Nexa Resources S.A. Q2 FY2020 Earnings Call

Good morning, and welcome to the Nexa Resources Second Quarter 2020 Conference Call. The presenters on this call are Mr. Tito Martins, CEO of Nexa Resources; Mr. Rodrigo Menck, CFO of Nexa Resources; and Ms. Roberta Varella, Head of Investor Relations. Please note this event is being recorded. I would now like to turn the conference over to Mr. Tito Martins. Please go ahead.

Thank you, and good morning, and good afternoon, everyone. Thanks for joining us in another Nexa earnings conference call. Today, we'll be talking about our results for the second quarter of 2020. I hope you and your loved ones remain safe and healthy. Please, let's move to Slide 3, where we will begin our presentation. As I stated before in our presentation related to the results of the first quarter, the health and safety of our people and the local communities are our highest priority. COVID-19, as for most mining companies, had a negative impact on our business in the second quarter. Our mining operations in Peru, in response to the Peruvian government requirement to combat the virus, remained suspended for almost half of the quarter while the Cajamarquilla smelter operated at reduced rates. By mid-May, we started to return our operations in Peru. Cerro Lindo mine and El Porvenir are ramping up production since then. We are still facing, from time to time, some constraints related to the workforce availability. The spread of the virus in our firm remains a big concern. This problem probably will last for some more months. In the process of returning the mines, we decided to keep Atacocha underground production suspended. Its higher costs made it less competitive. The Cajamarquilla smelter is already running at full capacity. In Brazil, the Juiz de Fora smelter, which was operating in May and June at reduced rates because of lower demand, is now almost back at full capacity. Our third smelter, Três Marias, has been operating normally during all this complex time. Despite the challenging scenario, we were able to mitigate the economic impacts of the pandemic. Thanks to the business continuity measures implemented and the strong commitment of our team, our mines in Brazil posted a record high throughput in the quarter. A series of measures were implemented in our operations, and all of our properties in Peru and Brazil have been home off since the beginning of the crisis. To mitigate the spread of the virus, we implemented benchmark protocols in all of our operations and projects. In order to keep social distance, we adapted our accommodations, cafeterias, and transportation. We changed the workforce shift in our Peruvian mines, and we are providing COVID antibody tests and health checks for all incoming personnel on our sites. In the second quarter of 2020, incremental costs related to COVID-19 were approximately $4 million. We believe that 50% to 60% of them will become recurring costs in all operations, at least until the end of the pandemic. Although a high level of uncertainty remains, we expect to deliver our production guidance. Also, the investment guidance for the year remains as previously announced. Our short-term strategy continues to look at cash preservation and cost reduction. We also continue to manage our balance sheet, and our liquidity remains strong.

Thank you, Tito, and good morning, everyone. I am on Slide 4 now. We ended March with a solid cash position, but in response to the COVID-19 escalation and the mandatory suspension of our operations in Peru, we increased our liquidity position by adding almost $350 million to our cash balance through new debt, bringing $45 million through our Brazilian subsidiary and the drawdown of our revolving credit facility in the amount of $300 million through Nexa Resources in Luxembourg. Taking advantage of the capital market momentum in June, we issued our new long 7-year bonds of $500 million, and its net proceeds were fully used to repay short-term debt and our revolving credit facility. As a result, maturity is now over 5 years. Please note that the revolving credit facility remains committed until October 2024. As we previously anticipated, due to the impact of lower metal prices and lower production in our cash generation, we were already expecting leverage to increase and potentially breach the 4x ceiling determined for the leverage ratio and financial covenants of certain loans. During the quarter, we were successful in paying certain debts and also in negotiating waivers with our counterparts. In a way, we will not be required to measure the leverage ratio until June 2021. Other financial covenants remain in place and are being complied with. Turning now to Slide 5. On Slide 5, we present Nexa's free cash flow generation. During the quarter, we generated $343 million, mostly driven by new debt incurred during the period. Describing it further and starting from our $40 million adjusted EBITDA, we had a $19 million gain in working capital, mainly as a result of increased average supplier payment terms, coincidentally offset by $19 million of sustaining CapEx and another $30 million of interest paid in taxes. Still, Nexa has generated $10 million of cash flow before expansion projects during a very tough quarter. Non-sustaining CapEx, which includes mainly our expansion project in Aripuanã, amounted to $41 million. Finally, during the quarter, as explained on the previous slide, we raised new debt and repaid others, having a positive net impact from loans and financial investments of $405 million, resulting in a final cash flow generation of $343 million. Moving to the next slide. Now, on Slide 6, I will comment on our investments. In the second quarter, we invested $69 million with a cumulative CapEx of $149 million in the first semester of the year. As we have disclosed previously, we revised our CapEx guidance downwards to $300 million in 2020 in response to COVID-19, aiming to preserve cash. Now, one quarter later, we confirmed our guidance for the year, but rebalanced its distribution. We have decreased the estimated Aripuanã investment to $172 million, as second quarter disbursements were lower than expected, partially impacted by COVID, and further reduced throughout the year as the current exchange rate level impacts favorably the amount in dollar terms. On the other hand, sustaining investments were increased to $73 million, fulfilling our commitment to keep our operations running safely. Complementarily, other operating investments amounted to $24 million during the entire semester, including exploration, mineral rights and project development being well reduced given the current situation, but it's still on track within our guidance. Now I would like to pass on to Roberta Varella, our Head of Investor Relations, who will comment on our second quarter results.

Thank you, Menck. Good morning, and good evening, everyone. Please, let's move to Slide 8. Beginning with the first chart on your left, zinc production of 62,000 tonnes decreased by 32% compared to the second quarter of 2019. The solid performance of our mines in Brazil was offset by the mandatory suspension of our mines in Peru, resulting in an estimated decrease of 1.7 million tonnes in treated ore volume in the quarter. Copper production was also affected and decreased by 44% year-over-year, primarily driven by Cerro Lindo. In respect to our Smelting segment, total zinc metal sales of 120,000 tonnes decreased 23% versus the same period a year ago, given the reduced operating rate in both Cajamarquilla and Juiz de Fora smelters as demand for all products was impacted by COVID-19. On the following graph, consolidated net revenue was $337 million compared with $613 million a year ago, reflecting the decline in volumes and lower base metal prices. The LME average prices for zinc, copper, and lead were down by 29%, 12%, and 11%, respectively, compared to the second quarter of 2019. Turning to Slide 9. We will comment on our consolidated EBITDA. Adjusted EBITDA decreased 66% to $40 million in the second quarter. This performance was mainly driven by lower sales volumes with an impact of $36 million, a negative price effect of $69 million related to lower LME prices and changes in market prices in respect of quotation period adjustments, the decrease in by-product credits due to lower treated ore volume and LME prices, which were partially offset by lower operating costs and expenses, partially driven by lower production volumes, the reduction in exploration and project development expenses, and the decrease in corporate expenses. The U.S. dollar appreciation against the Brazilian real had a positive impact of $14 million in the period. Please let's move to Slide 10. We will discuss our Mining segment guidance. On this slide, we discuss guidance and mining operation results. The strong performance of Vazante and Morro Agudo mines was offset by the mandatory suspension in Peru. As a result, zinc production in the second quarter of 2020 decreased 32% to 62,000 tonnes, while zinc equivalent production decreased 39%. Cerro Lindo and El Porvenir resumed operations on May 11, gradually increasing their throughput. Ramp-up continued into Q3. Atacocha and San Gerardo open-pit mine restarted operation on June 8, while the higher-cost underground mine remains suspended. The scenario still requires caution as the number of COVID cases in Latin America has continued to increase. And although the high level of uncertainty remains, we maintain our 2020 production guidance for all our metals. We assume there will be no additional suspensions, but we estimate we will continue to face restrictions in our operations due to adopted measures to combat COVID-19. Regarding cash costs, in the first half of 2020, mining cash costs averaged $0.45 per pound, below our annual estimate. This performance was mainly driven by the temporary decrease in Cerro Lindo and El Porvenir, as we did not incur some operating costs due to the postponement of certain mining activities, following lower production volumes. As we expect to increase production in both mines compared to the first half of the year, we believe we will perform according to our estimated guidance. In order to have an appropriate comparison, please note that the cash costs presented for both Mining and Smelting segments do not include the costs of idleness in our operations. Moving to the next slide, on Slide 11, we will discuss the Mining segment performance. In the second quarter of 2020, adjusted EBITDA was $3 million compared to $44 million a year ago. This decrease was primarily driven by lower volumes due to the temporary suspension in Peru with a negative impact of $77 million, market-related factors with a negative variation impact of $13 million from lower LME prices and higher treatment charges, and lower byproduct credits totaling $19 million. These negative effects were partially offset by the decrease in operating costs and mineral exploration and project development expenses. Looking to the graph at the bottom right, we present the global cash cost curve for zinc. Despite the challenging scenario, we remain well positioned at the beginning of the third quartile of the cash cost curve. Moving to the next slide, on Slide 12, we will discuss our Smelting segment operational results and guidance. Metal sales in the second quarter of 2020 were down 23% year-over-year, reflecting the reduced operating rate of our smelters, as already explained. Despite a total volume reduction, Três Marias smelter had another solid quarter. Zinc metal production of 45,000 tonnes increased by 11% compared to the same period of 2019. Cajamarquilla smelter also operated better than we estimated during the quarantine period and resumed full capacity in the beginning of June. Juiz de Fora smelter is also close to its full capacity in July. That said, we maintain our metal sales and cash cost guidance, assuming we operate at normal CapEx during the second half of the year. Moving onto the Slide 13, we will discuss our smelting EBITDA for the quarter. Smelting EBITDA was $39 million, 47% lower year-over-year. The decrease was primarily driven by the negative net price effect of $59 million related to changes in market prices and $5 million from lower byproduct credits, $19 million negative variation from the reduction in volume, partially offset by the $11 million gain from higher treatment charges, and lower operating costs and corporate expenses. The BRL devaluation also had a positive impact of $7 million. Looking to the graph at the bottom right, we present the global cash cost curve for zinc smelters and Nexa is positioned at the beginning of the second quartile of the curve. I will now turn over the call to Tito who will continue our presentation.

Thanks, Roberta. Please turn to Slide 15. Here, we will talk about the Aripuanã project. As disclosed, we have had a change in our management team, and Mr. Marcio Godoy was appointed as Nexa's Senior Vice President for Project Development, and the Aripuanã project is one of his responsibilities. We have also reorganized our project team and made some change in the scope of our contractors looking for mitigating risks of the project execution. In Aripuanã, we have joined efforts with the local authorities to combat COVID-19. We kept mobilizing works to the site, but at a reduced pace given the protocols implemented. Mobilization should increase along the next month, reaching our construction targets. The amount invested in the second quarter was less than expected and our estimated CapEx for the year is now something around $172 million. Going forward, the new rebaseline for the project will be available sometime in the second half of this year. Aripuanã is our main priority and we keep on working to successfully execute the project plan. Please move now to Slide 16. On this slide, we'll comment about our pipeline of projects. As you know, we reassessed our capital allocation strategy because of COVID, and most of our Greenfield projects were placed on hold. Magistral studies progressed in the quarter, but as we had anticipated, COVID-19 related measures could end up slowing down our 2020 targets. As a result, the FEL3 conclusion is now expected for 2021. Feasibility studies for Shalipayco and Pukaqaqa remain on hold. Regarding Hilarion, we intend to resume our exploration campaign in the second half. Moving now to our next slide, Slide 17. Here, we will make some comments about market fundamentals. Despite the first impact of COVID-19 on LME prices, we are seeing now some signs of recovery. During the quarter, zinc price reversed the downward trend and gradually recovered. There are some positive signs from China with authorities reaffirming their plans to spend heavily. We may see consistent investment in areas where there is an intensive use of zinc like infrastructure. However, refined zinc stocks in the official warehouse maintained its upward trend, reflecting a still depressed demand. In light of zinc, prices also reversed their downward trend, driven by signs of demand recovery and tightening supply in important production regions as Latin America. Now, let's move to our final slide, Slide 18. As I stated in the beginning of our presentation, our commitment to protect and preserve the wellbeing of our people and our host communities remains our first priority. The business continuity measures and the commitment of our team to improve efficiency in our operations were fundamental and helped us to reduce the COVID-19 impact on our results. The short-term scenario, however, is still very challenging. We remain focused on ensuring the sustainability of our business, and we expect to continue delivering our guidance. Aripuanã is progressing, and we remain committed to building the mine of the future, supported by operational and financial discipline with a highly qualified team. Thank you all for your time and let's move to the Q&A session.

Our first question comes from Jackie Przybylowski with BMO Capital Markets.

I have a specific question regarding the Jarosite conversion project mentioned in the release. Can you provide an update on the plan for this project? Is it currently on hold or has it been canceled?

Jackie? Thank you for your question. I hope you are okay. Life has not been easy for anybody. Jarosite, what's going on? As we announced over the year, we stopped the project to revise it. It has been suspended. With COVID, we decided not to go back to this along the year. It is still in our plans, the revision has been almost at the end. So as soon as we can actually come back to a more normal situation, we should have news about the Jarosite. It is still a very important project for us in terms of increasing the recovery and the production capacity in Cajamarquilla.

Great. And on Aripuanã, I know you're working on the rebaselining study now. Can you talk a little bit about what that might include? Is it going to be a new project timeline and some sort of inflation do you think to the CapEx budget that you have right now?

We encountered challenges at the end of last year that pushed back the project completion to the third quarter of 2021, and we are still targeting that date. We have assessed some potential impacts of COVID in the first half of the year. Throughout this crisis, we continued making progress on the project, albeit at a reduced capacity, operating at about 80%. Currently, the main challenge is determining if we can stick to the schedule for the third quarter of next year and understanding the financial implications. I'm generally optimistic, although I anticipate some additional costs because the timeline has changed from what we initially expected. We're nearing completion but are still uncertain about future impacts from COVID. While we know its current effects, the potential for additional delays remains. We should be able to bring more personnel on-site soon; right now, we have around 1,500 people when we should have over 2,000. There are difficulties with the protocols regarding bringing people to Aripuanã, which is quite remote. We need to test workers before sending them there, followed by a two-week waiting period before they can enter the site, and we require ongoing testing. We're working with authorities to explore adjustments to these protocols to eliminate the quarantine requirement for the on-site team. Once these issues are resolved, we'll be able to provide a more precise timeline and cost estimate for the project. Overall, the project is progressing well despite the challenges we are facing.

Okay. But it's really just a question of the schedule? You're not actually changing the scope of the project at all? It's just the...

No, not at all. Not at all. Everything is pretty much the same.

Our next question comes from Jens Spiess with Morgan Stanley.

Yes. I just wanted to ask if the percentage of the $4 million due to COVID-related costs that you mentioned, I think it was about 60%, and that will be recurring. Is that already included in the cash cost guidance that you didn't change? And secondly, at the Atacocha, the decision to keep it closed the underground mine, is it due to the cost of the mine? Or is it related to operating issues? What's the rationale there?

Jens, it's Rodrigo Menck here. Thank you for your questions. First of all, the COVID-related expenses are already included in the cash cost, that guidance that is provided until the end of the year. So we are absorbing those costs, yes, but we are also constantly looking for other efficiencies that can result in cost reduction. So the costs are not in a magnitude that worries us. We understand, in the coming quarters, costs can be approximately the same as we saw in the second quarter, probably a bit higher in the third quarter, maybe converging towards the end of the year. But I believe that not only for our case but also for all the peers, it's yet too early to define how much of this cost has come to stay. In any case, we are constantly revising and absorbing other efficiencies so we can cope with it. In case of the Atacocha question, addressing your point, we have Atacocha underground as a high-cost mine. So, under the current situation and provided that we had already the operation suspended, we decided to maintain suspension so that we operate in that specific mine only with the open pits of San Gerardo, which has a much lower cost. There are no operational issues, as you mentioned in your question, so we are only suspending it due to cost.

Yes, that's clear.

Our next question comes from Orest Wowkodaw with Scotiabank.

And I hope everybody is well there. I realize that most of the focus this year has been on COVID and managing through the pandemic, but I was wondering if there's been any thought or discussion about the Nexa domicile and whether there is any consideration being given to moving from Luxembourg to another location, likely North America, and whether that's a priority for the Board.

Thank you for the question, Orest. Everybody here is doing well. We are still working from home. To be honest, we haven't discussed that topic. It's possible that we might conclude that being based in Luxembourg isn't the best choice. We need to see how things develop as we enter a new phase post-pandemic. Everything is on the table, but currently, we have no plans to make any changes.

Okay. In my view, it would certainly help...

Is there a reason for that? Can I raise the question? Your question's trigger, is there a reason for that? I mean any specific issues related to the fact that we are based in Luxembourg?

I believe it affects your trading liquidity because you are not included in any of the North American indices due to your location. In my opinion, relocating would improve trading liquidity.

Okay. That makes sense.

Our next question comes from Oscar Cabrera with CIBC.

I hope everyone and your families are doing well. To start, let's discuss your smelting segment. The treatment charges for ore have been decreasing, and I'm curious if you can clarify the contract structure. Is most of your sales in the smelting area based on annual contracts? Do you have any exposure to the stock market?

The standard contract remains unchanged from before, typically spanning over a year. The portion related to the spot market is minimal. This is why our treatment charges are usually three times higher, based on an average of three years of benchmark treatment charges. Consequently, in 2020, our treatment charge is slightly lower than the benchmark treatment charge of $300. During the crisis, we did not encounter any issues; the supply of concentrate was consistent. The decision to temporarily shut down and reduce capacity at the Juiz de Fora smelter for two months was made out of concern for demand. If the lockdown had extended, COVID could have potentially disrupted the supply of concentrate to Cajamarquilla or Brazil. However, our contracts are very stable, and we are confident in maintaining them as they provide us with better stability when forecasting costs and impacts on our smelters. I hope this answers your question.

Yes. No, that's great, Tito. It's a good reminder that your smelting business is very strong and countercyclical to what we've seen at least in the beginning of the year. The other question I had for you is, you guys have done a really good job in keeping your costs down during the pandemic. The decision to keep a high-cost operation is sound. I was just wondering, because in that reduction in cost that we saw in the second quarter, there's a mention of deferred maintenance and what I believe is maybe just putting your subcontracting activities on hold. But as you move forward, like are you lagging in the development of stopes in the mines? Can you just put context around these savings? And how do you plan to move forward?

Oscar, it's Rodrigo. I hope you’re doing well. Thank you for your question; it’s a good one. We see those expenses decreasing in the second quarter mainly because most of the operations were shut down during that time. Looking ahead for the year, part of the capital reallocation in our CapEx guidance, which is shifting from expansion to sustaining CapEx, reflects our continuous monitoring of the situation. The majority of the activities driving this increase in sustaining CapEx are indeed related to mine development, as you mentioned. In our last call, we noted that we would maintain all essential operations to ensure both safety and business continuity. Because of the spending throughout the second quarter and expectations for the second half of the year, projects like Aripuanã and Vazante have experienced delays due to a reduced workforce. We’ve also adjusted expenses related to mine development and maintenance to keep the business secure and in good shape, avoiding any delays that might lead to future costs. You’ve hit the nail on the head; that’s exactly what’s happening.

Can I add one thing? I would add one thing here. It's important to note one thing. The performance of our mines in Brazil, which were not affected by the crisis, has been very close to what we were planning to improve. So the guidance shows that the performances match perfectly the costs that we are incurring right now in the mines in Brazil and even in smelters as well.

Yes. No. As a matter of fact, just looking at that, Tito, and the first half is lower than your guidance.

Our next question comes from Timna Tanners with Bank of America Merrill Lynch.

Hope you're all doing well. I wanted to ask 2 questions. One is pretty high level. Just listening to some of the other commentaries from miners that have operations in Peru and Brazil, I feel like they've talked about the worst being behind and kind of more the repercussions of the better outlook. And I feel like your outlook still talks about risks and uncertainties. So I'm just wondering, is that more on the cost side? Is that more potential disruptions? Or maybe why there might be a difference there, if you would?

Thank you for your question. I would say the risks we face are mainly related to our ability to maintain our current performance. The lockdown in Peru, for instance, caused significant disruption for all mining companies in the region. We have managed to resume operations, but we are still in the process of ramping up production and have not yet reached full capacity at our sites. The primary challenge is our capacity to bring in the necessary workers. This is due to strict quarantine protocols from officials and our own protocols, which are even more stringent than government guidelines. We require testing before workers arrive at the site, and additional testing after a few days on site, leading to many individuals being unable to join us. The contamination rate in Peru is around 20% among those tested, which is significant. In Brazil, the situation is somewhat different; while there are still risks, they are not as severe as what we observed in Peru over the past couple of months. Therefore, as long as we can continue operating and manage costs, our main concern remains the disruptions associated with the availability of professionals and workers.

Okay. If you could provide a bit more detail, I would appreciate it. On Page 10, the cash costs are projected to increase in the second half to meet the guidance. Can you clarify the factors influencing this? It appears to consider byproducts, but I'm uncertain since commodity values seem to be rising. Shouldn't that be a positive factor? Additionally, the resumption of operations seems promising, yet premium costs are elevated. I'm trying to grasp the various factors that lead us to the guidance.

I'm going to address that on behalf of Menck since he was cut off. The lower costs we experienced primarily in the mining operations in Peru were due to not operating at full capacity. As a result, some services and maintenance were not fully performed, impacting our cash costs. Once we return to full operation, we expect costs to rise and align more closely with our guidance. Our goal is to finish the year with costs slightly below or at guidance levels, even accounting for additional COVID-related expenses. To date, we've incurred approximately $12 million in costs associated with COVID, including $4 million in the current quarter. Prior costs were lower, and we anticipate another $2.6 million. Most of these will be one-time expenses, with few recurring costs expected outside of taxes and similar items. We are managing the situation effectively, provided it remains stable. I recommend referencing the guidance we've shared, which indicates we should meet our expectations by year-end.

Showing no further questions, this concludes our question-and-answer session. We will now hand over to Tito for his final remarks. Mr. Martins, please go ahead.

Thank you very much. I would like to thank all of you for being here today. I hope you found this call useful. We want to improve the communication we're having with all of you. And please, if you have any suggestions and feedback for us, our Investor Relations team would be glad to hear. We will see what we can do actually to be closer to you and to be more transparent, as much as possible actually. Just to end up, our priority has been actually the safety and the health of our people and those who are close to our operations. It's really important for us. And of course, we want to keep our production in good shape, meaning being able to produce as much as possible, as planned, and at the same time, developing our Aripuanã project, which is our main priority and being able to come later after Aripuanã's completion with the other Greenfield projects in our pipeline. Finally, I think that given the situation we are living today and considering what we've been through already, I tend to be more optimistic about the year. Moving back, as I said, our operations to normal life, not a new normal life, let's look at it this way, and assume that no big disruption will cause us to actually close again the sites in Peru, we should have a more smooth second half. And hope to see you in the next earnings call in the next quarter. Thank you very much, and have a good day. Stay healthy.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.