Turquoise Hill Resources Ltd (TRQ) 2017 Q4 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Turquoise Hill Resources Q4 and Full Year 2017 Financial Results Conference Call. (Operator Instructions) As a reminder, today's conference is being recorded.

I would like to introduce your host for today's conference call, Mr. Tony Shaffer. You may begin, sir.

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

With me today is our CEO, Jeff Tygesen; Luke Colton, our CFO; and Brendan Lane, Vice President of Operations and Development. We'll take your questions at the conclusion of our prepared remarks. 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. 2017, a year characterized by underground development progress and record-setting open-pit performance. The year was a major step forward in advancing value for our shareholders. I was quite pleased with where we ended 2017, and I think have entered 2018 in a good position. We continue to expect first draw bell mid-2020 and first sustainable production in early 2021.

Another highlight for Oyu Tolgoi during 2017 was their safety performance, which has been gratifying to see as the workforce matures, entering their sixth full year of operations, leading the industry in safety performance. Safety is the cornerstone of Oyu Tolgoi's culture and it shows.

During 2017, the major components of the underground project were lateral development and work on Shafts 2 and 5. For the year, we completed just over 6 equivalent kilometers of lateral development, which was in line with expectations in the technical report. Since project restart in 2016, we have completed a total of 7.7 equivalent kilometers of lateral development. In the MD&A, we have provided a breakdown of lateral development and mass excavation, which we will include going forward.

The sinking of Shaft 2 was completed in January and 2018 will be devoted to fit-out of the shaft. This includes installation of steel guides, given the shaft is more than 4,200 feet deep. This is a significant amount of work to place guides approximately every 3 meters. The completion of Shaft 2 is critical to increases in lateral development, which is expected to begin in 2019. Shaft 5 had approximately 100 meters remaining at the end of 2017, and sinking is expected to be complete in late March. The team has already commenced installation of exhaust fans, which is expected to be complete in early second quarter, which will allow an increase in development meters.

Development momentum is good, and I am confident we will continue to make good advancement in 2018. For 2017, cash basis underground expansion spend was about $835 million, which was at the lower end of our guidance. Since notice to proceed, cumulative project expansion spend has been approximately $1.1 billion, which is about $0.4 billion under tech report projections. In addition, Oyu Tolgoi had further capital commitments of $1.2 billion at the end of 2017.

For 2018, we are expecting approximately 10 kilometers of lateral development, an underground spend of $1.1 billion to $1.2 billion. Brendan will cover underground development in more detail later in the call.

During the fourth quarter, Rio Tinto undertook their schedule and cost review, concluding there were no material changes to project's scope, schedule or cost.

Moving to open-pit operations. 2017 was also a strong year for open-pit operations. Despite the grade challenges that we have been talking about for some time, material mined and concentrator's throughput set records for the year. The concentrator benefited from a softer Phase 6 ore, and it was the second year in a row that concentrator exceeded nameplate capacity.

We met production guidance, and Oyu Tolgoi generated more than $325 million in operating cash flow. For reference, we went into 2017 anticipating neutral operating cash flow and benefited from stronger copper prices. Regardless, the outcome is a real testament to the Oyu Tolgoi workforce. Since 2014, the mine has generated more than $2 billion of operating cash flow. Oyu Tolgoi has been working for quite a while to optimize the open-pit mine plan in order to bring cash flow forward. We have been talking for some time about splitting Phase 4, which contains higher gold grades.

With our 2018 guidance release, we said we are bringing approximately 100,000 ounces of gold into 2018. To be clear, it's not additional gold but taking production from future years. The result is advanced gold production and related cash flow by about 6 months sooner than the original mine plan. Because of processing harder Phase 4 ore in 2018, we expect throughput to be about 37 million tonnes.

In February, we announced the Government of Mongolia had canceled the Power Sector Cooperation Agreement, which results in the restart of the 4-year time frame for Oyu Tolgoi to source power domestically. There has been a lot of market discussion about the announcement, but we are of the view it is a net positive for Oyu Tolgoi because it puts the issue of power within Oyu Tolgoi's control. For reference, in 2013, Oyu Tolgoi was headed down the path of building its own in-country power source, but those plans were put on hold to work with the government to look at other options in the SouthGobi region.

From a cash flow perspective, the technical report model assumes approximately $0.12 per kilowatt hour, which includes a capital component. By building our own power plant, the costs are expected to be about $0.05 per kilowatt hour but we will have to invest the upfront capital. Oyu Tolgoi is busily evaluating the various options, and I would expect the final decision in the latter part of this year.

All told, 2017 was a good year. Open-pit operations performed well, and the underground development is advancing towards first draw bell in mid-2020. From a valuation standpoint, I don't think the market prices are expansion progress, proximity expected to first draw bell or Oyu Tolgoi's cash flow generation potential. At $3 copper and $1,300 gold, by no means aggressive assumptions, Oyu Tolgoi is expected to generate approximately $9.5 billion in free cash flow from 2022 to 2026. Expected first draw bell is just a little over 2 years away. At some point, the market has to start pricing us in and our current valuation should be a thing of the past. Oyu Tolgoi is a true world-class asset, and we are full steam ahead toward underground production.

With that, I'm going to turn the call over to Luke to discuss the financial highlights.

Thanks, Jeff, and hello to everyone on the call. Moving right into our financial results. Revenue year-on-year was down approximately 22%. That's primarily due to lower gold sales volumes, driven by decreased gold grades compared to 2016. Copper revenue was slightly higher due to an increase in copper pricing, which is partially offset by decreased sales volumes as a result of lower copper grades compared with 2016.

During 2017, average copper prices increased by about 27% from $2.20 per pound to $2.80 per pound compared with 2016, with a strong finish at the end of the year at $3.27 per pound. Higher gold prices, averaging $1,257 per ounce compared with $1,219 per ounce, also partially offset the impact from lower sales volumes. Concentrate sold in copper and concentrate decreased 13% and 21%, respectively, compared with 2016, impacted by the lower grades. Gold in concentrate produced of 114,000 ounces was down 62% year-on-year but is expected to more than double in 2018, with guidance set between 240,000 and 280,000 ounces as a result of mine planned optimization, allowing production to be brought forward from future years, as Jeff explained.

Gross margin for the year was 19% compared with 28% in 2016. The decrease was the result of the lower sales revenue. Cost of sales included an adjustment of $9 million in 2017 for a reversal of provision against concentrate inventory, reflecting improved spot prices at the end of 2017. Finance costs of $153 million or net of amounts capitalized on the underground construction of about $200 million.

Income attributable to Turquoise Hill's shareholders in 2017 was $181 million. Cash flow from operating activities in 2017 was $326 million compared to $399 million in 2016, primarily reflecting lower sales volumes for copper and gold.

Capital expenditure on a cash basis was $918 million for the year compared with $326 million in 2016. And this, of course, includes $836 million for the underground project, in line with guidance. Since the 1st of January, 2016, the total amount spent on underground development is $1.1 billion and we've got capital commitments of $1.2 billion at December 31, 2017. 2018 guidance for underground capital expenditure is between $1.1 billion and $1.2 billion.

The net realizable value of copper-gold stockpiles at the end of the year was $99 million, which is an increase of $38 million compared to the end of 2016. The increase in the stockpile net realizable value compared to the prior year was primarily driven by the addition of higher copper grades stockpiled ore from Phase 6 during the final quarter of 2017, combined with an improved short- to medium-term price outlook that positively impacted the value of the remaining medium-grade stockpile. A net reversal to the income statement of $7 million was consequently included within operating expenses for the year, and this includes a $2 million charge related to the materials and supplies provision.

During 2017, Turquoise Hill increased the total deferred tax asset recognized from $296 million to $474 million, which contributed to a net income statement credit of $154 million for taxes in 2017. The movement in the deferred tax assets primarily reflects additional Mongolian operating losses and interest charges incurred by Oyu Tolgoi during 2017, improved long-term commodity price projections and updated technical and operating assumptions during the year.

At December 31, 2017, Turquoise Hill's cash balance remained at about $1.4 billion, which is consistent with 2016. Total 2017 operating cash costs at OT were $712 million, beating our guidance of $720 million. The lower operating cash cost in 2017 compared to the $775 million in 2016 reflects mining and production efficiency improvements, benefits from cost-reduction programs and reduced royalty expense due to the lower revenue. This is partially offset by higher open-pit material mined and concentrated throughput in 2017 compared to 2016. For 2018, we expect operating cash cost of approximately $700 million.

C1 costs for the year were $1.92 per pound compared to $1.02 per pound in 2016. C1 costs in 2017 were impacted primarily by the lower gold sales. All-in sustaining costs for 2017 were $2.39 per pound compared to $1.48 per pound in 2016, again, because of the lower gold revenues.

This concludes my comments. And I'll turn the call over to Brendan.

Thanks, Luke. The operational and development success we saw with Oyu Tolgoi in 2017 was particularly pleasing. Notably, Oyu Tolgoi received and Rio Tinto CEO Award for excellence in safety, set production records in mill throughput and material mined, while simultaneously continuing the ramp up of the underground project and adding over 6,500 new workers to the operation. These are clear indicators of an engaged and dedicated workforce with the right culture, and it provides a strong sign for the delivery of the future underground operation as planned.

Safe operations are quite often a sign of productive and efficient operations, with safety and productivity working hand-in-hand. This is the case for Oyu Tolgoi as the safety performance has been delivered along with productivity achievements. 2017 was Oyu Tolgoi's best year yet in terms of operational performance. The mine achieved the highest truck utilization to date and set mine records, including over 41 million tonnes milled and 106 million tonnes of the total material mined from the open pit. The mining rate was delivered by ongoing high equipment availability and utilization, where these improvements in equipment productivity were supported by further improvements in mine planning. Ultimately, copper and gold production was in line with guidance despite significant grade and metallurgical challenges throughout the year. As we've previously discussed, in 2018, we will see a return to significantly higher grades of gold in the second half of the year and less challenging metallurgy. However, this will come with an increase in ore hardness and lower expected mill throughput. Additionally, during the first quarter of 2018, the mill undertook planned maintenance and a second outage is planned for later this year.

We will continue to mine some Phase 6 ore during 2018 before we move towards our majority of the harder, higher-gold southwest ore from Phase 4A. The operations team will continue to look for ways to optimize mill throughput, importantly, by maintaining improvements already made to date. They'll also look for further improvements in mill throughput by continued debottlenecking projects, such as in the crushing and conveying system's reliability and capacity. Additionally, in the mine, projects such as controlled high-intensity blasting are being trialed in an effort to maximize throughput, and we hope to see benefits from all these initiatives over 2018.

Moving to the underground, overall development continues to advance and the workforce has continued to grow, with over 6,500 people currently working on the project. Since underground restart in 2016, the project has excavated over 30,000 cubic meters and constructed over 6.3 kilometers of additional tunnels for an on-plan total of approximately 7.7 equivalent development kilometers. December 2017 saw a record 850 equivalent meters developed underground, which was exceeded again in January this year.

In the second half of 2017, crushing and hoisting exceeded expectations, with the Shaft 1 jaw crusher consistently operating above the 3,500 tonnes per day nameplate capacity. Shaft fit out and equipping work progressed during the last quarter. In particular, Shaft 2 hoist equipment positioning achieved significant progress during the last part of 2017, and the installation of Shaft 5's ventilation fans commenced before year-end.

In the second half of 2017, the project team also undertook the first annual cost and schedule review based on approximately 12 months of project execution data. The Oyu Tolgoi project team, based on the [service side] review, found no material change in cost expectations, overall schedule or scope of activities.

The highlights for 2018. Some key activities that will be taking place will include: an increased focus on underground risk to achieve the next level in safety performance; completion of Shaft 5's sinking and ventilation system; Shaft 2 stripping, fit out, equipping as well as construction of associated infrastructure; completion of approximately 10 kilometers of lateral development and additional mass excavation; continued implementation of mining optimization systems to drive performance and productivity improvements; expansion of the central heating plant, fans and mine dry; and preparation by the project team will begin for business integration and handover to operations. Of these key activities, work around Shafts 2 and 5 are important enablers of increased underground development activity, in terms of both equipment and people, and support the next step-ups in mining development. The commissioning of Shaft 5 ventilation is expected early in the second quarter, following sinking completion this month. This will enable more equipment and personnel to operate underground with increased airflow. Shaft 2 and associated infrastructure will increase crushing, hoisting and logistics capacity, and the fit out will be the largest combined activity in 2018. It will require coordinated delivery of a number of integrated packages and eventually a complex commissioning project. Some of those interrelated packages are: the surface facilities, including structural, mechanical and piping construction; electrical and instrumentation installation; continued headframe fit out; service and production hoist installations; underground structural mechanical and piping construction; the underground ore bin installation; and a new material handling system, with an additional 6,000 tonnes per day development crusher.

Finally, we remain on target for the first drill point blast in mid-2020 and sustainable production in early 2021.

That concludes my comments, and I'll now turn it back over to Jeff.

Thanks, Brendan. To summarize 2017, open-pit operations set a number of records and generated more than $325 million of operating cash flow. Underground development continues to advance, lateral development is progressing well and sinking of Shaft 2 was completed in January 2018 and sinking of Shaft 5 should be finished in the first quarter. We maintain our expectation for first draw bell mid-2020 and first sustainable production in early 2021.

That concludes our remarks, and Kevin, we are ready to take questions.

(Operator Instructions) Our first question comes from Orest Wowkodaw with Scotiabank.

I was hoping to get some more color on the study that Rio Tinto did with respect to the project. You stated that there was no material change to the scope, schedule and cost of the project, but can you please define what that -- what they mean by material? Is it material to Rio Tinto? Or what is the threshold of materiality that's been used to characterize the study review?

Orest, thanks for your question. This is Jeff. The basis of that review, as Brendan mentioned, was through the first 12 or 13 months of the project, which would've been approximately about 10%. And through that period, the plan as far as schedule and cost and scope were considered equivalent to the feasibility study. This year, there'll be another review, and followed by another review next time -- or next year as well. But all indications from everything that I've seen and where we're at to date, I would still say the feasibility study is on track.

And can you give us any more detail on that? Like, with respect to the capital, are we talking it's within 5% or 10% of plan? Or what's the threshold on the materiality?

The original project had a contingency of about 13%, 15%, overall, in that range. There was also a contingency for schedule as well, and we're within those. So our -- my target is 5.3%. Now there's still remaining project to finish, but I think it's well within the range of our order estimate.

Okay. And is it fair to say that Turquoise Hill was not involved in the completion of that study?

It was a study undertaken by Rio Tinto, of which we're provided information on the results. But were we directly involved in the review? No.

Okay. Is that something that will change moving forward with respect to direct involvement in the review moving forward?

I am requesting to have Turquoise Hill participation in the next round for this year. All expectations that I have is we will participate in that review.

Okay. And so is it reasonable to expect that this will now be an annual process?

Well, Rio, on major projects internally, does an annual review. So yes, this will continue through at least through 2021. I'm not saying through 2022, but through 2021. Now the scope will get a lot less because a big portion of the CapEx spend is more in the upfront, later on it'll be part of the concentrator and the installation of the decline conveyor. So the range will get less as we finish Shafts 5, Shafts 2, when we finish the decline. A lot of the surface facility is done, excluding the concentrator. So the scope will just get smaller. But this year, it will be a big year for that review.

The next question comes from Matt Murphy with Macquarie.

Jeff, I had a question about the outcome of your meeting with the SailingStone that the board responded to with a letter on Wednesday. That letter says TRQ will consider sensible enhancements to governance. I'm just wondering what is meant by that? And is there a formal process underway to address that?

Matt, thanks for your question. The meeting was held this -- what week is it? This past week with SailingStone, and it was the minority shareholder -- or minority -- the independent board members met with them, management was not part of that. And all indications are there is follow up planned is what information I have.

And do you think we'll get more disclosure on that going forward?

That's my understanding that there's further discussions planned, and they're working towards meeting some of those requests.

Our next question comes from Craig Hutchison with TD Securities.

Just on Q1 shipments for your concentrates, there was the blockade and then the restarted force majeure, et cetera. Can you give us a sense of how much material you'll actually ship in Q1?

Craig, what I can say -- I don't have a firm number on the shipments, but the mine was not impacted by -- it was just -- to go back, it was a coal blockade of coal trucks on the Chinese side that had an issue with a new Mongolian tax for a social insurance. Once that was socialized and explained, those guys freed the blockade and we were back to regular shipments, and that's why we lifted the force majeure. But all expectations are we're going to hit our production guidance because, like I said, the operation was not impacted.

Okay. So now you can give us a sense whether it's, like, 50% of shipments actually made it through during the quarter or...?

I don't have that number in front of me, but there's -- everything is -- indication is we're going to meet our production guidance.

And in terms of the power plant, I know you guys are going to come up with a study by year-end, but can you give us a sense of the capital you're looking for that? And whether you guys feel like you can finance that internally based on your existing liquidity and cash position, et cetera, or whether you need to go in and sort of tap that remaining, I guess, $1.5 billion for OT.

So the -- in February, we received a notice on the PSCA that the government wanted to cancel that portion of that agreement, which included a power plant by a third party at Tavan Tolgoi. As I mentioned in my remarks, OT had started engineering and planning in 2012, 2013 to build an on-site power plant. We have a space located. We have water and land, 2 key components to construct it. They are going down the permitting process. The estimate that we still have at -- based on the earlier information, and the engineering is going on right now, is about that $1 billion mark.

With respect to financing, what I've said over the last several years is we have the $4.4 billion of project finance. We're planning to get the other $1.6 billion in supplemental debt. Currently, as Luke mentioned, we have $1.4 billion in cash. And the open pit is generating -- or has been, and if you project that $250 million to $300 million, you could -- if everything holds together by 2022, we have sufficient money with all of those combined.

Okay. And when do you think you'd break ground on the power plant? Like, 2020?

Oh, no. We're -- we have to have it up and running by February 2022. So the target is to have -- there's going to be a very quick review at all the options. I think one of them is going to rise to the top very quickly only because we've done the most amount of work, which is on site. They're looking at configurations because there's been improved efficiencies in plant designs as far as boiler efficiencies. So the build-on-site is probably leading, but I can't say that firmly. They will start engineering and permitting later this year, and the goal would be to build through '19, '20 and '21.

(Operator Instructions) Our next question comes from Oscar Cabrera with CIBC.

Oscar, is it -- it's coming through very low. Is there a possibility -- we're turning it up, but it was not coming through well. Let's try it again.

Yes, can you hear me now?

We can. Yes, the Verizon commercial is working.

Perfect. Although in Canada, we don't have that luxury. Yes, just -- I know it's early, but getting back into the power plant questions, in your trade-off studies, have you estimated how much you could save a year in power, starting after the plant runs out?

Meaning power costs?

Well, if you're spending 25% of the total cost in a given year and that cost were $150 million, would you be saving 40%,50%?

Our early estimates is -- in the tech report, we've assumed about $0.12 a kilowatt hour, which -- a component of that, if you look at it, where we're buying power from China includes a capital component. Our estimates with our own power plant, including fuel, is about $0.05 a kilowatt. So we'll put in the capital and operating costs will then be lowered from roughly $0.12 to around $0.05. Currently, with the current agreement we have with Inner Mongolia Power, it's about $0.11. So it's still in that $0.11 or $0.12. So it's just a trading off in time of put the capital in, then we have a lower operating cost to pay back that capital. Early indication, very high level, that might generate somewhere around the 10% return. But not fixed, depending on fuel component.

Right. Okay. No, this is helpful, Jeff. Now the other thing too is, like, you talk about options, so I was under the impression that the plant would be built right next to the project. Are you thinking about still an option where you could build a higher-capacity plant so that you can sell power to other [mines]?

No, no. What I meant by is the normal course is because the earlier engineering that had been done looked at one configuration. Since 2012, the study team has found that there is more efficient boilers and as far as -- and turbines. So they're looking at those, the features inside. Not necessarily -- we're not going to be in the power business to export power, we're just looking to cover the OT requirements.

Right. And -- okay. So, that's helpful, Jeff. Just in terms of the gold production, I know that you're bringing production forward from the open pit, but what sort of level should we expect the project to be producing at for 2019 and '20?

We haven't finalized that yet. There is the production profile in the tech report. And upon average, again, not to the ounce, but we're moving about 50,000 ounces forward each year from '19 and '20. So you could go through and lower those bars in '19 and '20, but we'll come out with that later this year. And I'll tell you the reason why I don't have an exact answer. It's a function of how fast is the stripping going to be in the B part and that hitting the ore zone, and that's the part that they're working on to see how the performance is on that waste stripping in 4B.

Our next question comes from Dalton Baretto with Canaccord Genuity.

There seems to be a little bit of a shift in the dynamics of the relationship between Oyu Tolgoi and the Mongolian government just given recent news flow. Can you talk a little bit about that? Where that stands right now? And then just you guys as a -- as a Turquoise Hill management team, how much involvement do you have in these discussions?

Thanks for the question, Dalton. I don't know if I can speak for the Mongolian side, but what I would want to first qualify is this government that we're currently talking to has been in power since September of last year, so fairly new. And on average, a prime minister and his ministers and cabinet is about 2 years. So every time there is a new group managing or governing Mongolia, there's a intense period of ramping up the understanding of Oyu Tolgoi, and it takes a long time because it's a fairly big project. I think we're making lots of progress. Recently, it was mentioned in the press that the JS went to Mongolia earlier this year, met with the Prime Minister, had some discussions. They're establishing a working group to make sure both sides understand what the project is about, which I think is a good thing, just having the open dialogue. I think from my -- and this -- I'm only speaking for myself, I think when statements are made, it's more based on a lack of understanding and that's the gaps that we try to fill when those are identified. So I wouldn't say it's strained by any means. I would say that there are political statements made, which I think are different than a government policy or approach. I think, as we've stated multiple times, Oyu -- or Mongolia is a big beneficiary of having OT. Some of the stats are 90% of the workforce are Mongolian. Since 2010, we paid $1.7 billion in taxes. #1 corporate tax payer in 2015, 2016. $7.2 billion spent in salaries and local supplies, $2.2 billion on procurement and national businesses. In the SouthGobi, we've spent and invested more than $25 million in sustainable projects. So from my standpoint, we are committed to Mongolia and the local area. So I think it's -- like any new relationship, there's -- you need to get to know each other, and I think that's the path we're headed down.

Okay. And I guess it's fair to say that it's Rio that's managing that conversation.

No. Well, there's parts from the government, there's representatives from Rio and there'll be representatives from Turquoise Hill.

Okay. And then just maybe switching gears a little bit. You mentioned that you guys weren't involved in the actual project review, can you comment at all in terms of what the current thinking is around any sort of expansion scenario?

You mean expansion beyond the base plan?

Correct.

That isn't being considered at this point by the project team. The project team has been given a specific scope to build. There are -- I can say there are other groups looking at the options beyond getting Lift 1 completed. But the focus and everybody's attention is pretty much for the most part on getting Lift 1 because that's what generates the biggest value at this point.

Okay. So a decision on even a small expansion isn't imminent?

Like I said, there's thinking that's going on, but if we don't get the first step, we can't get to the second step. But as we meet the milestones on this phase of the project, then resources could be looked at as far as what are other options. But it'll take 5 to 7 years to go from 0 tonnes in the underground to full production. So there's a fair amount of time in that ramp up.

Okay. I was thinking more in terms of a mill expansion, but okay.

The -- there is a mill component of this phase, which is adding a fifth ball mill for a finer grind to get the recovery of the higher-grade material, and then the back end of the plant for the flotation cells to recover all that metal. On average, it's going to be 4.5 to 5x in the initial part of what we're getting now. So that's part of the -- of this phase of the project.

Ladies and gentlemen, this concludes the Q&A portion of today's conference. I'd like to turn the call back over to our host.

Thanks, Kevin. For all of those who joined in the call today, thank you for joining us. Just a comment -- final comment I'd like to make is we advanced the underground production and Oyu Tolgoi realizing its full potential.

Ladies and gentlemen, this concludes today's presentation. You may now disconnect, and have a wonderful day.