Nexa Resources S.A. Q3 FY2021 Earnings Call

Thank you. Good morning, and good afternoon, everyone. Welcome to Nexa's earnings conference call, and thank you for taking the time. Today, we will be talking about our results for the third quarter of 2021. Please, let's move now to Slide 3, where we will begin our presentation. I will start by briefly making some comments about our results. In the third quarter of '21, we have continued to benefit from favorable base metal prices. Our adjusted EBITDA was $155 million, up 141% year-over-year. Note that adjusted EBITDA in the quarter was affected by silver streaming and by the recovery of undue energy costs with a total negative impact of $9 million. Excluding these effects, adjusted EBITDA would be $164 million. Planned and unplanned maintenance shutdowns affected our operational performance, but operations are already at normal levels of utilization rates, and we expect to deliver our guidance. In terms of zinc production, we estimate we will be closer to the midpoint of the guidance range, while copper is moving toward the upper-end range. In addition, we have revised our cash cost guidance, which we will cover in more detail during this presentation. In the first 9 months of the year, we generated approximately $517 million of adjusted EBITDA, strongly recovering from 2020, and achieving a record high for the 9-month period. This performance not only reflects favorable market conditions but also the commitment of our team through operational and financial performance. Global demand for our products remains strong and is expected to continue to expand, supported by government stimulus packages in the transition to a more green economy. Growing global concern over rising inflation rates, logistics bottlenecks, and energy shortages are risks to this scenario. We ended the quarter with total cash around $800 million and leverage of 1.2x, relatively flat compared to the previous quarter. We continued to monitor COVID-19 evolution, and all protocols to mitigate the spread of the virus remain in place in our operations, exploration activities, and projects, and we believe they have been very effective. Most of our employees and contractors have already been vaccinated at least with one dose. We also continue providing support to our host communities and to the governments in the regions where we operate. We remain fully committed to delivering our first greenfield mining project, Aripuana. Moving to the next slide, Slide 4, I will discuss it in more detail. On October 7, the operating license for the Aripuana project was granted. Construction works continue to advance, and overall, fiscal progress has reached 96.5% at the end of September, up from 89% in June. Several systems from the beneficiation plant have reached mechanical completion and have started commissioning at the end of the third quarter. These deliver systems allow the cold commissioning of the front-end equipment. We are on track to conclude mechanical completion in the fourth quarter of '21 as well as most of the cold commissioning. Hot commissioning is estimated to start next month, and first production is anticipated during the first quarter of '22. In addition, the qualification program for future mining operators continues to progress. There are currently 161 students in the fourth training class, of which 46% are women. Aripuana will be one of the few mines in the world with a strong presence of women in its total workforce. We believe the new mine will start production with at least 35% women in its workforce, and we are planning to increase it to 50% within the first 2 years of production. With respect to our exploration program, exploratory drilling has been focused on northwest expansion at Babacu, and new drilling continues to confirm a high-grade mineralization area, supporting our belief that Aripuana will be a long-life mine. Moving now to Slide 5, please. Mining development activities in RX and link mines have continued to progress and reached an accumulated 13,400 meters at the end of September, with approximately 435,000 tons of ore already stockpiled, which corresponds to roughly 2 regular months of production. We plan to have 3 months of ore stockpiled ahead of the startup of the plant. We have today 443 employees working on the mine plan, environment, safety and health, and administrative facilities. This number should continue to increase as we prepare for the startup.

Thank you, Tito. Good morning, and good afternoon, everyone. Please, let's move to Slide 7. Beginning with the chart on your upper left, consolidated net revenue in the third quarter of 2021 was $655 million, up 22% compared to the same period a year ago, mainly driven by higher metal prices and product contribution, which was partially offset by lower sales volume and the silver streaming adjustment. In the third quarter, Nexa recognized a reduction of $19 million as a remeasurement adjustment in its silver streaming revenues, given forecasted higher long-term prices and the updated mining plan for Cerro Lindo. Also, for the quarter, Nexa recognized a recovery energy cost of $10 million related to undue costs paid by our energy power plants in the past. These non-recurring items had a negative net impact of $9 million on our adjusted EBITDA of $155 million. Compared to the third quarter of 2020, adjusted EBITDA increased by 2%, mostly driven by the Mining segment performance. In the next slide, we will discuss in further details our segment's performance. On Slide 8 and 9, I will comment on our Mining segment results. Zinc equivalent production reached 136,000 tons, down 1% year-over-year, while remaining flat compared to the previous quarter. Zinc production in the quarter decreased by 2% compared to both the third quarter of 2020 and the second quarter of 2021, mainly driven by lower zinc head grade and planned and unplanned maintenance shutdowns in Peru during the period. As Tito mentioned earlier, we are already operating at normal levels. In terms of net revenue, we reached $276 million in the third quarter of 2021, up 34% year-over-year, explained by higher average LME prices and lower benchmark treatment charges, which offset the negative impact of the silver streaming adjustment of $19 million in the quarter. Adjusted EBITDA for the Mining segment was $92 million compared to $67 million a year ago. As you can see on Slide 9, this performance was mainly explained by the positive net price effect of $46 million due to higher zinc prices, lower treatment charges with a positive variation of $25 million, and higher byproduct contribution, which were partially offset by the increase in operating costs driven by increased maintenance and mine development costs in the period, higher workers' participation provisions due to better results, higher exploration and project evaluation expenses, and the negative effect of $17 million related to silver streaming and energy cost adjustments. In the first 9 months of the year, adjusted EBITDA amounted to $331 million, strongly recovering from a year ago. Consolidated mining cash cost was $0.23 per pound in the third quarter of 2021, down 32% compared to last year. This decrease was primarily driven by higher by-product credits and lower treatment charges, which were partially offset by lower zinc volumes and higher operating costs. Note that the operating costs in the third quarter of 2020 were temporarily reduced as operations in Peru were still ramping up after the maintenance shutdown due to COVID-19. Compared to the second quarter of 2021, cash costs increased by $0.09 per pound due to lower volumes and increased operating costs. We have revised our full-year cash cost guidance for the Mining segment. Although we are starting to see additional inflationary pressure in our mining operations, cash costs at Cerro Lindo and Atacocha mines have been better than expected due to continued higher by-product metal prices. Consequently, cash cost guidance for these two operations has been reduced. Consolidated cash cost guidance is now $0.23 per pound compared to our previous guidance of $0.33 per pound. Now, let's turn to the Smelting segment results. On Slide 10 and 11, we will discuss our Smelting segment operational results. In the third quarter of 2021, metal sales amounted to 156,000 tons, down 2% year-over-year and 1% from the second quarter of 2021. The decrease in production was partially offset by the increase in the resale of metal from third parties. Net revenue in the quarter was $523 million, totaling $1.5 billion in the first 9 months of 2021, positively impacted by higher LME prices and sales volumes. Adjusted EBITDA for the Smelting segment in the third quarter of 2021 stood at $65 million compared with $86 million a year ago, driven by lower treatment charges and higher operating costs. As you can see on Slide 11, this performance was mainly explained by lower treatment charges with a negative impact of $21 million and higher operating costs driven by higher consumption of imported material, inflation, maintenance and energy costs, which were partially offset by the positive net price effect of $15 million related to higher LME prices and changes in market prices, resulting in quotation period adjustments and the energy cost adjustment of $80 million. And before proceeding, I'd like to further discuss the treatment charge impact. For the majority of our third-party contracts, which are renewed during different periods throughout the year, we used the 3-year benchmark TC as a reference. So for this year, the reference price considers the treatment charge of 2021, 2020 and 2019. At the beginning of the year, we tend to receive raw material reference at all the TCs. And as demand evolves, our reference is closer to the treatment charge of the current year. Consequently, we are seeing a higher negative treatment charge impact in the third quarter compared to the previous quarter. Going back to our results, in the first 9 months of the year, adjusted EBITDA increased by 29% to $241 million. In terms of cash costs, consolidated cash costs of $1.16 per pound in the third quarter of 2021 increased by 47% year-over-year, mainly driven by market-related factors such as higher zinc prices and lower treatment charges. We also updated our full-year smelting cash cost guidance to $1.14 per pound compared to our previous guidance of $0.95 per pound, primarily driven by higher zinc prices. Operating costs have also been affected by higher energy prices due to the current Brazilian scenario, as well as an increase in maintenance costs, which have also been affected by inflation.

Thank you, Roberta. Good morning, and good afternoon, everyone. I am now on Slide 12. 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 current available liquidity was $1.1 billion, which includes our undrawn revolving credit facility of $300 million. As of September 30, the average maturity of our total debt was 5.5 years with a 4.96% average debt cost. Our leverage, measured by the net debt to adjusted EBITDA ratio, increased to 1.24x from 1.19x, mainly driven by higher net debt as a consequence of reduced cash. The debt breakdown by category and currency is shown on the right side of the slide. In light of our strong balance sheet, during the quarter, we continued to advance with our liability management program and have prepaid additional existing financial debt, reducing our gross debt by $177 million. Now, moving on to Slide 13. On this slide, we present Nexa's free cash flow generation. During the quarter, our free cash flow generation was negative at $260 million. Describing it further, and starting from our $155 million EBITDA, we had a $21 million loss in working capital, $57 million of sustaining CapEx, and $30 million from interest paid and taxes. Still, Nexa generated $39 million of cash before expansion projects during the analyzed period. After that, we invested $80 million in non-sustaining CapEx, which includes mainly our Aripuana development project with $79 million. We also had a negative net effect of $172 million as we prepaid, as mentioned, debt during this quarter. Finally, dividends paid of $9 million in our energy subsidiary projects and other non-operational impacts, including foreign exchange effects of $38 million, concluded a free cash flow of negative $260 million. Now, I turn to the next slide, Slide 14. As previously disclosed, our 2021 CapEx guidance remains unchanged at $510 million. In the second quarter, we invested $144 million in CapEx, of which $79 million was directed to the Aripuana project. In the 9 months of 2021, we invested a total amount of $344 million, with 52% directed to Aripuana and the remaining 48% to other projects, including sustaining and HSE. As projects attain, we estimate we will have a higher disbursement in the fourth quarter of '21 compared to the previous quarters due to mine development, mining equipment purchases, planned maintenance shutdowns at the Tres Marias smelter, among other less material events. With regard to mineral exploration and project evaluation, we invested a total of $18 million in the quarter, totaling $49 million in the 9 months of 2021. For the whole year, we expect to continue our mineral exploration and project evaluation investments as we maintain our efforts to replace and increase mineral reserves and resources, supporting our business growth. On October 21, we published our exploration report for the third quarter of 2021. We hope it provides further clarity over our results and exploration program strategy.

Thank you, Menck. We are now at Slide 16. Here, we will make some comments about the market fundamentals. Zinc price maintained its upward trend and increased by 28% when compared to the third quarter of '20 and 3% when we compare to the second quarter of '21. Despite price volatility during the quarter, the planned stimulus packages in infrastructure in the United States and the positive signs from the Fed to maintain economic funding boosted sentiment in equity and commodity markets and supported zinc prices at high levels. In the short term, we expect zinc prices to remain at the levels they are today, mostly because of the tight balance between supply and demand. In the mid to long term, zinc fundamentals also remain attractive. As you can see on the chart on the upper right, despite the estimated increase in supply, there is an imbalance between supply and demand. With respect to copper, price volatility was driven by some signs of slowdown in the Chinese economy, which was intensified by a potential downturn in the real estate sector as well as concerns about the delta variant of COVID-19. In the mid to long term, the outlook for zinc and copper also remains positive, given their role in the energy transition. Moving now to our last slide. As many of you may know, we will start my transition process during this quarter. First of all, I would like to extend my sincere gratitude to our employees for their constant dedication and professionalism that allow us to innovate our business, transform our culture, and achieve our goals. It has been an honor and a pleasure to be part of this outstanding team. I also want to thank our Board for its support of long-term initiatives and decisions along these years. I have witnessed a remarkable evolution of the company and the expansion of its operations in mining and smelting. In 2019, we launched the Nexa Way program, implementing a continuous improvement strategy that has resulted in operational efficiency, cost optimization, and culture transformation. Nexa Way helped us navigate this pandemic scenario while generating value for our shareholders. We have closely monitored the progress of the Nexa Way, and we believe this is now a part of our DNA. It's our day-to-day work. Another milestone for us is Aripuana. As I mentioned earlier, we are close to delivering our first world-class greenfield project. Last but not least, we continue to create shared value through pursuing ESG initiatives that align with community needs, our business strategies, and our customers' priorities. We are also finalizing our corporate ESG goals and metrics, which will be presented soon. I am very proud of what our company has become today, and I believe we are on the right track to build the mining of the future. It was a privilege to lead this company as CEO for nearly a decade. Thank you all for your time, and let's move to the Q&A session.

And today's first question comes from Orest Wowkodaw with Scotiabank.

And firstly, Tito, I want to wish you the best of luck in your next endeavors. We'll be missing you here. But I wanted to get a better understanding of what's happening at the Aripuana mine. It sounds like you've already started commissioning some parts of it and you expect to finish mechanical completion by year-end. And then I'm confused though why you do not anticipate first production until the end of the first quarter. Can you maybe give us some color on what's happening there.

Thank you very much for your words. I hope we can connect sometime in the future. About Aripuana, we have been very cautious. You're right; we have already started commissioning part of the plant. Actually, the mine is on track according to schedule. So the development of the mine is proceeding as planned. We would be ready to start production as soon as the plant is completely conditioned. While we've been cautious, you have to consider that we are entering the rainy season, and there will also be holidays at the end of the year. Based on our experiences and what happened last year during this period of time, we decided to take a more conservative approach to our plans. When we state that we should see production start sometime in the second half of the quarter, it's because we may see good things happen even before that. But we didn't want to give the impression that everything is going to be fine on demand. This is a conservative approach.

And Tito, just as a follow-up, your disclosure seems to reference that you plan to revise your Aripuana guidance, I guess, in January. Should we interpret that to suggest that you plan to lower the Aripuana guidance?

If we have these delays, we will mention them about the ramping up. Of course, it will affect production. The reason we haven’t stated anything right now is exactly because of the level of uncertainty we have about how the end of construction and the commissioning will behave in the next two to three months. We will be more sure about how that will unfold by the end of this last quarter of the year.

We will, as always, provide guidance in the second half of January. Until then, we’ll have more certainty about, as Tito mentioned, we will be able to combine our three-year guidance and our 2022 guidance with Aripuana moving forward.

And just finally, do you see any knock-on impact here on '23 at Aripuana or is it only...

No, no, no, no. We have not seen any impact at all. You can ask if we have changed. We should be operating at full capacity sometime in '22. The concerns we have today are much more related to the capacity to start commissioning at the time we believe that we should start. But we are based on the plans we are running right now, we are still working with full capacity production sometime in the second half of the year. It should be at 100%. No problem at all.

Our next question today comes from Jackie Przybylowski with BMO Capital.

I'll echo Orest’s comments. Tito, we'll miss you and best of luck as you move on. Maybe if I can ask about the zinc market because it's been such a coaster lately. I know you are in a bit of a different situation for things like power, just given your smelters are located in South America. Does that provide you with an advantage? Are you able to capitalize on the current shortages and closures that we're seeing in the rest of the world? And how do you approach that?

It's interesting you mentioned that. Our goal would be to capitalize on this shortage. We are seeing shortages in other places. The problem is we cannot produce more. If we could produce more, we would be selling more, no doubt about that. What we are seeing is clearly, the announcements made in Europe about cuts in production are helping the price. That's why we saw volatility in prices moving up aggressively. Demand in Latin America and North America is still very strong. So if we could produce more, we would definitely be selling more. We saw some reflects, some impact in premiums, mostly in both Europe and Asia, which in some ways may favor us in the coming months, though it's a marginal gain. Regarding the energy problems we are seeing in Asia and Europe, fortunately, in our case, there is a slight impact in Brazil due to hydro generation having suffered over the last few months. But in general, we have not seen impacts as severe as those in other places. Overall, I would still say we are very optimistic about the market. We are already planning for the first quarter of next year. The demand, even though we may see a slight reduction in demand in China, looks strong. If I were to bet today, I would say '22 is likely to be similar to '21 in terms of supply and demand. There's no additional information; we are not seeing a greater supply of concentrates in China, which means what we've been saying for years is still validated. Most additional concentrates being absorbed in the Chinese market are being sourced from abroad. So if we have a shortage of metal today, we might see a shortage of concentrates sometime in the near future.

Does this improve your smelter situation regarding treatment charges? I understand some of it will be inter-company, but are you able to secure better terms on the materials you're purchasing from third parties?

Probably, probably. If that happens, we will indeed have better conditions to negotiate with our suppliers. It's interesting; we haven't yet seen the impact in the concentrate market due to the announcements made in Europe regarding production cuts. Some commodity analysts have expressed doubt about whether producers in Europe will actually cut production. The only way we will see it is when we see more concentrate availability coming from Peru. If that happens, we will certainly benefit from that for sure in the next treatment charge negotiation.

And if I could just ask a separate question on the management transition. It's unfortunate that we are not able to speak with the incoming CEO. I guess, he starts the role next week. So this might not be a fair question, but since this is the only time we will have the opportunity to talk before you leave, I'm going to ask anyway. Do you have any sense, Tito, when the new incoming CEO joins, if there is going to be any kind of strategic shift for the company or in terms of the new projects packing order? Is there going to be any change to the way he moves things forward? Are you able to give any color at all?

What I can tell you is the following. Our Board has been very concerned about the strategy. We have strategic discussions on a regular basis. After '21 is the year when we had a chance to promote what we call our internal strategic dialogue; we do this every 3 years. So every 3 years, we check the strategy and revise what needed to be revised. We validate the original plans. Every 3 years we do it, and we just finished that. In the last call, you read the questions about whether we would look for new geographies and geopolitical considerations, and I said yes, we are doing that. We are not neglecting our current projects, but we have the responsibility to look at other opportunities in the market. If you ask me today whether you think things are going to change dramatically, no, I don't think they will. Nexa has been very consistent. We may have some setbacks regarding our projects, but we have consistently told the market that we would pursue the development of our projects. The Nexa coming in doesn't mean any major changes. I don't think that's going to happen. But that's my perspective. I am sure that when he steps in, he will have a chance to speak with you even before the next results release. He will probably connect with you sometime in early next year.

Sometime in the beginning of the year, Jackie, you can revert to me on that. It's a promise.

Our next question today comes from Alex Hacking with Citi.

And let me be the third to wish you luck, Tito, and best of luck in your new endeavors. My question is just coming back to Aripuana. Any update on how you're thinking about the operating cost there? I mean, I think since the technical report, obviously, costs of some things, consumables have gone up. There have also been movements in exchange rates. So any update on the cost guidance would be helpful.

Alex, it's Rodrigo here. We haven't discussed this type of information in detail so far. That's part of what we included in the earnings release, stating that we will revise our guidance. There are also cash cost changes, as you mentioned. But in any case, Aripuana is really well placed within the cash cost curve and will remain so, with some impacts here and there. However, I wouldn’t expect a major shift on that. As you said, consumables are more expensive, and FX has widened wider than anticipated, which offsets part of its impact. So although you will see annual guidance for the year of 2022, especially considering the slight potential delay that Tito described, I would consider having it in the same range that you were looking at.

And then just one follow-up question. Has the new Peruvian government provided any sort of framework yet in terms of how they're thinking about changes to mining taxation?

It's an interesting question. Actually, this week, the new government is in the process of getting the confidence vote from parliament. However, there were some developments as the government released information about potential plans to increase taxes in general. These tax increases would also impact the mining industry there. The biggest uncertainty is whether the government will be able to take any action given its challenges with Congress, where they do not hold a majority. Congress has been quite tough on the government, which has been in place for the last 3 to 4 months without securing the vote of confidence necessary for the ministry to operate. We don't anticipate an easy tenure for the new government and expect a situation similar to what we've observed over the past 10 to 15 years, where Congress held a strong position and the presidency had to negotiate on a case-by-case basis. We do not believe Congress will respond positively to the proposed tax increase. Therefore, we are closely monitoring this situation and remain skeptical about any significant changes occurring during this period, including in the upcoming month or years. It's important to stay attentive.

Just to complement what Tito is saying, Alex, there is a process. They need a vote of confidence and discuss the proposal that was sent this week. And let’s remember that they have to approve anything by December 31 to make it valid for 2022. Otherwise, it would take an additional year of discussion to be valid for 2023. So it doesn’t necessarily go on the urgent side of Congress matters that could potentially follow the Chilean behavior. These are all possibilities that are on the table.

I would pay attention to what's going on in Chile to at least try to guess what may happen in Peru later on.

By that comment, do you mean that the tax framework that eventually emerges out of Chile could be a benchmark for Peru or are you talking more about the procedural?

They may try to pursue a similar path. That's what I'm saying. Yes.

My comment was rather on the process, Alex, because it takes time. And they’ve mentioned in Chile it was really difficult, and the reality check was not so easy to implement. But also, of course, they are neighbors, and there are some practices they might follow.

That's a good example. The Chileans want to have a new constitution there were some debates in Peru regarding that. However, Peru does not want to change the constitution. This is just an example. But in terms of tax increases, the Peruvian government may pursue something similar to what the Chileans intend to do.

This concludes our question-and-answer session. Now we will hand it over to Tito for his final remarks. Mr. Martins, please go ahead.

Thank you. Before I make my final statement, Rodrigo, do you want to add anything we might have overlooked?

I think we covered everything. Maybe Roberta has something...

What I'd like to add in terms of highlights is that we included some information in our earnings about the outstanding metal. With this, we believe it will help you update your models and forward-thinking. One thing I would like to point attention to is the outstanding price adjustment in our Mining segment. When we compare the second quarter of 2021 with the third quarter, we had a negative net price effect of $24 million. The future pricing movement will depend on current prices. So, I just wanted to point that out as we believe that this information we are now providing will help in the future valuation.

Thank you, Roberta. Besides that, I would like to highlight that we have increasing costs in the smelters over the last quarter, but you should note that the margins are still very high. I mean, margins in the smelters traditionally range between 8% and 12%, and we are currently around 12%, which remains strong. Furthermore, I know that the quarter was a disappointment for most analysts. I think you should look at the bigger picture. The 9 months of '21 have been very good despite many problems we faced. Of course, prices are supporting us, no doubt about that. But in terms of performance, we had disruptions in the first half of the year. We faced issues with housing availability in the Peruvian market because those runs were shut down. We had blockages in the third quarter. Overall, the prices were good, which is why we decided to maintain our production levels in the first half in order to benefit from prices. Of course, in doing so, we had to reschedule some maintenance shutdowns which occurred in the third quarter. However, looking at the big picture, I would say that we expect a very good year ahead. This may indeed become the best year for Nexa's efforts, considering the favorable prices and the strong performance we foresee for the last quarter of the year. So I ask you to pay attention to that because we may again face analysts not being satisfied with our projections since they might forecast the fourth quarter looking like the third. Please keep that in mind. Having said that, it’s my last call. I thank you all for your attention and your support over these years. I'm unsure what I will do next, but I hope we can meet again in the future. I am truly confident that Nexa can deliver. I have no doubt about that. We have a very strong team that knows where they want to be in the future and what they need to do to get there. The company is very well structured, has a solid strategic plan, and a knowledgeable Board that has been very supportive of us and an energetic management team. Therefore, I am confident that Nexa will be able to accomplish what it intends to achieve. I wish all of you the best, and once again, thank you very much. Have a good day and a great weekend.

Thank you, sir. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.