly and erection of structural steel for the primary crusher the ball mill and flotation areas as planned. During the third quarter, we expect to complete the construction of our water reservoir; continue to advance steel and electromechanical assembly throughout the process area; install our primary crusher and ball mill, which are both on-site; and install our main substation, which is completing final testing and should arrive on site in the coming weeks. In summary physical progress and procurement at Tucumã remains on track. And with over 95% visibility on planned capital expenditures for project completion we are reaffirming our $305 million capital cost estimate. We expect capital spend at Tucumã to be second half weighted this year due to ramp-up on steelworks, electromechanical assembly and piping, as well as a number of final equipment deliveries expected during the second half of the year. At our Caraíba operations we are focused on executing our operational plans and advancing our Pilar 3.0 initiative, which includes the construction of a new external shaft for the Pilar Mine and an expansion of our mill capacity. The new external shaft project for the Pilar Mine is progressing according to schedule and was approximately 25% complete as of quarter end. As David mentioned, we completed the pre-sink phase of the shaft during the period. Subsequent to quarter end we successfully lowered the sinking stage into the shaft collar and commenced hoisting of the preassembled head frame into its permanent configuration. Our mill expansion project which includes installation of a third ball mill and a new flotation upgrade is on track to start commissioning and ramp up during the fourth quarter. Looking ahead at Caraíba, we remain fully on track to complete our mill expansion project and initiate the main sink on the new shaft by year-end. Underground at Pilar we remain on schedule with development and permanent underground infrastructure installations for shaft handover to operations by the end of 2026. It is worth noting that during the quarter we completed a detailed assessment of support infrastructure at our Caraíba operations. This thorough review identified new capital investments and upgrades totaling approximately $15 million to $20 million. These investments are specifically focused on bolstering the support infrastructure for the deepening project of the Pilar Mine, our underground paste-fill distribution system, and overall tailings capacity. The primary objective behind these strategic investments is to enhance the operating resiliency of the Caraíba operations and support its extended mine life. In the months and years ahead we will continue to look at staged strategic investments in infrastructure and new technologies to improve operational performance, ensure operating resiliency, and protect our frontline workforce. I will now turn the call to Wayne to discuss our financial results.

Thank you, Makko. As David mentioned earlier, our second quarter financial performance reflected a notable increase in copper production mixed with lower copper prices and a stronger Brazilian real compared to the first quarter. This drove operating cash flows of $55.5 million that helped to fund capital expenditures of $126.9 million, which were primarily directed towards the ongoing execution of our organic growth initiatives. We ended the quarter with a robust liquidity position of approximately $330 million. This included cash and cash equivalents of $124 million, short-term investments of $56 million, and $150 million of undrawn availability under our senior secured revolving credit facility. Regarding our Brazilian real to US dollar exchange rate hedges, we reported realized gains of $2.8 million and unrealized gains of $2.1 million. Looking ahead to the second half of the year, we are hedged on approximately $15 million per month at an average floor rate of 5.3% at an average cap rate of approximately BRL6.3 billion to the US dollar. We also remain hedged on approximately 75% of our copper production for the remainder of the year through a zero cost collar hedge program initiated in January. Hedge contracts provide a full price of $3.50 per pound on 3,000 tonnes of copper per month through December 2023. It's worth noting that our realized metal prices for each quarter reflect settlement adjustments and other miscellaneous items not captured in C1 cash costs. Furthermore, average realized prices are influenced by the timing of the metal sales, which do fluctuate within a given quarter. With that, I'll now hand the call back to David for some final remarks.

Thank you, Wayne and everyone who joined the call today. Before we proceed to the Q&A session, I want to take a moment to express my sincere appreciation to our dedicated colleagues in Canada and Brazil. The commitment and hard work have been instrumental in not only executing our operating plans but also driving progress on our organic growth projects. Additionally, I am pleased to announce the publication of our 2022 sustainability report earlier this week. This report outlines our strategy and performance across key environmental, social, and governance topics. As the global decarbonization movement gains momentum and stakeholder interests converge, we are proud of our strong ESG profile, which we firmly believe will translate into positive financial outcomes. We are excited about the opportunities to expand our contributions to the green economy as we execute on our growth strategy. On a personal note, many of you know Courtney very well. I'd like to also extend our congratulations to Courtney who was promoted to Senior Vice President of the Corporation for Corporate Development, Investor Relations, and Sustainability. This is a true testament to her strength and what she adds to our team that we were pleased to be able to provide her with this promotion. So congratulations Courtney from us and the rest of the team. And with that operator we'll now open the lines for questions.

Thank you. We will now begin the question-and-answer session. The first question comes from Dalton Baretto with Canaccord Genuity. Please go ahead.

Thank you. Good morning, guys. And congrats, Courtney. I wanted to start by asking about the realized price and I understand Wayne just touched on it, but maybe just a little bit more context. Over the last few quarters I mean you've been realizing somewhere between a 10% and 15% discount to the LME. I'm just trying to understand really what's in there and whether that's kind of a go-forward assumption to make? Thanks.

Yes, Dalton, we have several adjustments that affect this. There are also settlement adjustments involved. When considering the final deliveries, you'll notice there are weight and assay adjustments. Therefore, when you assess what we realized compared to the headline price, I believe that's a reasonable assumption for the future.

Okay. Great. Thanks, Wayne. And then maybe I can just ask you another one. On the BRL implications if the BRL does stay around BRL 4.8, BRL 4.9. And I understand the floor on some of your hedges is around BRL 5.3. If the BRL does stay around BRL 4.9 what are the implications on your C1 costs as well as on your CapEx estimates for the two projects? Thanks.

Yes. Dalton, this is Makko. I'll pick that one up. When you look at our business and I think we've talked about this in the past particularly in the operating cost level, our operating costs are about 95% denominated in Brazilian reais. That excludes things like diesel which do have a dollar link component. So that's a 9.5:1 ratio on the BRL and 0.95:1 ratio on the BRL. On our capital projects it depends on which one you're talking about. The Tucumã when you look at the remaining spend is about 90% to 95% BRL. When you're looking at the shaft project it's less. It's probably about 60% BRL. And on the mill expansion it would be the same 95%. It's predominantly labor at this stage.

Great. Thanks, guys. I will jump back in queue.

Hi, good morning. David, can you provide an update on the nickel exploration? I'm also wondering if we should still expect a more comprehensive nickel update in October, as you previously mentioned. Is that still accurate?

Thanks, Orest. I'm surprised Dalton didn't beat you to the punch on that one. With regards to nickel, we continue to advance the projects and moving them forward. I think where we are standing right now is we're hopeful to be able to have a more fulsome conversation with the market probably more likely in November. But I don't want to get too into the reads with regards to everything that's going on in and around the projects as we're working on them. But we want to be able to give the most comprehensive update we can with regards to how that's all coming together. And it looks like the best guidance I can give you right now is possibly November with regards to doing that. There's a couple of items that we're working through with regards to land packages. And as they come to fruition and we're hopeful they still come to fruition in the near term, so we'll be able to have a more fulsome discussion. So I think right now the best indicators I can give you is sometime in November is likely when we would like to be able to have a more fulsome discussion with the marketplace about it.

Okay. Thank you. And just as a follow-up to that, should we be anticipating a potential maiden resource on the nickel, or is that way too premature?

I think it's a little premature that – Orest, I mean, what we're trying to understand with regards to the various areas that we have is what is the quantum of opportunity we have with regards to various nickel targets that we're dealing with. I think resources right now, I think is premature. I think what we're trying to understand is what is the quantum of the opportunity throughout the Curaçá Valley in terms of the number of these that we can look at and we can start working on in a comprehensive fashion over the course of the next few years.

Okay, perfect. And just one follow-up to Dalton's question for Wayne about the realized nickel price, sorry copper price. I realized this quarter was pretty volatile with respect to copper price. I mean, going forward in a flat copper price environment, which eliminates the provisional pricing impact, what kind of run rate discount should we be anticipating to LME in that environment? Because I feel like the discount this quarter was exaggerated to the downside.

This quarter, we had one shipment that was impacted by an unusual settlement on assay. We decided to book it even though it's still pending confirmation, which resulted in a larger effect on this number. Looking ahead, I expect it will align more closely with historical levels, which range from 5% to 10%. This is due to various adjustments specific to the different contracts we have with our off-takers. As you know, we operate under short-term contracts rather than long-term ones, and each of these contracts has its own specific adjustments and terms regarding treatment and refining charges.

Okay. I find it unusual to see it reported this way. Shouldn't these be reflected in the costs rather than a discounted LME price?

We have a specific approach that we adhere to. We are confident that these reflect discounts to the metal price, and we have maintained this approach consistently over the past few years. Therefore, we haven't altered our strategy, which is evident if you review our previous reports.

Okay. Thank you very much.

The next question comes from Gordon Lawson with Paradigm Capital. Please go ahead.

Hey, good morning and thank you for taking my question. Can you please provide a little more color on the 45% completion at Tucumã in terms of the status of delivery of long lead items?

Yeah. Hey, Gordon, this is Makko. So when you look at our long lead items, effectively all the purchases have been placed. As I said the longest lead items which we've been on are ball mill and primary crusher. Those have arrived on site. When I go through the manufacturing punch list across the remaining long lead items, those are in near completion stage at most of our providers for those pieces of equipment. And we expect deliveries to occur throughout the balance of the year on all long lead items that we purchased or put deposits on in the last 12 to 14 months.

Okay. Great. Thank you. And looking at the pre-stripping, seeing how far it's ahead of schedule are there any plans to mine and stockpile the sulfide ore prior to the mill completion?

Yeah. If you look at the schedule Gordon, it's a great question we're about 2.7 million cubic meters advanced or approximately five million tonnes on the pre-strip. We anticipate reaching first sulfide ore in November of this year, so sometime during Q4. And we will accumulate a stockpile of ore in advance of commissioning which we anticipate occurring in 2024 as you know.

I'm really impressed with the team's attention to detail, especially regarding the stockpile. We all understand that we will be mining very high grades early in the mine's life. The team has developed a plan to have both a high-grade and a lower-grade stockpile. This approach means that during re-commissioning, as we start testing everything, we won't waste high-grade material. Instead, we'll use lower-grade material for testing purposes. I want to commend Makko and the team for their thoughtful planning and the careful attention to the details involved in this strategy.

Okay. That sounds great. Thank you very much. Appreciate it.

The next question comes from Stefan Ioannou with Cormark Securities. Please go ahead.

Thank you very much, and congratulations Courtney. I'm just curious, in past calls you mentioned seeing potential in areas beyond Tucumã. I know it's difficult to comment on these matters, but can you provide any updates on what you're observing in that region?

Nothing new to report at the moment, Stefan. We are collaborating on a project with Soma, but it’s still too early to share detailed insights. The team is also expanding its analysis for a broader review of the area surrounding the Tucumã project. So, no further updates on that topic.

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

Thanks for taking my question, and I'll add my congratulations to Courtney as well. Well deserved. I was wondering on the changes to your CapEx guidance that you've given for 2023. Can you talk a little bit about which projects you've brought forward or added to the list for this year for the second half? Thanks.

Yes, Jackie, this is Makko. It's important to highlight that there are several line items involved, none exceeding $2.5 million. These consist of small investments and operational enhancements related to the permanent infrastructure for the Deepening project, which we won't be able to revisit once the shaft is operational. We're also moving forward with the installation of our permanent infrastructure, as well as improvements to the tailings and the underground distribution system for the paste-fill line. These are the primary areas of focus. Overall, these various investments and line items total approximately $15 million to $20 million.

Can I ask just as a follow-up, what prompted those projects to be brought forward? I know you mentioned coordinating with the shaft. But is this related to the fact that your balance sheet is in better shape than you had anticipated, or is it because the shaft is moving forward more quickly than you had expected?

I'm going to take this one. In terms of Makko taking over the role as COO, he decided to do a comprehensive review. And he felt that certain projects needed to be moved up in terms of the overall profile of some of the items with regards to efficiencies in the business, along with some projects that he felt needed to be spent sooner rather than later.

That makes a lot of sense. Thanks, very much.

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

I'd just like to thank everybody again for coming on the call. I hope everybody is having a great summer. And as always, we are available for questions. Please feel free to reach out to Courtney, myself, Makko, Wayne if you have anything further you'd like to get clarity on. Thanks again, operator and thanks to everybody. Bye-bye.

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