Nexa Resources S.A. Q3 FY2023 Earnings Call

Good morning and welcome to Nexa Resources Third Quarter 2023 Conference Call. All participants will be in a listen-only mode. This 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. I would now like to turn the conference over to Mr. Rodrigo Cammarosano, Head of Investor Relations for opening remarks. Please go ahead.

Good morning, everyone, and welcome to Nexa Resources' third quarter 2023 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 onscreen presentation through the webcast. Before we begin, I would like to draw your attention to slide 2, 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 is now my pleasure to introduce our speakers. Joining us today is our CEO, Ignacio Rosado; our CFO, Jose Carlos del Valle; and our Senior Vice President of Mining, Leonardo Coelho. So now I will turn the call over to Ignacio for his comments. Ignacio, please go ahead.

Thank you, Rodrigo, and thanks to everyone for joining us this morning. Please let's move now to slide 3, where we will begin our presentation. Let me start by providing you a brief overview on our third quarter of 2023. We continue to experience a scenario of downward pressure on metal prices driven by negative external factors such as inflation and high interest rates in the US, in addition to uncertainty about the performance of key sectors of the Chinese economy. Although the prices of our main metals have performed at levels below our expectations, we remain committed to our financial discipline, which has made it possible to achieve positive cash generation in the third quarter of this year. Our operating performance was in line with expectations in our mining and smelting segments. We also provided cash cost guidance that was revised downwards. Total revenue reached $649 million and was down 8% year-over-year, mainly due to lower Zinc LME prices and smelting sales volumes. Compared to the last quarter, net revenues increased by 4%, as a result of higher mining production and metal sales volume in the period, which were partially offset by lower LME metal prices. Consolidated adjusted EBITDA for the quarter decreased by 32% year-over-year, reaching $82 million. This performance was mainly explained by lower LME prices. Compared to the second quarter of this year, adjusted EBITDA grew 14% due to higher metal sales, mine production, and lower costs in Brazil. We revised the Aripuanã production range downwards for the year, given the limitations we found related to the design capacity of the flotation pumping system, which resulted in the extension of the ramp-up phase. Nonetheless, 2023 production estimates for Nexa’s other mines and smelters remain unchanged. Our Cerro Pasco integration project is advancing as expected. Exploration project evaluation and other expenses were reduced by 15%. However, we are still prioritizing the expansion of the resource and mineral research base in our mines. I would like to close this slide by mentioning that we have successfully closed a $320 million sustainability-linked revolving rate facility, which will support Nexa’s liquidity profile and is linked to our carbon reduction key performance indicators. Jose Carlos will go into details later on in the presentation. Now moving to slide 4.

Thank you, Ignacio. Good morning to everyone. I will continue on slide 10. As you can see, beginning with the chart on your upper left, total consolidated debt revenues for the third quarter decreased by 8% year-over-year, mainly due to lower Zinc LME prices and lower smelting sales volumes. Compared to the second quarter of 2023, net revenues increased by 4% as a result of higher mining production and metal sales volumes, partially offset by lower Zinc prices. In the first nine months of the year, consolidated net revenues reached $1.9 billion, down by 14% compared to the same period a year ago. In terms of profitability, consolidated adjusted EBITDA in the third quarter of 2023 was $82 million, compared to $121 million in the third quarter of 2022. This lower performance was mainly explained by lower Zinc metal prices. Compared to the second quarter of 2023, adjusted EBITDA increased 13%, mainly due to higher mining and metal sales and lower costs in Brazil, which were partially offset by lower Zinc prices and FX rates. In the first nine months of this year, consolidated adjusted EBITDA reached $286 million, down by 55% from the same period last year.

Jose Carlos, I think you could continue what you were saying related to costs in Cajamarquilla and the working capital that's affecting our results.

For the third quarter of 2023 and starting from our $82 million of adjusted EBITDA net of non-operational items, we paid almost $38 million related to interest and taxes and spent $75 million in sustaining CapEx and HS&E inner operations, including Aripuanã. Additionally, loans and investments and dividend received and paid had a positive net impact of $3 million. We then had a negative impact of also $3 million due to the effects of foreign exchange on our cash and cash equivalents. This was driven by the depreciation of the Brazilian Real against the US dollar during this period. Finally, there was a positive contribution of $93 million from an improvement in working capital, which is part of the result of our ongoing program of cash optimization measures for 2023. Combining all these effects, our free cash flow in the third quarter of 2023 was $14 million.

Now moving to slide 9, on this slide, I would like to highlight that we continue to advance the technical studies of the Pasco Integration Project. These technical studies cover different works, such as new mine design and studies for the underground interconnection, shaft upgrade, and engineering assessment of the plant, as well as the assessment of options to improve capacity to provide a long-term solution for tailings storage facilities. Furthermore, we continue to advance the required environmental permits. As studies progress, the project demonstrates the potential to unlock important value for Nexa through economies of scale, cost improvement, and extension of asset life. We expect to submit this project for approval during the first quarter of next year.

We will start with a question from Alexandra Symeonidi from William Blair and Company. What is the interest rate in this new sustainability-linked RCF?

Good morning to everyone. This is Jose Carlos del Valle. In relation to this question, just to clarify, the interest rate is SOFR, which is the Secured Overnight Financing Rate, plus 1.6%, with the possibility of another net point, depending on compliance with the ESG target that has been established for this sustainability-linked facility.

Thank you, Jose. We have another question from the audience. It's from Alexandra Symeonidi as well. In terms of leverage, it seems that the leverage has increased in this quarter. Is there leverage targeting for the company, and how does the company plan to address this?

Thank you for the question. This is something that we talk about continuously. As you can imagine, leverage has increased mainly because of the reduced EBITDA, as our net debt hasn't changed that much. Apparently, we are right above 3x and we are doing all our efforts to bring this below 3x towards the end of the year. However, in the medium to long term, we will feel more comfortable with levels around 2x. We don't have any leverage covenant in our facilities, but we believe that something around 2x would be more sustainable. So we continue to work on a number of initiatives to bring this down. Our top priority in the next months and years is to reduce our net debt. Obviously, a good part of that will depend on prices, but we are trying to influence all the factors that we can control to maximize cash flow generation and reduce net debt, and consequently bring leverage to below the level that it currently is.

Thank you, Jose Carlos. We have another question from Camilla Border from Bradesco BBI. What can we expect in terms of free cash flow impact in Q4 and 1Q '24 from Aripuanã?

Okay. This is Ignacio, so far, the impact on cash flow in Aripuanã in the first nine months of this year was $146 million, as we put it in the presentation. For the first quarter, we expect a number of cash outflows of around $40 million to $50 million. Depending on the ramp-up and how it goes in the summer or in the first quarter of next year, we will assess the impact on cash flow. However, we expect to start to break even towards the end of the first half of the third quarter and beginning in the fourth quarter. We cannot provide a specific number here because this is a process. So we will keep the market posted when we provide guidance in January for the rest of the months.

Thank you, Ignacio. We have a follow-up question from Camila from Bradesco BBI. Could you provide some color on what you expect in terms of volumes for Zinc and Copper for 2024?

Yes, this is going to come also in our guidance that is coming in January. I would like for you to please wait until we provide that in two or three months.

Okay, thank you, Ignacio. We have a question from Orlando Barriga from Creditcorp Capital. Good morning. Thanks for taking my question. My first question is related to costs in Cajamarquilla. Why did costs increase quarter-on-quarter despite lower raw materials and conversion costs?

Yes, actually, the main driver of increasing the conversion cost or cost driving in Cajamarquilla was energy.

Thank you, Ignacio. We have a question from Alexandra Symeonidi from William Blair and Company. There was a big working capital outflow due to higher payables and lower inventory in the quarter. Can you please provide more color there and should we expect this to reverse in Q4?

Thank you for the question. Jose Carlos again. Actually, if you go back and review the result of the first quarter, you will see that we had a very significant investment in working capital, which is actually what we've been reversing in the second quarter and the third quarter. So if we compare ourselves with the beginning of the year, we're pretty much at the same level, marginally lower working capital. These variations are the result of a number of initiatives that we have taken to optimize working capital, have more control over our inventory as we should always do, but also adjusting the terms that we have with our suppliers, for example, to always be in industry standards, renegotiating slightly longer payment terms. So this is a structural change that will continue. This takes time to implement as contracts renew, and it's also related to our cost control initiatives when we renegotiate contracts, consolidating contracts to get better terms. So I wouldn't worry about that. I don't expect a reversal in the fourth quarter, because I think the key point here is that we are recovering the working capital that we lost in the first quarter of the year.

Thank you, Jose. We will go back to one question because it seems that we had an audio problem. And the question was from Orlando Barriga from Creditcorp Capital. The question was related to Cajamarquilla cost. So why did cost increase over quarter despite lower raw material and conversion costs?

So as I was explaining, I'm sorry about the problem with the communication. As I was explaining, Cajamarquilla is exposed mainly to energy cost inflation. This is linked to our contract. We have a longer contract, and this is linked to that. So this was the main variable that increased the conversion cost. Having said that, we started a program in September to work on reducing costs, increasing production, and implementing productivity measures to reduce workforce in the operations, and this is being very successful. Most of these benefits will be reflected in our budget for next year and in the first quarter of next year as well.

Thank you, Ignacio. We have a question from Carlos from Bank of America. Thanks for the presentation. Could you provide some insights on capital allocation moving forward? Is Nexa looking into growth opportunities in other regions?

Yes, this is a very important question. With these prices, it's worth mentioning that most of our mines still make money on our smelters. We are seeing positive results from all the optimization programs that we are running, which are also generating more cash. However, as you can see, we have a high debt, and the priority in this capital allocation is to reduce the debt. We are putting together the budget for the coming months and for the coming year, and we have to assess how much cash generation we can provide to start reducing the debt. As I was saying, this is the priority. Based on that, we might look for other options to change the capital allocation of the company. This is still early days, and we will provide more detail to the market at the beginning of next year or mid-next year. Regarding inorganic growth, I believe the best options lie in organic growth. This is something we are assessing. That said, our priorities are to finalize Aripuanã, to have more clarity on the approval of the Cerro Pasco project, and reducing the debt. So these are the three priorities that we have for the coming months and 2024.

Thanks, Ignacio. We have one question related to Aripuanã. It's from Alexandra Symeonidi from William Blair and Company. What production should we expect from Aripuanã next year? And what is the annual capacity?

Okay, this is Leonardo speaking. We expect to keep ramping up over the next year. By the second quarter, we expect to start to reach full production. When we reach full production, the running duration is about 2.2 million tons a year. We are still working on the plan and will provide more details when we issue the guidance in the next quarter.

Thank you, Leo. I think can you explain? Sorry, hold on just a moment. There's one another question related to Aripuanã from Orlando Barriga from Creditcorp Capital. When would you expect Aripuanã to reach breakeven?

Yes, as Leonardo Coelho mentioned, we expect full capacity towards the end of the first quarter of next year, and probably during those months, we will also reach breakeven. However, this is also the case because the CapEx that we are investing in Aripuanã is related to changing the pumps and installation of these pumps, which is a higher CapEx. This is affecting our breakeven costs, but as we mentioned in the presentation, in the second quarter of next year, we should be at breakeven.

Thanks, Ignacio. We have another question related to Aripuanã from Braga at Morgan Stanley. Are there any other bottlenecks for the Aripuanã ramp-up that management can identify?

Yes, this is a very good question and I can summarize that Aripuanã has been very difficult to start the ramp-up due to some flaws in the original design that also affected construction. So we had many small bottlenecks in some of the processes, but today I would say the main choke point is the flotation pumping system. Besides this, we don't see any other major bottlenecks, although there might be some related to the ramp-up, but this is the case today. The replacement of the pumps in the flotation system is the one thing that will enable us to reach full production towards the end of the first quarter of next year.

Okay, so these are all the questions that we have. We go back to the moderator, please.

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

Thank you. Thank you, everyone, for attending. As you can see, this is still a difficult quarter for us. As we were saying, we are committed to our financial discipline. We're working on many work streams to reduce costs, bring down CapEx, and ensure that we are up and running well in the coming months. Thank you very much again for your time, and we look forward to providing you with more updates in the next quarter at the end of the year. Have a good day. Thank you.

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