Nexa Resources S.A. Q4 FY2021 Earnings Call

Good morning, and welcome to Nexa Resources' Fourth Quarter and Full-Year 2021 Conference Call. All participants will be in listen-only mode. The event is being recorded, and is also being broadcast via webcast, and may be accessed through Nexa's Investor Relations website, where the presentation is also available. After today's presentation, there will be an opportunity to ask questions. I would now like to turn the conference over to Mrs. Roberta Varella, Head of Investor Relations, for opening remarks. Please go ahead.

Good day, and good afternoon, everyone, and welcome to Nexa Resources Fourth Quarter and Full-Year 2021 Earnings Conference Call. Thanks for joining us today. During the call, we will be discussing the company's performance as per the earnings release that we issued yesterday. We encourage you to follow along with this on-screen presentation through the webcast. Before we begin, I'd like to draw your attention to slide number two, as we will be making forward-looking statements about our business. And we just ask that you refer to the disclaimer and the conditions surrounding those statements. It's now my pleasure to introduce our speakers. Joining us today is our CEO, Ignacio Rosado; our CFO, Rodrigo Menck; and Leonardo Coelho, our Senior Vice President of Mining; as well as the Investor Relations team. With that, I'm going to go ahead and turn the call over to Ignacio. So, Ignacio, please go ahead.

Thank you very much, Roberta, and thanks to everyone for being with us this morning. This is my first formal interaction with the financial community since I was appointed CEO. It is a privilege to lead this company and be part of this very talented group of people. During my transition period, I had the opportunity to visit all the operations, and I believe we have world-class assets with high safety and environmental standards. I'm also impressed by the commitment of the team and the strong culture based on diversity. Please, let's move now to slide number three, where we will begin our presentation. In slide number three, as you can see in our highlights, 2021 was a very strong year for Nexa. We had strong operating results and achieved guidance in production, mining cash costs, and metal sales. Aripuanã is on track for production, and we believe it will become a flagship operation with a long life of mine. I will also give some updates on our exploration program. We have been very successful in finding potential in most of our mines. We have continued to benefit from high base metal prices, which combined with our strong operational performance, generated a high adjusted EBITDA and robust cash flow generation. Our balance sheet remains strong, with available cash of over $1 billion, and allows for financial leverage. Finally, we remain very optimistic about market fundamentals. Moving now to the next slide, slide number four, I will discuss our results in more detail. In this slide, you can see that zinc production in the fourth quarter of last year decreased by 12% compared to the fourth quarter of 2020. This was mainly driven by lower production in Cerro Lindo due to the expected lower average rate and a temporary reduction in production due to a community stoppage in December. However, in 2021, zinc production reached 320,000 tons, which is 2% higher than in 2020. This increase was possible due to higher production in our mines in Peru, but partially offset by lower production in our Vazante mine because of the Extremo Norte suspension. This area of the mine restarted its activities during the fourth quarter of '21, ahead of our initial plan. Mining cash cost in 2021 decreased by 45% compared to the prior year, which was mainly explained by higher byproducts and lower TCs. It is worth mentioning that we had increases in operating costs related to maintenance activities and third-party services. We also face and continue to face inflationary cost pressures. Now, moving to the smelting segment, in 2021, metal sales totaled 619,000 tons, 6% higher than in 2020, mainly due to higher production in Cajamarquilla. In this smelter, despite the stoppage of our calcine supplier at the beginning of the year, we were able to source material from third-party companies and increase our sales year-over-year. Our smelting cash cost in 2021 increased by 39% compared to 2020, mainly driven by higher LME prices, which increased 33%, and lower TCs. Now, moving to the next slide, I will discuss the completion of our Aripuanã project. In Aripuanã, we made strong progress in 2021. Overall, physical progress had reached more than 99% at the end of December. Mechanical completion is almost concluded, and commissioning is underway. It is worth mentioning that during the last two months, productivity of the workforce went down due to heavy rains and the impact of the Omicron virus. These effects, combined with engineering issues, added additional pressures on costs and the project timeline. These effects have caused the ramp-up to now be scheduled for early third quarter of 2022. In mine development, we have been very successful developing our Arex and Link mines, and have reached 2.5 months of production in stockpiles. I had the opportunity to visit Aripuanã in December last year, and I am impressed with the high quality of infrastructure, a strong mine development program, and the potential to grow reserves. I am confident that Aripuanã will become a long-life flagship mine. Moving now to the next slide, where I will give you an update on exploration. In 2021, we executed over 110,000 meters of exploratory drilling. At Cerro Lindo, the discovery of the Pucasalla mineralized body opened a large and promising brownfield exploration zone. At Vazante, the brownfield exploration confirmed the extension of ore bodies, especially in Extremo Norte. At Aripuanã, exploration drilling continues at Babaçu ore body, with very promising results. In the following slide, we show that at the Pasco Complex, the results on our Sara ore body are very promising. And we are aggressively drilling the San Gerardo pit to extend its life. In Bonsucesso, our advanced project that will accommodate its ore in the Morro Agudo plant, our exploration plan reflects continuity in the parallel ore body. Finally, I would like to comment on Hilarión, where the 2021 drilling campaign was completed and confirms the continuity of minerals in the southern extension. Moving to the next slide to show our financial results, beginning with the chart on your upper-left, consolidated net revenue for the fourth quarter grew by 7% compared to the fourth quarter of 2020. This was mainly driven by higher LME prices. In all, 2021 net revenue increased by 34% compared to 2020, due to the higher prices and volumes already explained before. However, consolidated adjusted EBITDA for the quarter decreased by 19%, which was explained by three main factors: First, we recognized a non-cash impact of $6 million related to our annual asset retirement obligation. Second, due to the sharp increases in metal prices at the end of the year, we had a temporary difference in the hedge book with a negative impact of $18 million. Such impact is expected to be reversed in the upcoming months as the stock position turns over. Last, the temporary decline in Cerro Lindo affected production due to some community relation problems. Nevertheless, the adjusted EBITDA for 2021 was a record high, increasing by 75% to $704 million. This was driven by higher volumes and increases in prices. In the next slide, I will discuss the financial performance by segment. In the Mining segment, net revenue totaled $323 million in the fourth quarter of '21, an increase of 20% versus 2020. This was mainly driven by higher average LME prices and low benchmark TCs. Adjusted EBITDA followed the upward trend and reached $110 million, 26% higher compared to the fourth quarter of 2020. In 2021, mining net revenue grew 56% to $1.2 billion, supported by the same factors mentioned before. Adjusted EBITDA was $441 million in 2021, resulting from strong performance across all mines. In the smelting segment, net revenue in the fourth quarter of '21 totaled $516 million, rising by 7% compared to the same quarter in 2020, also supported by higher LME prices. Adjusted EBITDA was $27 million, a decrease compared to the fourth quarter of 2020, mainly explained by lower volumes and TCs, in addition to the factors I mentioned in the previous slides. In 2021, net revenue grew by 31% to $2 billion, also supported by higher LME prices and the increase in sales volume, while adjusted EBITDA was almost flat year-over-year. On slide 11, we can see the stronger operating cash generation of $277 million. Most of this cash flow has been invested in Aripuanã. We have also prepaid debt of $276 million and paid dividends of $52 million, which includes dividends paid to minorities. With all these effects, the free cash flow in 2021 was a negative $342 million. This negative effect was manageable due to our strong cash balance, which is explained in the following slide. In this slide, you can see that our liquidity remains strong as we continue to report a healthy balance sheet with an extended debt profile. By the end of the year, our current available liquidity was $1.1 billion, which includes our undrawn revolving credit facility of $300 million. As of December 31st, the average maturity of our total debt was 5.3 years, with a 4.7% average debt cost. Our leverage, measured by the net debt to adjusted EBITDA ratio, decreased to 1.37 times from 2.29 times at the end of 2020. This was mainly driven by higher adjusted EBITDA as previously explained. Now, moving on to slide 13, where we present the market fundamentals. In this slide, we want to show you that average prices in 2021 increased more than 30% year-over-year. During the last months of 2021, prices stabilized between $3,300 and $3,400 per ton. More recently, the price has increased and was trading above $3,600 per ton. Copper prices also followed this upward trend, increasing by 50% in 2021 compared to 2020. Regarding market fundamentals, you can see that the supply projections for zinc are above real mine production, and this effect, combined with strong demand, creates a favorable scenario for zinc in the coming months. In a scenario where macroeconomic factors should be less volatile, the price of zinc is expected to reflect market fundamentals, meaning that prices are expected to be at high levels in the coming months. I will now turn the call over to Rodrigo Menck, our CFO, who will comment on our three-year guidance. Rodrigo, please.

Thank you, Ignacio, and good day everyone. As shown on slide 16, for 2022, zinc production at the mid-range of guidance is estimated to decrease by 5% from 2021, driven by expected lower grades from Cerro Lindo and temporary capacity reduction in Vazante due to heavy rainfall in the state of Minas Gerais. For 2023, zinc production is estimated to increase by 16% over 2022 due to the startup of Aripuanã, with a further 1% increase forecasted for 2024 over 2023. At the midpoint of the guidance range, copper production in 2022 is expected to increase by 6% on average compared to 2021, mostly driven by Cerro Lindo and Aripuanã. On the same basis, lead production follows the trend and should increase by 5%. In terms of cash costs, we estimate mining average costs of $0.23 per pound in 2022 compared to $0.21 per pound in 2021, as we forecast inflationary pressures impacting third-party services, logistics, and consumable goods, continuing health protocols to fight COVID-19. This should be partially offset by higher by-product credits in our mines and cost reduction initiatives. Turning to slide 17, for our smelting segment's full-year guidance, metal sales volume in 2022 at the midpoint of the guidance range is estimated to decrease by 7% from 2021 due to lower production. As we disclosed in the first quarter of '21, our calcine supplying to Peru shut down its facility, and for the forecasted period, we are assuming it will not resume activity. The temporary decrease in present mine production is also impacting the production of our smelters in Brazil during 2022. For 2023-2024, we assume supply from our mines maintains historical levels, and thus we expect sales volume to increase over 2022. Despite such decreasing volumes, we remain focused on improving the profitability of our business. In terms of cash costs, we estimate smelting average cash costs of $1.15 per pound in 2022. As we forecast inflationary cost pressures on third-party services, consumable labor costs, higher energy prices, and concentrate prices at higher levels, which should be partially offset by higher by-product credits and ongoing cost reduction initiatives. Turning now to the next slide, slide 15, for 2022, we expect capital expenditures of $385 million, which includes an additional $55 million to conclude the implementation of the Aripuanã project. Sustaining investments are expected to total $256 million, including $42 million for Aripuanã's sustaining expenses. Also, we expect to invest $12 million in technology and to contribute $5 million to our host communities, where we invest in education training, and we endeavor to hire local services supporting their social and economic development. In terms of mineral exploration and project evaluation, in 2022, we estimate a total investment of $82 million as we maintain our efforts to replace and increase mineral reserves and resources, supporting our business growth. Moving to slide 19, where we provide more details of our exploration strategy for 2022. We plan to drill over 120,000 meters, with approximately 63,000 meters in Peru, 50,000 meters in Brazil and the remaining amount focused on expanding mineral resources through brownfield and infield drilling, near operating lines and extension drilling on advanced projects. I will now hand the call back to Ignacio for his final remarks. Ignacio, please.

Thank you, Rodrigo. I'm now on slide 20. I would like to close this presentation by briefly explaining our priorities for this year. We need to focus on taking Aripuanã into production and work on its life of mine extension. We also need to continue working on improving our cash flow. Thank you all for attending this presentation. I will now open up for questions.

We will now begin the question-and-answer session. And our first question will come from Carlos de Alba of Morgan Stanley. Please go ahead.

Yes, good morning, everyone. Thank you very much. Ignacio, good luck with your new responsibilities as CEO. I have a couple of questions, maybe three questions. One is on the smelting results in the fourth quarter, which were very challenging and below what we were expecting. Could you maybe give us a little bit more color on the quotation period? We see that zinc prices increased following September 30, and therefore we would have probably expected a positive impact on higher zinc prices versus the curve that existed at the end of the third quarter. So, some color there would be appreciated, maybe we just didn't have it clear. Also, could you give us some comment as to what exactly has been hedged in the smelting business? Finally, can you give us some color on the conversion costs embedded in the guidance for smelting from 2022 to 2024? Thank you very much.

Okay, Carlos, thank you for the questions. Do you hear me? Menck is going to give you more color on the detail on the hedge. But first, I would like to comment and reiterate what happened in the fourth quarter of 2021. The hit we suffered in EBITDA was around $40 million. One was because of Cerro Lindo, which accounted for $6 million due to a four-year stoppage because of community relations problems. The second was $6 million related to mine closure effects, which is a non-cash item. The third event that affected us was almost $10 million on Aripuanã, with expenses such as insurance and other costs you cannot capitalize in the project. These primarily affected the fourth quarter of 2021. Additionally, the $18 million negative impact from the hedge is vital, but we know this effect will reverse. Rodrigo will explain this effect more clearly so you understand what's happening and how it's going to reverse.

Carlos, nice talking to you. The hedge that we do is not on pricing for final sales. Instead, it is to match the quotation periods for the concentrate we buy from third parties relative to the zinc metal that we are selling on the other end. The idea is to match cash flow from what we buy—which usually is QP M minus one—and what we sell, which is the QP of the month, and we try to match this. An imbalance arose from this specific hedge because there was an increased position in inventory that will be sold in the coming months, reversing the negative impact of the hedge.

Yes, thank you, Rodrigo.

Yes, and one more comment, Carlos. We've been reviewing reports that came out this morning, and thank you for that. In terms of costs, the cost per ton in the mine and the cash cost overall were aligned with our expectations. We didn't experience significant increases. However, we faced inflationary pressures in some uncontrollable areas, along with additional costs related to maintenance and third-party services. Overall, we have managed to maintain flat costs while offsetting several of these increases with productivity measures. We expect similar trends in 2022. In light of this, we will provide more color on costs in the coming months.

Thank you. And just on costs then or the guidance on smelting costs, you provide the cash cost guidance. Can you give us the underlying assumptions for conversion costs that don't include benefits from byproducts?

We don't have that information to disclose now, Carlos. Conversion costs are constantly monitored, and we aim to have a reliable source of information. Once we have the performance of this specific KPI, we intend to disclose additional guidance for next year. So, I would ask you for some patience as we follow up on this information in the coming quarters.

All right, thank you very much, Rodrigo.

Thank you, Carlos.

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

Thanks very much. I wanted to just go back to the Aripuanã project. Could you talk about the gap between the hot commissioning or hot and cold commissioning, which has already started, and the first production, which has now been pushed back by two quarters to Q3 2022? What activities do you do in the meantime to get to that first production after commissioning has been completed?

What really happened, Jackie, is that we were somewhat optimistic in the guidance we gave before. We had considered that rain and COVID impacts would be minimal, but these two factors significantly affected us. Between December and January, we experienced heavy rainfall and the Omicron virus spread, limiting labor productivity. Furthermore, as the project nears completion, many workers sought new opportunities, leaving the project, while we struggled to replace them. We also encountered engineering-related issues, particularly in piping, that took time to rectify. While mechanical completion is nearly done, we foresee slight delays in commissioning. We aim to ramp-up production shortly after. In essence, we remained committed to maintaining an updated timeline, even amid our prior missed expectations. We anticipate starting ramp-up and production in early Q3 2022 and will keep you updated.

That's super helpful. Thank you very much, Ignacio.

The next question comes from Lawson Winder of Bank of America Securities. Please go ahead.

Hello, Ignacio, Rodrigo, Roberta, and team. Thank you for the update. I would like to understand the impact of COVID and absenteeism and your outlook for improvement. How has that trended so far in January? When do you expect absenteeism to return to manageable levels, particularly in relation to Aripuanã and other operating underground mines, and even smelters, as they're impacted? Thanks very much.

That's a good question, but we need to separate Aripuanã from the other mines because Aripuanã has specific workers with unique skill sets. It peaked at almost 900 positive cases with Omicron. We managed the isolation protocols responsibly. In other mines, we have seen increases in positive cases week on week since late December and into January, with some mines experiencing 300 to 400 cases of absenteeism. In Peru, the laws dictated a longer isolation period, which delayed the return of workers. However, in Brazil, it was more manageable, allowing quicker replacements. Overall, while COVID impacted Aripuanã significantly, we have managed production in smelters and mines. Fortunately, the trend of positive cases has been decreasing. We are diligently monitoring this and keeping our safety protocols robust.

Thanks very much for that. I would also like to ask about your cost reduction initiatives and which you view as most promising for 2022. Could we start seeing benefits flowing into lower unit cost guidance versus 2023?

I think Leo, our Senior VP of Operations, can add some comments.

Most of our cost optimization initiatives aim to examine every cost line item we have. Improving productivity across operations while simultaneously addressing inflationary increments is critical. We are back to identifying productivity improvements, with special emphasis on cost-cutting measures that can standardize operations across all lines.

Would you expect to see positive impacts in 2023 based on those initiatives?

Projecting future impacts can be challenging. We are focused on tracking costs and CapEx monthly. Leo mentioned that approximately 30% of costs are related to productivity, which we're addressing. Overall, we expect trends to carry into 2023, but external factors like inflation and rising oil prices remain uncertain. We are managing the controllable costs diligently, aiming for cost analysis and forecasts around cash costs per ton.

No, that's abundantly clear. If possible, I just need a clarification point—should we be looking to adjust for a working capital positive adjustment in Q1 based on the $80 million hedging impact from Q4?

Conceptually, yes. However, how inventory is realized can affect this, leading to some variations. When accounting for FIFO, the impact will be distributed throughout the quarter. It won’t necessarily directly translate to a line item but conceptually you're correct.

Thanks very much.

Thank you.

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

Hi, good morning. Ignacio, as the incoming CEO, can you give some color on your vision for Nexa's future growth? Development of Aripuanã hasn’t gone as expected, and you've seemingly lost some third-party zinc feed in Peru. Do you plan to pause building the next generation of mines or move quickly to address the concentrate shortfall?

You are right. First, we need to ensure robust cash flow delivery in 2022. Our mines are generating cash flow, coupled with the significant expenditures on Aripuanã, totaling around $400 million. By optimizing Cerro Lindo, Vazante, and Aripuanã in 2022 and 2023, we will focus on cash flow generation. We also have the Pasco Complex with promising integration projects, which we've been assessing thoroughly. We also have a small mine in Brazil that has all necessary infrastructure. While it doesn’t generate substantial cash flow, it can be a beneficial addition when evaluated. Our current project portfolio allows us to explore future opportunities without sacrificing existing performance.

Thank you. I appreciate the insights.

Our next questions come from the webcast. Isabella Vasconcelos from Bradesco, good morning. We’d like to know your view on the zinc market outlook, considering recent strong performance. Should we expect higher dividends, while growth projects post-Aripuanã may take time to materialize?

Yes, as shared in the presentation, the zinc market outlook is strong today. Mine supply is low, which is visible in rising treatment charges. While we aren’t expecting dramatic increases in TCs, they are heading upwards. Suppliers face pressures to maintain production, leading to a scarcity of metal. Meanwhile, the demand fundamentals are strong, meaning we expect elevated zinc prices to persist for the coming months. Regarding our capital structure, we aim to build a cash flow mechanism to support dividends. Although I’m new to this, we intend to ensure dividends are returned to shareholders while maintaining cash flow for growth.

Our dividend policy states we should pursue at least 2% of market cap around the payment. Last year reflected the difficulties of 2020, where we paid around 0.5%. Currently, we’re aiming for a greater payment this year. We analyze every payment proposal to the Board to ensure we adequately reward our shareholders while also funding growth.

If there's one more question, would you like to read it out?

We have time for one more question. The next question comes from Bastian. Can you give more detail about the Aripuanã ramp-up delay? While we appreciate the impact of COVID and rainfall, the delay of two quarters raises concerns—should we expect more future delays?

As I explained to Jackie, we were overly optimistic about our timeline and considered the rain and COVID impacts would be minimal. Besides those factors, we also faced engineering challenges and quality issues with equipment, which are more typical as projects near completion. We’re actively resolving these concerns and remain committed to hitting our revised timelines while focusing on the potential of Aripuanã to create long-term value for Nexa.

That concludes our question-and-answer session. Now we will hand over to Ignacio for his final remarks. Mr. Rosado, please go ahead.

Thank you very much for all the questions and for attending this call. It's crucial for us to convey our plans to you. I'm excited about this role and confident we can drive Nexa to create shareholder value through our strong assets and well-managed smelters. Our goal is to enhance cash generation while fostering closer relations with the financial community. Given the volatile market, we must adopt a more cautious stance on guidance to ensure we meet production metrics while maintaining profitability. We aim to focus primarily on cash flow this year. Thank you again, and I look forward to our next conversation during the first quarter results.

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