Turquoise Hill Resources Ltd (TRQ) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Turquoise Hill Resources Q2 2017 Financial Results Conference Call. (Operator Instructions) As a reminder, this conference call may be recorded. I would now like to turn the conference over to Tony Shaffer. You may begin.

Thank you, operator. Welcome to our financial results conference call. Yesterday, we released our second quarter 2017 results press release, MD&A and financial statements. These items are available on our website and SEDAR.

With me today is our CEO, Jeff Tygesen; Owen Thomas, acting CFO; and Brendan Lane, Vice President of Operations and Development. We'll take your questions after our prepared remarks. This call will include forward-looking statements. Please refer to the forward-looking language included in our press release and MD&A.

I'd now like to turn the call over to Jeff.

Thanks, Tony. It's been good to see the copper market moving in a positive direction over the last few weeks and how Turquoise Hill's valuation has benefited alongside the upward movement in copper prices.

I think this also demonstrates how quickly copper price can move on potential supply constraints. We are even starting to hear $4 copper being discussed. This supports our long-term view that copper prices will not remain at current levels with the expected supply gaps anticipated to start around 2019 to 2020.

Recently, we were actively marketing to investors in June and July, and it was good to hear from them their positive sentiment on long-term copper prices as well.

During the second quarter, Oyu Tolgoi had an excellent safety performance, with an All Injury Frequency Rate of 0.27 per 200,000 hours worked. With the ongoing increase in the underground workforce, Oyu Tolgoi has done a fantastic job introducing new employees and contractors to our strong safety culture. Underground development continued to progress. Lateral development advanced at a good rate during the quarter and Shaft 5 saw its second-highest month of sinking progress in June.

Brendan will provide more detail on underground development later in the call. But we continue to expect production from first draw bell in mid-2020 and sustainable production in 2021. Commissioning of a new crusher is expected to be completed in August, allowing for full utilization of the third development crew. We expect lateral development to increase with the introduction of the third crew. Crews 4 and 5 are in training and should be deployed in the second half of the year.

For the first half of 2017, Oyu Tolgoi spent more than $320 million on underground development. Going forward, quarterly spend is expected to continue to increase. At the end of June, Oyu Tolgoi had further capital commitments of $1.1 billion beyond spend to date.

Lastly, open-pit operations continue to make the best of low grades and recovery challenges. The concentrator is on target to process 40 million tonnes this year, which will be a tremendous achievement and a first for Oyu Tolgoi. We expect gold grades and recovery to move up slightly in the second half of 2017. As such, we are maintaining our production guidance for the year. For 2017, Oyu Tolgoi's strategy is to focus on copper in order to maximize copper metal production, because copper share of revenue is over 80% when compared to gold.

Revenue in the second quarter decreased approximately 14% compared to Q1. For reference, first quarter revenue benefited from higher gold production in the latter part of the fourth quarter of 2016.

Operating cash flow for the second quarter was more than $50 million and almost $140 million for the first half of 2017, with Oyu Tolgoi benefiting from strong copper prices. That said, OT has worked extremely hard to control operating costs in order to deliver positive operating cash flow. I would note that since 2014, OT has removed over $200 million in operating costs.

I previously made comments about 2 numbers to remember for Oyu Tolgoi, which are 3 and 8: 3 years until production from the first draw bell and 8 years until significant free cash flow from Oyu Tolgoi.

Our definition of free cash flow includes principal and interest payments for project finance and supplemental debt. Based on feedback from investors, we have a very conservative definition of free cash flow. We are told that depending on how we structure long-term financing for OT, investors may not include principal repayments in their calculation of free cash flow. If that were the case, it would likely result in cash flows in less than 8 years. Another major factor in such a calculation would be the price of copper. For example, the price assumed for 2017 in the technical report for the reserve case showed $2.15 per pound. Today, we're at $2.80 per pound.

Overall, current operations are performing well despite the lower grades this year. 80% of Oyu Tolgoi's long-term value resides in the underground. From a near-term perspective, the most important value driver for Turquoise Hill is to deliver on the underground development timetable and production ramp-up schedule. This should enable good cash flow to Turquoise Hill and expected dividends to our shareholders. We are working closely with Rio Tinto to achieve these targets.

I'm very happy with the concentrator's performance history and what the team at Oyu Tolgoi has achieved.

With that, I'm going to turn the call over to Owen to discuss the financial aspects of the quarter.

Thank you, Jeff. Revenue for the quarter was $204 million, a decrease of approximately 14% over the first quarter of 2017, reflecting lower concentrate sales and lower copper prices. Average copper prices in the quarter decreased by about 3% from the first quarter, from $2.65 per pound to $2.57 per pound. Average gold prices for the quarter increased by about 3% from the first quarter, averaging $1,257 per ounce. Concentrates sold decreased approximately 4% over the first quarter.

Gross margin for the quarter was approximately 7%, down from 18% in the first quarter, driven by lower sales revenue. Cost of sales included an adjustment of $4 million for a reversal of provision against concentrate inventory, reflecting improved spot prices at the end of the quarter.

Finance costs of $41 million are presented net to the amounts capitalized on underground construction of $47 million. Income attributable to Turquoise Hill shareholders in the second quarter was $24 million.

Cash from operating activities of $51 million reflects the impact of lower sales. Interest paid of $107 million includes payment of project finance interest of $99 million. Payment of project finance interest takes place twice yearly, in June and December.

Capital expenditure on a cash basis was $205 million in the quarter compared with $148 million in the first quarter and includes $185 million for the underground project. Since January 1, 2016, the total amount spent on underground development is $548 million, with capital commitments of $1.1 billion at June 30.

Cash generated from investing activities of $35 million in the second quarter compared with cash used for investment activities of $83 million in the first quarter. The change reflects increases to amounts withdrawn from the related party receivable. The increased withdrawals were needed in order to fund the higher levels of underground capital expenditure in the quarter and the payment of project finance interest and due to the impact of lower operating cash flows on cash available for reinvestment.

The net realizable value of copper-gold stockpiles at the end of the quarter was $96 million, an increase of $15 million from the first quarter due primarily to reduced estimated conversion costs per tonne and increased estimated metal recoveries, both of which positively impacted the value of the medium-grade stockpile. A net reversal to the income statement of $14 million was consequently included within operating expenses for the quarter.

In the quarter, we increased the total deferred tax assets recognized from $339 million to $368 million. This was the main driver of an income statement credit for income and other taxes of $24 million. The increase primarily reflects additional Mongolian operating losses and interest charges incurred by Oyu Tolgoi in the second quarter of 2017.

At June 30, Turquoise Hills' cash balance remained consistent with previous periods at $1.4 billion. C1 costs in the quarter were $1.92 per pound compared to $1.85 per pound in the first quarter, mainly due to lower gold sales revenues in the second quarter.

That concludes my comments, and I'm going to turn the call over to Brendan.

Thanks, Owen. During the second quarter, the concentrator continued to process ore from Phase 6, 4A and stockpile. As noted during the first quarter results, Phase 6 is a challenging ore and complex blending is required to meet shipping specifications. Also, given the very low grades of gold expected in 2017, Oyu Tolgoi's objective this year has been to maximize copper production and the resulting revenue. We do this by using the highest copper grade available, which is currently Phase 6. Phase 6 also has another advantage of being a soft ore, enabling a higher throughput in the plant compared to ore from Phase 4 and significant portions of the stockpiles.

Oyu Tolgoi continues to perform well in managing this complex ore blending, where it's offsetting factors such as high arsenic and high pyrite levels, as discussed in the previous quarter. In the second half of 2017, we will continue to mine Phase 6 as an ore source as we move towards 2018 and return to a majority of the harder southwest ores of Phase 4. Phase 4 ore will contribute to a slight improvement in gold grades in the second half of 2017 and significantly higher gold grades in the second half of 2018.

Planned concentrator maintenance during the quarter was carried out successfully by an all-Mongolian management team without injury and encompassing over 20,000 hours through a temporary increased workforce of nearly 400 people. When taking this 5-day concentrator shutdown into account in the second quarter, the mill performed at a 40 million tonne per annum rate, with around 1/3 of the mill feed being the softer ore from Phase 6. This good plant performance is expected to continue through 2017 with the Phase 6 central zone ore. This also provides an indicator of performance when the Hugo North Lift 1 block cave eventually becomes a majority of the ore feed to the concentrator.

Moving to the underground. Overall, development continues to advance and the workforce has continued to grow, with over 8 million man hours worked on the project to date. Camp expansion works continued during the quarter, with increased deliveries of modular accommodation blocks ready to be installed. When fully complete, the new camp will be a world-class, large-scale accommodation facility, with more than 1,800 rooms, 18 buildings and catering for over 5,000 people.

Since the project restart in mid-2016, we've completed over 4 equivalent kilometers of lateral development. The second quarter featured 2 of the 3 best months of underground development since project restart, beating the previous best month in March 2017. During the quarter, important increased development enablers moved forward, including the mechanical completion of both the high-capacity dewatering system and a new larger underground development crusher. At the end of July, the crusher was in commissioning and is expected to be compete in August, allowing for the full utilization of a now deployed third crew. Development at the end of June was effectively carried out by only 2 crews. The fourth and fifth crews are expected to follow on later in the second half of this year, with training currently in progress.

During the second quarter, the Shaft 2 1,202 lighting level mass excavation works were completed and sinking activities recommenced towards the 1,256 level. The Shaft 2 1,202 [skip] lighting station design included mass excavation of approximately 80 meters wide, 34 meters long and 22 meters high. Shaft 2 will be a multipurpose production, service and primary intake ventilation shaft, moving up to 30,000 tonnes per day as well as people and equipment. It will be 10 meters in diameter, concrete lined and sunk to a depth of 1,284 meters. The 60-tonne production [skips] from 1,202 and the 150-person service cage, operating primarily to the main access level of 1,256, are designed for simultaneous hoisting of both ore and personnel. Sinking is expected to be complete in 2017, with the fit-out planned to occur over 2018.

Process improvement initiatives during the second quarter led to increased Shaft 5 sinking rates of around 40% compared to the first quarter. The better sinking rates over the last quarter are expected to continue going forward. Shaft 5 is expected to reach its final depth in early 2018. We continue to expect that the lateral development rate we are currently seeing will provide a buffer to the longer-than-expected sinking of Shaft 5. As such, we don't expect this to materially impact the lateral development plan.

In the coming quarters, we expect to see a step-up in lateral development, with July and August being targeted as the largest month since project restart.

Finally, we remain on target for production from the first draw point blast in mid-2020 and sustainable production in early 2021. That concludes my comments. I'll now turn it back to Jeff.

Thanks, Brendan. For the second quarter, open-pit operations performed as planned, with Oyu Tolgoi focusing on copper production in order to maximize revenue. We expect grades and recoveries to increase slightly in the second half of 2017, and we are maintaining our production guidance. The concentrators are on pace to have a record year. Underground development continues to advance, lateral development is progressing well and sinking rates for Shaft 5 have improved significantly. We maintain our expectation of underground production from the first draw bell in mid-2020 and sustainable production in 2021.

That concludes our prepared remarks. [LeeAnn], we are ready to take questions.

(Operator Instructions) And your first question is from Ian Grundy with Scotiabank.

Just a quick follow-up question on the interesting comment Jeff made there about free cash flow and principal repayments. What kind of quantum in the first few years of the ramp-up are you assuming for principal repayments on the debt in terms of that statement about free cash flow to shareholders?

So the terms of the agreement we have for the project finance have interest-only for the first 5 years. I think that gets us to mid-2021. It ramps up slowly, and then we end up having it all paid off by year 2027. So the first couple of years are low and then it ramps up to meet the total payment back by 2027.

Okay. That's very helpful. And then if the copper market does surprise favorably versus your expectations and if we did end up in closer to a $4 a pound environment, how would you think about using any excess cash flow you get over that time? Would it go to paying down project finance faster? Or would you think about repayments to shareholders or expansions? Just if you could give some color there too, that would be great.

$4 copper would be great for everybody. We have a fixed payment schedule currently. That would be an option to consider, to repay earlier. But one option considered today would probably be looking at any excess cash as a possible dividend earlier. But that would be a good position to be in at $4 copper.

(Operator Instructions) And I'm showing no further questions. I would now like to turn the call back to Jeff Tygesen for any further remarks.

Thank you for joining us today. Just a final comment. We continue to advance the underground and Oyu Tolgoi realizing its full potential.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program, and you may all disconnect. Everyone, have a great day.