Nexa Resources S.A. Q1 FY2021 Earnings Call

Good morning, and welcome to Nexa Resources First Quarter 2021 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. Good morning, and good afternoon, everyone. Welcome to Nexa's earnings conference call. I hope you and your loved ones remain safe and healthy. Today, we'll be talking about our results for the first quarter of 2021. But before I begin our presentation, I would like to thank our entire team for their resilience and commitment to our business, our customers, and our host communities and all of our stakeholders. Please, let's move now to Slide 3. As still an unprecedented scenario with COVID-19 cases increasing in Peru and Brazil during the quarter, our commitment to protect and preserve the well-being of our people in the host communities remains our highest priority. We have safely continued to operate, developed our Aripuanã project, and progressed with our exploration program. Our financial performance recovered from the same period a year ago, and we delivered the third highest EBITDA in our history. This strong result could not have been achieved without the continuous commitment of our team, the desire to transform, and capital allocation discipline. We ended the quarter in a strong financial position with cash above $1 billion and leverage down to 1.73x. Further details of our financials will be provided by Menck in his speech. In March, we announced the acquisition of approximately 9% of Tinka Resources. Tinka owns 100% of the Ayawilca project, one of the largest zinc projects under development in Peru with excellent potential. We maintain our efforts to build a sustainable business model, generating value for all of our stakeholders. Now please move to Slide 4. On this slide, you can see our roadmap with regard to ESG. It's worth mentioning that our commitment to ESG comes even before the timeline presented here. By nature, I dare to say, mining companies have been since day one committed to this matter. Corporate social responsibility is key for our industry, and it is core to our strategy. Last year, we raised our material topics relating to corporate goals and ESG management guidelines. And during this year, we are working to set clear targets and KPIs, enhancing our transparency and accountability through our ESG initiatives. In addition, we are also establishing metrics related to our executives and our compensation. Moving to the next slide, please, Slide 5. Slide 5 shows the main projects in our pipeline. As most of you probably know, we have projects in different stages of maturity. Aripuanã is our project under development, and I will discuss it in more detail ahead. Despite some COVID-related restrictions and protocols to be observed, we were able to progress with our engineering studies and our exploration program in the first quarter. Engineering studies at Magistral copper project have continued to progress, and in Q1, we concluded the mining refinement study, which is a detailed study of mine engineering. The prefeasibility studies at Pukaqaqa remain on hold, but metallurgical tests have continued to progress, and the first phase was concluded in Q1 with positive results. We are now updating the block models to initiate Phase 2, which is scheduled to begin in the third quarter of the year. Regarding Hilarión, exploratory drilling was completed at Mia target in 2 pending drill holes. We also began to drill the Hilarión Sur target. Our goal is to confirm the Southeast continuity of the Hilarión deposit. With respect to Bonsucesso, we have carried out expansion drilling in the central zone of the project and scout drilling at the Carrancas target located south of Ambrosia. Turning now to Slide 6, please. Here, I will make some comments about Aripuanã development. Construction awards continue to advance, and overall, physical progress reached 79% at the end of March compared to 70% in December. In Q1, we invested $40 million in the project, totaling $353 million since the beginning of the construction. Mine development activities continue to progress in both Arex and Link mines. Priorities at Arex have started in March. Regarding our exploration program, in Q1, we continued exploratory drilling on the Northwest extension of the Babaçu body. As I mentioned before, the Aripuanã project is one of the few zinc projects under development in the world, and we believe it will be a long-life mine operation with competitive costs. Now I would like to pass to Roberta Varella, our Head of Investor Relations, who will comment on our results. Roberta, please?

Thank you, Tito. Good morning, everyone. Please, let's move to Slide 8. Beginning with the chart on your upper left, consolidated net revenue in the first quarter of 2021 was $603 million, up 36% compared to the same period a year ago, mainly driven by higher metal prices. Adjusted EBITDA stood at $180 million, strongly recovering from $44 million in the first quarter of 2020. As Tito mentioned, this is the third highest figure in our trajectory, a milestone for us. This performance reflects not only the increase in metal prices, but also our cost reduction initiatives and improved operational performance from Nexa Way program. It is worth mentioning that this number was affected by the impact of approximately $6 million related to the update of the environmental provision for the Três Marias smelter. On the next slide, we will discuss in further details our segment's performance. On Slides 9 and 10, we will discuss our mining segment's operational results. Zinc equivalent production reached 130,000 tonnes, up 7% year-over-year, mainly driven by Cerro Lindo and El Porvenir mines. Note that mining production in Peru was temporarily suspended by mid-March 2020 due to the mandatory measures announced by the Peruvian government to control COVID-19 spread. In the first quarter of 2021, zinc production was slightly higher compared to the same quarter a year ago, while copper production increased by almost 13%. As previously disclosed, Atacocha production was temporarily suspended due to community blockades. Going forward, we expect a decrease in zinc production in Vazante as Extremo Norte mine is expected to remain suspended until the end of the second quarter. Consequently, we decreased our annual zinc production guidance by 10,000 tonnes. Production guidance for copper, lead, and silver are maintained. In terms of net revenue, we've reached $255 million in the first quarter of 2021, up 57% year-over-year, explained by higher average LME prices and the increase in sales volume. Adjusted EBITDA for the mining segment stood at $97 million, significantly recovering from the negative $70 million in the first quarter of 2020. As you can see on Slide 10, this performance was mainly explained by the increase in volume with a positive variation effect of $12 million, followed by market-related factors such as higher prices and lower treatment charges, with an impact of approximately $80 million and higher byproduct credits. In terms of cash costs, as you can see on the bottom right, consolidated mining cash costs in the first quarter of 2021, compared to the same quarter a year ago, decreased by 54% to $0.24 per pound. Positively driven by higher byproduct prices and lower operating costs. Now let's turn to the smelting segment results. On Slides 11 and 12, we will discuss our smelting segment's operational results. Net sales amount to 148,000 tonnes, up 2% year-over-year and down 80% from the fourth quarter of 2020 due to lower seasonal demand. Demand remains robust and we expect the smelter sales to improve in the next quarters following typical seasonality. Thus, our annual sales guidance is maintained. Net revenue in the quarter was $467 million, partly driven by higher prices and volumes. Adjusted EBITDA for the smelting segment stood at $84 million, up 36% from the first quarter of 2020. As you can see on Slide 12, this increase in EBITDA was mainly explained by higher prices, higher treatment charges and the Brazilian real devaluation against the U.S. dollar, all of which had a positive $25 million impact on EBITDA, and the increase in byproducts and the decrease in costs also contributed with an additional $7 million. In terms of cash costs, consolidated smelting cash costs increased to $1 per pound in the first quarter of 2021, mainly driven by market-related factors such as higher zinc prices impacting the concentrate purchase price. Third-party services also had a negative impact in the quarter. I will now turn over the call to Rodrigo Menck, our CFO, who will provide more detailed information about our balance sheet. Menck, please?

Thank you, Roberta. Good morning, and good afternoon, everyone. I am now on Slide 13. As demonstrated in the upper left graph, our liquidity remains strong, and we continue to report a healthy balance sheet with an extended debt profile. By the end of the first quarter, our available liquidity was $1.3 billion, which includes our undrawn revolving credit facility of $300 million. As of March 31, the average maturity of our total debt was 5.3 years, with an average debt cost of 4.7%. Our leverage, measured by the net debt-to-adjusted EBITDA ratio, decreased to 1.73x from 2.29x, mainly driven by the recovery of our cash generation, replacing a much lower first quarter of 2020. The debt breakdown graphs are shown on the right side of the slide. Now moving to Slide 14. For 2021, our investment guidance remains unchanged. In the first quarter, we invested $84 million in CapEx. The Aripuanã project amounted to $40 million, approximately 50% of total. For the year, as previously disclosed, we estimate to invest $232 million to further develop Aripuanã. Sustaining investments, including health, safety, and environmental efforts amounted to $31 million in the quarter. As projects advance, we expect disbursements to increase over the quarters, meeting guidance. In terms of mineral exploration and project evaluation, we invested a total of $14 million in the quarter. For 2021, we expect to continue our mineral exploration and project evaluation investments as we will maintain our efforts to replace and increase mineral reserves and resources, supporting our business growth. As we anticipated to the market, this quarter, we published our first exploration report. I encourage all of you to read it and hope the document provides further clarity on our exploration program strategy and its results. Turning now to the next slide, Slide 15. On this slide, we present Nexa's free cash flow generation. During the quarter, we consumed $80 million of our liquidity. Describing it further and starting from our $180 million adjusted EBITDA, we had a $13 million gain in working capital, which was more than offset by sustaining CapEx, interest paid, and taxes. Still, Nexa has generated $105 million of cash flow before expansion projects during the annualized period. After that, we invested $52 million in nonsustaining CapEx, which includes mainly our Aripuanã development project. Also, we had $42 million from loans due in the quarter, $6 million of the acquisition of 9% equity interest in Tinka Resources, $33 million in net dividend payments, and finally, other non-operational impacts of $51 million, including foreign exchange adjustments. I will now hand the call back to Tito. Tito, please?

Thank you, Menck. We are now on Slide 17. Here, we will make some comments about the market fundamentals. During the quarter, zinc prices were up by 29% compared to the same quarter a year ago and around 5% compared to the fourth quarter of 2020. This increase continued to be driven by strong economic activity in China and also by better sentiment towards commodities in general. The robust recovery in manufacturing, in addition to expectations of global economic growth in 2021, is also supporting this performance. In terms of zinc supply, both mines in Latin America resumed their activities last year, with no further production back in Q1. In China, on the other hand, some mines reduced production in Q1 due to the winter season disruptions and Chinese New Year, which caused a reduction in concentrate availability. This contributes additional pressure to an already highly competitive market. And Chinese spot treatment charges have increased dramatically in the quarter, affecting smelters' profitability. In terms of our home markets, Latin America, zinc metal demand remained strong, exceeding pre-pandemic levels. We know that demand recovery has been sustained mostly by construction, infrastructure, energy, and agribusiness sectors. Base metals demonstrated strong performance during the quarter. Looking ahead, we believe this trend will remain at least in the first half of the year. Now please move to the last slide. As I stated earlier, we recorded the third highest quarterly result in our history. We were able to overcome the challenges we faced and deliver a strong performance. COVID-19 remains a risky factor, not only for our business but for the global GDP recovery. Our health protocols to mitigate the spread of the virus remain in place in our operations and projects, and we will continue to monitor and evaluate COVID-19's potential impact on our value chain. In order to navigate in this still uncertain scenario, we will continue to maintain our capital discipline and cost control. We believe we have an attractive pipeline of projects, and we have been preparing ourselves to generate long-term value, building the mine of the future. Thank you all for your time, and let's move on to the Q&A session.

And the first question will come from Gabriel Galvão with Crédit Suisse.

First of all, congratulations on the results. My first question is about the Nexa Way program. You mentioned discovering additional opportunities due to the COVID-19 outbreak. We've been discussing for some quarters now the potential for an extra $60 million in annual savings from these opportunities. Could you explain why these initiatives weren't identified earlier? It would also be helpful if you could provide some practical examples of these initiatives so we can better understand their nature. My second question relates to treatment charges. Can you share your expectations for TCs for the remainder of the year?

Hello, Gabriel, thank you for your question. This is Rodrigo Menck. Regarding Nexa Way, as we mentioned at the beginning of the program, we anticipated achieving up to $120 million by the end of this year, and we have already captured $105 million in the first quarter. The program officially concluded last September, and we aimed to keep the market from confusing new initiatives with those that were disclosed previously. The efforts we undertook are part of a continuous and dynamic process that we plan to integrate into our company's culture. During the period from last September to December, we estimated that additional initiatives could add up to $60 million beyond the initial $120 million. This is why we have made this distinction for better control over the figures. We are closely monitoring the impact since December and expect to provide additional information in the second quarter. The initiatives stem from various activities within the company, including efficiency programs related to financial flows, CapEx spending procedures, and project analysis methods. Many efficiency measures have contributed to the gains you observe. The $60 million in additional initiatives were not originally anticipated, but they emerged through the other initiatives contributing to the $120 million. This process will continue throughout the year. This addresses your question, and Tito will discuss the treatment charges.

Hi Gabriel, thank you for your question. Regarding treatment charges, the benchmark was set less than a month ago at $159. It's worth noting that treatment charges in Asia remain very low, averaging around $80 to $90 per tonne. As mentioned previously, we operate under brief contracts, meaning that our treatment charges are influenced by the new benchmark only one-third of the time. Generally, our treatment charges with suppliers are negotiated individually and typically lie 5% to 10% above or below the benchmark. We will need to monitor the situation next year, particularly in Asia, especially China, where low treatment charges could affect the smelters. We expect a rapid decline in treatment charges, dropping from $300 to $159 is significant. We haven't seen such a drastic change before, but we benefit from the balance between mining and smelting. We will need to see how this develops next year.

And the next question will come from Jackie Przybylowski with BMO Capital.

I just wanted to ask you about the investment that you made in Tinka. Can you tell us a little bit about your rationale for that investment? Is it something that you're planning to work more closely with Tinka going forward? Or is this really just an investment? And if so, should we just think that this is sort of the best use of your cash for now? Or are there no alternative growth projects in your own company? How should we be thinking about this?

Hi Jack, thank you for your question. Basically, what happened is the following. We see Tinka, specifically the Ayawilca project, as a very attractive one. And our interest in this investment up to now has to be a position to potentially follow up the project. Of course, in the future, we have our pipeline of projects, but in the future, we have the obligation to pay attention to different projects mostly in our area of influence, right? So when you look at the pipeline of projects to be developed in Peru, there are not many, except for 2 or 3 that belong to us and 1 or 2 that belong to another company. There are not many. So the idea is to follow up and see if there's an opportunity in the future with them. But so far, it's just a follow-up, I would say. The investment was not significant, right? So it was an opportunistic approach, I would say.

Got it. So are you thinking that this might be something that would make sense to acquire in the future, and you're just sort of using the investment as a way to monitor it?

Right now, we are simply monitoring the situation. I can't say whether we will take another action or not. It's not appropriate to discuss that today. However, we are not completely certain about our plans regarding it.

Got it. Okay. And maybe just more broadly, can you talk about what Nexa's view or what your view is of the political landscape in Peru right now? And specifically on the presidential runoff election?

This is an excellent question. Because, to be honest with you, everybody was really surprised by the first round. Listening to what the candidates ahead of the polls are saying right now scares everybody for sure because he has very radical positions, particularly regarding our business, specifically mining. But at the same time, we have to consider that democracy in Peru has been well established. The law works very well. We already know that if this candidate wins, he will not have commerce on his side because commerce has a more centrist approach. So as long as the situation, the formal situation prevails, we should not be worried about who is going to win. But by the way, it's too early to say that he really will win. We've seen in the past changes at the last minute in previous elections. So we have to just wait and see. If you ask anybody in Peru today what they think about the situation they are living through, there are lots of different opinions. But everybody agrees that Castillo being ahead in the polls is a huge surprise, really huge surprise. Early, it can change.

The next question will be from Isabella Vasconcelos with Bradesco BBI.

I have 2 questions on my side. The first one, Tito, you were talking about demand exceeding pre-pandemic levels in the home market. My question is regarding inventory throughout the chain. Do you see restocking already supporting demand, or has the process not really happened yet? And the second question on the Aripuanã project. It seems to be making good progress now. Is there any possibility of anticipating the start-up date or not really?

Hello, Isabella, thank you for your questions. Regarding demand, no, we are not seeing any imbalancing in the stocks. There was a restocking in the last six months. But what we are seeing today is really demand management being strong not only in the home market. Management is strong everywhere. I mean if we have a drop in demand in Latin America today, I'm sure that we would easily sell anywhere in the world. Why is this happening? It's a huge impact from the incentives provided by the different governments, not only in Latin America but everywhere. And when you look at the situation in the U.S. and China, you clearly see that the incentives are working and the demand for base metals is really strong. I don't see the situation changing at least for the next six months. I remember in the last call we had, I was saying that we were sure that demand was strong for the first half. Now we already can see what's going to happen in the third quarter, and it looks like the situation will remain pretty much the same. You may have, for example, Brazil suddenly demanding less material, but it will be compensated by other countries in Latin America. So we are not concerned about what the short-term shows us today. In terms of Aripuanã, Aripuanã is doing well. Despite the difficulties we are still facing with COVID-19, you have to remember, Aripuanã is located in a very remote area. So we have to implement a lot of different protocols and measures in order to keep people safe. Just to give you an example, we have more than 3,000 people right now working on our site in Aripuanã. It's a lot of people working together in a city with 25,000 people, total population. So more than 10% of the people in Aripuanã are working for us. Our involvement with the authorities to implement these measures was huge. Do we expect to anticipate? No, I would not say that. I think maybe if we were not facing the difficulties with COVID, the situation would be different, and we could try to anticipate. But given what we have today, I don't think so. We are on schedule, and we expect to be on schedule.

The next question is from Orest Wowkodaw with Scotiabank.

Tito, I was wondering if you could give us some more color on how the operations are faring, given the COVID situation in both Peru and Brazil. Specifically, I was wondering, there's a comment in your release about the Cajamarquilla smelter, I guess some of the feed that you were anticipating in Peru has been shut down. I'm just wondering if that's COVID related or how the mines and smelters are handling the supply chains right now?

Hello Orest, thank you for your question. Let me explain how we are operating. In Brazil, we have protocols in place at our sites to keep the number of people on-site to a minimum. Administrative staff are working from home, and only operators are present, following specific protocols. We have implemented active testing, ensuring that all our people are tested regularly, which helps prevent internal contamination. Additionally, we have initiated specific programs to educate the families of our employees about contamination risks. We have had some cases of contamination, mostly when employees return home and interact with others, but we have not faced significant issues in Brazil. In Peru, the situation is somewhat different due to rotational shifts. Employees spend 14 days at the mines and then return home for 7 days. We test everyone coming in and retest them after their time off. After we resumed production last year following the lockdown, it took us nearly 1.5 months to reach full production due to many employees testing positive. However, that is no longer the case. Even with the current contamination levels in Peru, our protocols and education efforts have been effective, resulting in a reduction of cases in our operations. We are also implementing active testing there, and overall, things are going well. Regarding Cajamarquilla and Juiz de Fora, over the past three years, we have been using calcined material from Doe Run, which is a state-owned smelter in Peru undergoing liquidation. The Peruvian government has unsuccessfully attempted to sell it multiple times over the past decade. A planned maintenance shutdown at the end of February was interrupted due to legal issues that halted operations as authorities expedited the liquidation process. I believe this situation will not last much longer as it affects over 2,000 jobs. As for our operations, it has not impacted us yet, and I don't anticipate it will, as we have alternative sources for additional material, including suppliers of concentrate and oxide material from Brazil, the U.S., or Europe. Therefore, we expect to maintain our production levels based on the understanding that this material may still be available.

And just getting back to Jackie's question about Peru, does the political theme there make you rethink any of your future growth projects in that country? Could we see you shift more of an allocation or priority to Brazil versus Peru? Or is it too premature for that?

No, Orest, it's too early to make that decision. As I mentioned earlier, we believe in the rule of law. While there are certainly concerns regarding a far-left politician, history shows that Peru has had presidents from various political backgrounds over the last two decades. The law has consistently held strong. Furthermore, the Congress in Peru has significant power; they removed two Presidents last year. This Congress is not inclined to support the leftists, so we can expect more stable actions from the future President if he is elected. It’s still too early to make any conclusions.

Okay. The next question will be from Carlos De Alba with Morgan Stanley.

A couple of questions, if I may. First one is on your cash cost, the mining cash cost. So they came out at $0.24. The guidance for the year is $0.33. How do you feel about the guidance? Are you being conservative because of COVID? I know that matters, maybe the reduction in zinc production kept you a little bit on the conservative side on the cost guidance. But if you could elaborate a little bit more on what you see in the coming quarters, that will be very useful. And the second question is if we can get a little bit more color on how you see the situation of metal purchased from third parties in Brazil to complement what the company smelters there are producing given the strong demand.

Hi Carlos, thank you for the question. This is Rodrigo. On the mining cash cost, it's not about being conservative at all. It's just that there are 3 elements there. One of which is the efficiency program that comes with the brand of Nexa Way, but it permeates all the procedures that we have. So it accounts for a share of it. We have higher byproduct prices, which impacts positively the mining cash costs. And also the FX devaluation, especially in Brazil, but also in Peru recently; Peru was more recent. It's much more about the Brazilian currency devaluation. When you look at the graph that we included in our presentation, we highlight the market-related effects, but there is also a fair share of our internal processes and savings. Could you repeat the second question, please?

I can answer that, right? No matter, we are acquiring. Well, basically, what happened is the following. We were surprised by the level of demand we had from some of our main customers; our contracts have a range for volumes on an annual basis. And because of that, at the end of the day, we had to bring in some metal from abroad. Actually, we bought it from Mexico. It's not a relevant amount, but it was just to balance the stocks. Just to give an example, we started the year with stocks below our regular levels because of the demand we were having. I don't know if that answers your question.

Yes, do you think that will continue in the coming months?

I hope it continues. We don't know why; we make money with that. And I said that in the last call, if we were able to produce more, we would sell it. And we are not foreseeing a major change in the market at least for the next, I would say, 3 to 6 months. It's good. It's really good.

In general, the market seems quite tight in Latin America because Grupo México's smelter had a solid first quarter. Their sales of refined metal were lower than anticipated, so they are still in the process of ramping up. Therefore, you are likely experiencing very good premiums across the entire region, including Peru and South America.

Yes, yes, yes. It's important to mention half of what we produce we sell in Latin America, right? And half we export to other places. So every time we have this excess demand, we actually reduce what we sell outside Latin America.

Ladies and gentlemen, this concludes our question-and-answer session. I would like to hand the conference back over to Tito for his final remarks. Mr. Martins, please go ahead.

Thank you. I want to emphasize that we are very confident about 2021. Looking back at the last three quarters, we successfully navigated the challenges posed by COVID and delivered on our plans. The second half of last year and the first quarter of this year saw strong operational performance. Despite the ongoing challenges related to COVID, some issues in Vazante with Extremo Norte, and initial difficulties with local communities this year, we overcame these obstacles and met our goals. The market conditions are favorable, with good prices, and we do not expect prices to drop to last year's levels. We anticipate that prices will remain within the range we experienced at the start of the year and what we see today. Demand has been a significant factor, boosted by the incentives provided by various global economies. Therefore, we are optimistic about the year ahead, and I look forward to speaking with you next quarter to report another strong performance. Thank you for joining us. Our team, including Menck, Roberta, and the Investor Relations group, is always available for discussions. Have a great day, a lovely weekend, and stay healthy. Thank you.

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