Turquoise Hill Resources Ltd (TRQ) 2012 Q4 法說會逐字稿

Good day, ladies and gentlemen. Thank you for joining us today. Welcome to the Turquoise Hill conference call on the fourth quarter and full year 2012 financial results held on March 26, 2013. I would now like to turn the call over to Mr. Jason Combes, Director of Investor Relations. Please go ahead.

Thank you. I welcome you to our fourth quarter and full year 2012 financial results conference call. Yesterday we released several items, including our results press release, fourth quarter MD&A, 2012 financial statements, annual information form, and the updated 2013 Oyu Tolgoi technical report. These items are available on SEDAR, and we have also posted them on our website. The call is being recorded, and will be available later today for replay. We've also posted slides on our website to accompany today's conference call.

With me today are Kay Priestly, our CEO and Chris Bateman, our CFO. Kay will discuss operations and our updated technical report. Chris will cover project financing. We'll take questions after our prepared remarks. This call will include forward-looking statements. We have outlined our forward-looking disclosure on slide 2. I would now like to turn the call over to Kay, who will begin her comments on slide 3.

Thank you, Jason. Good morning, or good afternoon, everyone. Before I begin, I want to let you know that going forward, we are planning to conduct regular conference calls with the financial community, like today's call, to discuss our quarterly results. We think it's important to conduct these calls, as Oyu Tolgoi transitions into a fully operational mine.

Let's turn to the highlights on slide 3. Oyu Tolgoi Phase-one construction was 99% complete by the end of 2012. This is a tremendous achievement, and I want to commend the team at Oyu Tolgoi for their impressive work in preparing the mine for operations. First concentrate was produced at the end of January, and the commissioning of the concentrator is progressing well. We are on track for the start of commercial operations by the end of June, subject to the resolution of matters being discussed with the Mongolian government. Chris will discuss project financing more thoroughly in a few minutes, but I want to touch on it briefly.

The project finance is well advanced, and we expect closing and first funding in the second quarter of this year. As many of you know, we have been having active discussions with the Mongolian government for several months about implementation of certain items in the investment agreement. We are working closely with the working groups set up by the government. There have been meetings at both the Oyu Tolgoi shareholders and the Oyu Tolgoi LLC board. I would describe the discussions as both constructive and productive. I think it's important to stress that Turquoise Hill, Rio Tinto, and the government all have a shared commitment to seeing Oyu Tolgoi succeed. There is active engagement among all the parties, and we are working hard to resolve the issues raised.

The Oyu Tolgoi board has approved ongoing funding for the mine. So development and commissioning can continue while the discussions take place. I'm happy to note also that SouthGobi's recent announcement that it has restarted production. SouthGobi's CEO, Ross Tromans and his team have been working very hard to get the business in a position to restart the mine on a sustainable basis. They expect to produce 3.2 million tonnes of coal in 2013.

Moving to slide 4. I'd like to review the operations of Oyu Tolgoi in a bit more depth. We continue to expect final Phase-one CapEx of $6.2 billion, which is within 3% of budget. This is quite an accomplishment, given the cost pressures the industry has experienced over the last several years. Stockpiling of ore began in May 2012, and by February 2013 there was more than 12 million tonnes of ore in inventory. The primary crusher, overland conveyor, and course ore stockpile circuits were commissioned in the third quarter of last year, and 435,000 tonnes of ore had been sent through to the course ore storage facility by the end of last year.

Oyu Tolgoi signed a power purchase agreement in November 2012 to supply power to the mine. By the end of 2012, construction of the concentrator was completed, and first ore was processed shortly thereafter. Overall, the ramp-up to commercial production is progressing, and we expect to reach commercial production levels by the end of June. Work on the underground mine continues. The interim funding approved by the Oyu Tolgoi board provides for ongoing underground development.

Construction of shaft number two at Hugo North is progressing well, with the head frame reaching its final height of 96 metres in the second quarter of 2012. The shaft reached 74% of its final depth by the end of 2012. Underground lateral development restarted in September, with 1500 meters of development from mid-September through the end of the year. Further, the head frame for shaft number five has been completed, and shaft sinking is set to begin in April. Shaft number five will be the primary ventilation shaft for underground operations.

Now moving to slide 5. Yesterday we filed an updated technical report for Oyu Tolgoi. The report is based on 100,000 tonnes per day concentrator and purchased power. This is the base case, and we continue to have multiple options which we are evaluating. The revised capital estimate for the underground development is $5.1 billion. As outlined in the IDOT technical report issued in March 2012, there have been a number of scope changes that have now been reflected in the capital estimates. This includes shaft number five, and infrastructure additions, including operations camp expansion and a central maintenance complex. Estimates also include improvements in the mine development to provide more confidence in achieving planned grades, and raising peak underground production by 12% to 95,000 tonnes per day.

We continue to evaluate several options for sourcing power from within Mongolia at the conclusion of the current four-year power agreement. However, for this technical report, we have assumed the purchase of power from a third party. Even with these changes, operating costs are in the first quartile of the industry cost curve at $0.89 per pound. As we move into operation, mine plans are constantly optimized. As a result of this ongoing effort, recovered metal and ore reserves have increased from an expansion of the open pit design. Not only have we increased our reserves, we have also increased our measured and indicated mineral resource. The reasonable prospects analysis identified a reduction in cutoff grade, which was the predominant factor for the change in resources relative to reporting in previous years.

Also included for the first time, are resources below the open pit. The result is an increase in the measured and indicated contained copper and gold of 13% and 20%, respectively. We believe that further design work could create opportunity to reduce costs and improve the economics included in the 2013 technical report. We are undertaking a focused and structured review of the ongoing feasibility study.

Slide 6 outlines the key metrics from the 2013 technical report. The project has a net present value of almost $10 billion using a real discount rate of 8%, and based on the current reserves and 100,000 tonne per day concentrator. Oyu Tolgoi contains more than 26 billion pounds of recoverable copper, and 13 million ounces of gold, and this is just reserves. The measured and indicated resource includes almost 46 billion pounds and 25 million ounces of contained copper and gold, respectively. The inferred resource adds a further 55 million pounds of contained copper and 37 million ounces of contained gold.

There are multiple options to further develop Oyu Tolgoi, and some options are shown here on slide 7. Oyu Tolgoi's a multi-decade project. It's important for us to invest time now to ensure an optimum plan is developed that balances capital costs and increased volumes. We do not expect the concentrator's operating capacity to remain unchanged over the mine's 40-plus year life, given the expansion opportunity. Projects like Oyu Tolgoi invariably evolve, and go through multiple expansion phases over the course of the mine's life. We are looking at all possible development scenarios for the mine, and not simply a single expansion scenario, has been the focus of past work. This ranges from no expansion, to expanding to 300,000 plus tonnes per day.

The Company will also have the benefit of incorporating actual performance of the operating mine into the study before the next investment decision is made. As a result of this pending work and the incorporation of real performance data, the capital and operating cost estimates will change. A decision to expand the concentrator is not needed until at least 2015, prior to the introduction of the higher grade ore from the underground mine. This time frame allows for sufficient time to assess our various options and maximize the value of the project. Our intent is to utilize the time between now and 2015 to gather and analyze as much data on operations, capacity, and our existing investment as possible before considering further expansion. I'm now going to turn it over to Chris, who's going to provide an update on project financing on slide 8.

Thanks, Kay. Since project financing is a significant part of our future funding strategy, I want to provide an update of where that process currently stands. This will be a landmark transaction, and is expected to be the largest project financing ever in the mining industry. This is evidence of the quality and strong economics of the Oyu Tolgoi project. We are seeking $3 billion to $4 billion of project finance, but we have agreed to a debt ceiling above that level, which will provide future financial flexibility. Proceeds will be used to repay the $1.8 billion interim funding facility with Rio Tinto and fund the future development of the mine.

Importantly, project finance will also diversify the funding of Oyu Tolgoi with the inclusion of international financial institutions, export credit agencies, and a large number of commercial banks. The project financing timetable is well advanced. A term sheet has been agreed in late February. The boards of the IFC and the EBRD approved their respective participation in the transaction. In early March, we received bids from a number of commercial banks, and we are currently in discussions with potential lenders to finalize the terms of their offers. We are on track to close the transaction and draw funds during the second quarter of this year. I'd now like to turn things back over to Kay.

Thanks, Chris. Turning to slide 9, I would like to provide an update on our other subsidiaries, starting with SouthGobi. I'm pleased that operations at the Ovoot Tolgoi mine resumed last week. The new management team has been working hard to reposition the mine to operate in the current market environment on a sustainable basis. SouthGobi expects to produce approximately 3.2 million tonnes of semi-soft coking coal during 2013. At Ivanhoe Australia, the Osborne copper gold operation has performed well during the year, producing in excess of 50,000 tonnes of concentrate. Ivanhoe Australia successfully commenced production at Starra in March 2013. This year, Ivanhoe Australia expects to mine between 1.4 million and 1.6 million tonnes from the Osborne operation's three mines. Ivanhoe Australia also successfully completed an $80 million rights issue in January 2013, strengthening its balance sheet.

Finally, in February 2013, we signed a binding agreement with Sumeru Gold to sell our 50% interest in Altynalmas for $300 million. The transaction is expected to close in the second quarter of this year. As you can see, a great deal of progress is being made at Oyu Tolgoi and our other assets. The Oyu Tolgoi commissioning process is well advanced, and first concentrate was delivered both on budget and on schedule. We remain on track to deliver commercial production by June of this year. Oyu Tolgoi is a world-class asset with strong economics.

Projected operating costs are in the first quartile of the industry cost curve, and there are multiple expansion options to further increase value for shareholders. We are looking at all possible development scenarios. The ongoing value engineering and development planning may result in opportunities to improve the economics through cost reductions and optimization of the mine plans. The project finance is well advanced, with the term sheet agreed, support from international financial institutions, and receipt of bids from commercial banks in March. We are on track to complete project finance in the second quarter. I am optimistic that matters being discussed with the Mongolian government will be resolved. We are all committed to the success of Oyu Tolgoi. With that, I'd like to now open the call up to questions.

Thank you. We will now take questions from the telephone lines.

(Operator Instructions)

The first question is from Ralph Profiti from Credit Suisse. Please go ahead.

Good afternoon, and thank you for taking my question. With regards to the rationale on the exclusion of the power plant in the capital plan, I was under the impression that this was required after four years of commissioning. Is this no longer a requirement, or because this could be one of the issues on the table with the government of Mongolia, given the uncertainties, you left it out? Just wondering what the rationale is behind it? Thank you.

Thank you. The power is still required to be sourced from within Mongolia within four years after the start of commercial production. That has not changed, and that has not been the rationale for taking it out. We are currently exploring several options on power, and until that decision is made, whether OT builds its own power plant and sources it, or there may be another power plant in Mongolia, we decided to keep the current purchase power assumptions in the reserve case that's part of the technical report that was issued yesterday.

I see, great. Thank you. I do have a follow-up. From a funding perspective, there was commentary that you'd be looking to repay the interim funding facility, and I have seen disclosures before that there is an option to extend or amend that. I'm just wondering, is that a hard target repayment, or could we see that $1.8 billion somehow be refinanced or extended? Thank you.

Chris, I'll let you answer that question.

Okay. In agreements between Turquoise Hill and Rio Tinto, it is a requirement to repay the interim funding facility on achieving project financing, or by December 31, this year, whichever is sooner.

Thank you very much.

Thank you. The following question is from Tony Lesiak from Macquarie Capital Markets. Please go ahead.

Good morning. I guess a question for Kay. Do you -- do all the parties in the OT LLC view the investment agreement as sacrosanct?

We continue to have very productive and constructive discussions with the government on these issues. There have been several issues that have been discussed, including project development costs, operating budget, project financing, and governance. The key messaging is most of this relates to the implementation of the investment agreement, and we have been very firm in our belief that the investment agreement is a critical fundamental document that we rely on for our investments, and the government has been very constructive in its discussions, and again, we're focusing on some of these implementation issues. It's fair to say that everybody wants the project to continue and be successful, and we are keen to find a path forward. But we're not going to compromise on key principles, such as the preservation of the investment agreement and the shareholders agreement.

Okay. Just on the shareholders agreement, do you feel that there might be some leverage within that document to resolve the disputes with the Mongolian government, whether it be interest rates on the debt that they've accrued? There has been some movement there in the past, or the management fee, for instance?

Clearly, we have had discussions in the past on some of these issues, and we are open to working to a successful resolution with the government. But again, nothing has been decided right now. The discussions are very productive and constructive, and we're working towards resolution of these issues.

Okay. Just on the $5.1 billion for the underground development, I mean, do you see a scenario where you'd spend the over-$5 billion then not expand the concentrator to 160,000 tonnes a day and beyond?

That clearly is one scenario, as I mentioned earlier. But that is just one of many scenarios, and we do not have to make that decision until 2015, at the earliest. The technical report is based on the feasibility work that has been done so far, and we continue to do additional work, value engineering and strategic production planning, to optimize the mine plan going forward, and it could include staying at the 100,000 [k case], but it could also equally include expanding. This is a tremendous resource. The economics are great at the 100,000 per day case, but we are looking at all possible development scenarios for the mine, and not simply the single expansion scenario of 160,000 tonnes per day that was done previously. Again, it ranges from zero to 300,000-plus tonnes a day.

Okay. Do you see water as a limiting factor? I mean, there is a restriction, I guess, to go above 870 liters a second, which would imply the 160,000 tonne a day case would be the max. Do you see movement there from the government in revising that to allow you to process at higher rates?

Well, at this point, we have enough water for the current plan of 100,000 tonnes per day. We are working on options, should we expand to the 160,000 or higher tonne per case day.

Okay, Just finally on the power station again, if you were to assume dedicated power, what would be the potential impact to your cost structure? Rather than the current case where you're importing it from a third party?

The technical report assumes $0.13 per day purchase power costs, and I think that the -- if we were to construct a power plant, it would be about 75% less.

Okay, so it would be a substantial --

Because of additional capital potential and operating costs if we were to construct our own power plant.

Okay, but this is something that you could be looking at off-balance sheet though?

We are looking at all options with respect to the power plant, and workings with the government of Mongolia in that effort.

Thank you very much.

The following question is from Terence Ortslan from TSO and Associates. Please go ahead.

Thank you. For me to try to understand the chronology of the banks and the financing and the ongoing discussions, irregardless of the outcome of the discussions, the banks are there for the financing?

The chronology, currently we've had offers in from a range of commercial banks. The next step would be the signing of commitment letters going through to final closing. The project financing ultimately would be put to the OT LLC Board for approval, and after approval at the OT LLC board, which includes the (inaudible) directors, we would execute the project financing.

And the timing of this is before the end of second quarter, which is the same time as you being in commercial production?

Correct. We're targeting signing of the definitive agreements by the end of this half.

Okay. I'm trying to understand, if you're side lining the ongoing discussions, or circumstances with the government, irregardless of that, as long as the OT board approves it, the banks will accept?

All of the issues are interrelated. So the project financing is one of the issues that we continue to discuss with government.

Okay, okay. In other words, this can be delayed or can be on time, but the internal target date is end of the second quarter, which is coinciding with the commercial production time?

Correct.

Okay. I'm sorry, in the longer term, where does the smelter issue fit into the ongoing discussions, and also in the second or third phase of the development?

Under the agreements with the government, we have agreed to assist the government studying options for a smelter in Mongolia. So if the government wish for that work to go ahead, we stand prepared to execute that work.

Okay. And final question is about the road conditions going to China. You made reference in your press release, if you're in commercial production end of June with weather cooperating, you will have enough traffic, will sustain the road conditions. However, can the border handle that? We've seen the example of that in the Ovoot Tolgoi, that the border couldn't handle the traffic and the volume. Is it fair assumption that the border can handle the volume of the traffic going through, assuming that the road can handle the traffic with the concentrate?

There's really no evidence to suggest that there would be any problems with respect to that issue.

Okay. Thank you very much.

Thank you.

(Operator Instructions)

The following question is from Oscar Cabrera from Bank of America/Merrill Lynch. Please go ahead.

Thank you operator, and good afternoon everyone. I just wanted to get back to the power plant, and just basically clarify. In the investment agreement, as long as you source the power from within Mongolia, you don't need to build a power plant, is that correct?

That's correct. The investment agreement specifically states it must be sourced from within Mongolia, and that's the only requirement.

Okay. So then the decision to evaluate the different alternatives was just based on the current, I guess, economics of building a power plant as opposed to just sourcing it?

Correct. That's correct. What the current technical report does by just including the current state, is not firming up an option one way or the other, that Oyu Tolgoi would build and source power from Oyu Tolgoi. Again, we have to force it -- we have to source it from Mongolia within four years, but there are other options to do that within Mongolia. We are working with the government as we look at various options with respect to ownership and sourcing that power.

Okay, great. No, that's helpful. And just, I was wondering if you could discuss, or provide us with a little bit more color with regards to the capital expense or inflation that you saw in the project, obviously the scope of the project, or the base case, as you call it, for 100,000 tonnes without the power plant, and we still have the same $5.1 billion in CapEx. What were the main deltas in terms of cost inflation that you saw there?

Well, as we mentioned previously, part of the cost increase we flagged in the IDOT report last year, part of it related to shaft five and additional infrastructure costs. We've also stated that there's been a 30% direct capital cost increase in this report from the prior report. That includes, as we mentioned, these costs that were flagged earlier, as well as we're now producing 95,000 tonnes per day, as opposed to 85,000 tonnes per day. We've achieved greater surety of the grade. And those all cover some of the costs. There are also execution cost changes in the report, and we're going to focus on the execution costs, and this is part of the value engineering and optimization work that we will continue to do with the current state of the feasibility work before it's finalized in 2014.

Right, and just remind me what level of contingencies did you have in the report that you published in March 2012 with respect to what you were expecting now?

We had a 20% contingency factor.

And is that the same still?

Yes, same.

Great. Thank you very much.

Thank you. The following question is from Tony Robson from BMO Capital Markets. Please go ahead.

Good morning, I'm sorry, good afternoon, Kay, Chris, and Jason. Thanks, by the way, for making your time and having an analyst call. It's really appreciated. In the plan to go now to increase to 95,000 tonnes per day for the underground. What was the limiting factor there? Why not just go to 100,000 tonnes per day, and essentially close the open cut, given the higher grades and the much greater cash flow available underground? Was there a limiting factor there, please? I have a follow-up, if I could.

Well, so far the increase from 85,000 tonnes to 95,000 tonnes is based on the work that Rio Tinto and OT LLC are doing, working on improving the design and efficiency in the underground mine. The increase in rate is a result of all this work on optimizing the mine design, and it will be integrated into the feasibility study, and still ongoing.

Okay. So in fact it may go to 100,000 tonnes per day, with no real need for an open cut, assuming that scenario of a flat 100,000 tonnes per day milling capacity?

It could, based on this additional work.

Okay. Thank you. Follow-up question. Turning to politics, and Kay, I understand you might be reluctant to answer. There's a view out there that in terms of the discussions you're having with the Mongolians, in part respect to past capital expenditure and the agreements you have, that nothing much will happen until post the presidential elections, which correct me if I'm wrong, I think is May. Do you have any general comments you can give us in terms of the time line?

Sure. Well, the presidential election is scheduled for the last week in June right now, and any time a project as important as Oyu Tolgoi is to Mongolia, based on the importance of it, we would expect it would receive a lot of attention at any time, and particularly at this time. So we don't really expect a lot of difference during the elections, but at this time we are, as I mentioned earlier, constructively working with the government at many levels, at the OT LLC board level, at the shareholders level, and at the working group level to address these issues. The cost figure, the cost increase from Phase-one, has been one of the key issues, but we've made very good progress in providing more information and details to the government on that increase. The initial estimate, as you know, was based on a July 2009 feasibility study. And this was developed before construction even began, and there are significant items that we have been discussing and presenting to the government to explain that Phase-one issue and that will continue -- that work will continue to be underway over the next few months.

Okay. Thank you very much.

Thank you.

(Operator Instructions)

The following question is from Craig Miller from TD Securities. Please go ahead.

Yes, thank you. Is there, or are there any explicit terms in either the investment agreement or the joint venture agreement or any other agreement that specifies how the cash gets distributed from the mine once it starts, of course, later this year? Is there anything that says so much goes to CapEx, so much goes back to shareholders, is there anything explicit?

Craig, there's no explicit agreements in either the R share, the amended and restated shareholder agreement, or in the IA that divvies up cash between capital dividends, interest.

Is that, then, part of maybe what you're discussing with the government of Mongolia? Is this some kind of a formula?

Currently, the agreement is that the shareholder loans have got to be settled first, and then after that point there will be dividends. As you probably aware, we are also funding (inaudible) 34% stake in the project, and that also will be paid out of dividends, their dividends, and settled prior to they receive dividends. What we've said is, we're happy to work with the government on a wide range of issues, but the core principles of the investment agreement and the R share are sacrosanct to us. So we'll discuss anything that's in the mutual benefit interest of all parties.

Just for clarification, the government would receive no dividends until their CapEx share is repaid, is that correct?

That's the current situation.

Okay. One more on the power plant. I've heard rumblings that someone wants to build a power plant and use Tavan Tolgoi coal, which would, they hope, would supply the power that you would need. Regardless of where that third party power might come from, what is the drop-dead date for making that decision of whether you have to proceed with your own power plant or someone else's, just to meet that four-year term or condition?

We would need to make the decision about a 1.5 years to 2 years before that deadline for sourcing the power.

Okay. Well that's --

Four years from -- couple years from when commercial production starts, we'd have to have that decision made.

And I guess one final thing. There seems to be a lot of mistrust between all of the different parties, Rio Tinto versus Turquoise Hill, government, minority shareholders. How are you trying to address and try to gain, I guess, trust and respect with all the stakeholders here?

Okay, a couple of things. First would be the working group process we had going on in Mongolia right now. Working groups have been meeting with members from the government of Mongolia from [urdenez] and from the board to continue to focus on these issues and have a very open discussion. I think there's a much better mutual understanding of the issues from both the government's perspective and from OT's perspective. So a lot of time and effort and energy has been focused on spending more time working together to get a better understanding of those issues. With respect to shareholders, clearly we want to start having these quarterly calls to keep everyone informed as the project progresses, as we begin commercial production. This is a big year for Oyu Tolgoi, and we're looking forward to watching the progress. So I think just continued interaction and interface with all the shareholders is one of our key objectives this year as we move forward.

Thank you very much. That's all I have.

Thank you. That concludes the question-and-answer portion of the call. I would like to return the meeting to Ms. Kay Priestly.

Okay. Thank you, everyone. We appreciate the time today, and we look forward to continuing to keep up with -- keep in touch with you as the project progresses. Thank you, operator.

Thank you. That concludes today's conference call. Please disconnect your lines at this time, and we thank you for your participation.