Sherritt International Corporation (OTCPK:SHERF) Q2 2022 Results Conference Call July 28, 2022 10:00 AM ET
Company Participants
Mark Preston – Investor Relations
Leon Binedell – Chief Executive Officer
Yasmin Gabriel – Chief Financial Officer
Operator
Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Sherritt International Second Quarter 2022 Results Conference Call and Webcast. At this time, all participants are in a listen-only mode. I would like to remind everyone that this conference call is being recorded today, Thursday, July 28, 2022, at 10:00 a.m. Eastern Standard Time.
I will now turn the presentation over to Mark Preston, Investor Relations analyst. Please go ahead, sir.
Mark Preston
Good morning. Thank you, operator, and thank you, everybody, for joining us today. Before we begin, I just want to make — mention of a couple of items. As you know, we released our Q2 results last night and all of our disclosure materials, including the press release, MD&A, financial statements, et cetera, are all on our website and on SEDAR.
As is customary, during today’s call and webcast, we’ll be using a presentation that is available on our website in the Investor Relations section. As well, we will Be make forward-looking statements and reference — making reference to certain non-GAAP financial measures. Non-GAAP measures and the reconciliations to the most comparable IFRS measures are included in the appendix to the presentation. Forward-looking statements and disclosures relating to such items are found on Slide 3 of our presentation.
With me today are Sherritt’s CEO, Leon Binedell; and CFO, Yasmin Gabriel, who will be reviewing our results in detail. Following their discussions, we will open the call for questions.
Please go ahead, Leon.
Leon Binedell
Thank you, Mark. Good morning, everyone, and thank you for joining us today. Our second quarter was again an active one. We had strong operating results, made progress towards deleveraging our balance sheet and continue to make progress on our expansion project. Most notably, we bought back almost $60 million of our publicly traded bonds at a discount, the first time in over a decade, we used operating cash flows to make a significant debt repurchase.
We had our third straight quarter of net earnings and strong adjusted EBITDA. We had our lowest net direct cash cost, or NDCC, since Q3 2018, driven by strong fertilizer and cobalt byproduct credits, and we continue to make progress on our expansion projects. I will be providing an update on our operations and expansion project, and Yasmin will be covering the commentary on our financial highlights, and then I will conclude with our near-term outlook before we address questions.
Taking a look at the Moa Joint Venture operations on Slide 6, if you’re following along. As we disclosed last quarter, the annual refinery plant maintenance shutdown for this year was scheduled for the second quarter, while last year, it was delayed into the third quarter due to the impact of the COVID pandemic. This was the main driver of lower production in the current quarter over the prior year for both nickel and cobalt.
As a result, our finished nickel and cobalt production in Q2 ’22 was down 12% and 17%, respectively, from last year’s quarter. All production is back at full capacity. Outside of the impact of this shutdown, production was largely in line with expectations this quarter, and we expect production in the second half of the year to exceed the first as we trend towards our guidance.
Our mixed sulfide production at Moa was not affected by the refinery shutdown and production was largely consistent with the prior year quarter. You would have noted that our percentage reduction in cobalt production in Q2 is slightly higher than that of nickel. This is primarily because nickel and cobalt ratios in ore we are currently mining is higher than that in recent past. If this trend continues, as we expected for the remainder of the year, finished cobalt production for the year is estimated to be at the lower end of the 3,400 to 3,700 tonne guidance range.
More impact for this quarter, as outlined on Slide 7 was the near term impact of our ability to sell our production into the market. As noted on the slide, sales volumes came in well below production volumes. While we have not seen a shift in our customer base, logistics-related challenges in transporting finished product to customers and the deferral of orders by certain customers that were negatively impacted by the slowdown of economic activity in China as a result of the country’s zero COVID policies and the related supply chain bottlenecks we’ve created, coupled with recent global economic headwinds have resulted in lower sales volumes and higher inventory levels than planned in the quarter.
We continue to work with our customers to facilitate their delivery challenges and have been able to partially offset the reduced volumes with higher netback sales to other markets than sales to new customers. A portion of the new customer contracts were finalized after the quarter end, and we continue to focus on reducing inventory levels to more typical levels during the second half of the year and anticipate that the impact of delayed sales will be resolved in the second half.
Turning to production costs. As you can see from Slide 8, higher mining, processing and refinery, or MPR, costs were primarily driven by higher input commodity costs as seen across our industry, of which the magnitude is outlined on the slide. However, these were more than offset by the higher fertilizer and cobalt byproduct credits during the quarter. These byproduct credits were instrumental in reducing our NDCC to $2.19 per pound, our lowest since Q3 2018 and the second running quarter in the lowest cost quartile of all nickel producers according to data maintained by Wood Mac.
During the quarter, which is generally our best quarter for fertilizer sales, our fertilizer realized prices increased by 167% compared to the prior year quarter. Fertilizer prices saw an unprecedented increase as a result of reduced supply out of Russia, a major supplier of fertilizers as a result of sanctions, high natural gas prices, transportation and logistics disruptions and strengthened demand as a result of high crop prices ahead of the spring planting season. While we expect fertilizer prices to remain robust for the fall season, we do not expect them to remain at the Q2 levels.
For Sherritt, the fall season volume is typically around 20% lower than the spring season. So the fertilizer byproduct credits in the second half of the year will not have as significant an impact on our NDCC in Q3 and 4 as — and these are reflected in our estimates.
Looking forward, with continued high input commodity prices prevailing in the near term and expected lower fertilizer byproduct credits, coupled with lower cobalt byproduct credits, we still expect to remain within our guidance range of $4 to $4.50 per pound, albeit at the higher end of the range. We continue to make good progress on our Moa expansion projects as outlined on Slide 9.
Just to remind everyone, our expansion program is targeting to increase annual nickel and cobalt production by 15% to 20% of our performance of 2021. This would represent an increase in annual nickel production of approximately 5,000 to 6,000 tonnes. For Phase 1, the construction of the slurry preparation plant is continuing with 50% of civil construction complete. 80% of the contracts for supply of materials and services were awarded, and the slurry pipeline design was completed and all materials related to it ordered.
Our early focus has been to complete engineering and ensure supply of materials and services for a smooth project execution process. The structural steel has arrived at site and prefabrication will commence in Q3 with field assembly in the latter half of Q4. This phase of project remains on budget, estimated at $27 million on a 100% basis and remains on schedule for completion in early 2024. And with most of the materials ordered and contracts led for this phase of the expansion, our cost risk is greatly reduced.
With regards to the Moa processing plant expansion scope, we completed the feasibility study for the leach plant 6 train at Moa and confirmed previously installed equipment is in an acceptable condition for use. This is an extremely important to the project as it enables us to leverage previously installed infrastructure in reducing both cost and time lines. We are also continuing engineering on the asset plant to ensure compatibility with the increased production needs. At Moa and the refinery in Fort Saskatchewan, we continue to assess existing process capacities and develop the plant for implementing a wide range of debottlenecking strategies to both make existing production more efficient and accommodate additional throughput.
Regarding the reserves review and adopting of an economic cut-off grade, we remain on track to complete this work and issue a revised reserve and resource report and a 43-101 compliant technical report by the end of the year. Work to date is encouraging that we will be able to extend the life of mine at Moa to beyond 2040.
As we have previously discussed, our focus is on identifying and implementing low capital intensity and high-return investment strategies. Recent inflationary pressures on construction materials, equipment and labor costs and continuing logistics issues primarily related to COVID-19 have put pressure on our estimates. While our most recent assessment for these projects remain in the prior indicated capital range, albeit at the high end of $25,000 per ton of nickel capacity added, we are still assessing the impacts mentioned on our final cost estimates.
We are working towards an investment commitment in the second half of the year with our partners and will disclose our planned project phasing at that time. We remain focused on capital discipline and will therefore make investment decisions that reflect this discipline and would be determined or would determine the appropriate scope and phasing of the expansion later this year once all the required assessments have been completed.
The benefits of the nature of this brownfield expansion leans itself to the optionality around the scope and phasing of implementation. As was demonstrated with our commitment to proceed with the SPP late last year, while additional work was being conducted on the remaining scope to derisk the projects.
For example, the refinery debottlenecking scope involves seven distinct scopes of work, which could be done as a single project to deliver the targeted capacity or could be pursued independently for small incremental increases in volumes. We have not changed our planned growth spending on capital for 2022 as it relates to construction associated with the SPP and engineering work on the remaining scopes, and we remain on track as per guidance disclosed in Q1.
We are progressing on plan with our expansion program. In the second half of the year, we expect to achieve the milestones outlined on Slide 10. Continue with the steel fabrication assembly on the SPP as mentioned, complete basic engineering and acid plant capacity testing at Moa, continue the debottlenecking reviews in basic engineering of the refinery and determine the scope and phasing of the next phase of expansion aligned with our disciplined capital approach and provide full details of the complete project scope and cost estimates, complete the new life of mine plan and release an updated 43-101 compliant technical report.
Turning to our Power division on Slide 11. We produced a 133 gigawatt hours of electricity in Q2 ’22, up 16% from last year when we produced 115 gigawatt hours. This increase was primarily a result of timing of maintenance activities. Maintenance activities were higher in Q2 last year and this year are skewed towards the second half of the year. As a result of higher production in the quarter, operating costs were $20.10 per megawatt hour, down 4% from $21.03 per megawatt hour in Q2 last year. We remain on track for full year guidance for both production and costs.
We continue discussion with our Cuban partners regarding increasing the availability of natural gas needed to increase power production as these facilities remain underutilized. Government approvals continue towards finalization of the extension of the power generation agreement with Energas, which is currently slated to expire in March ’23. The required feasibility study was submitted to the Cuban government in Q1 of this year and has been approved by eight out of nine impacted ministries to date. We still anticipate a final decision on extending the power generation agreement from Cuba’s Executive Counsel before the end of the year.
That concludes my remarks on the operational performance and our metals expansion projects. I’ll now turn the call over to Yasmin to review our financial results.
Yasmin Gabriel
Thanks, Leon, and good morning, everyone. As Leon mentioned earlier, and most of you are aware, we successfully completed and offered to repurchase debt this quarter, reducing the aggregate principal amount of notes outstanding by almost $60 million for $45 million in cash, utilizing our strong operating cash flow at a total discount of 24%. With this repurchase, we recognized a $13.8 million gain and we’ll be reducing our annual interest expense by approximately $5.5 million. $3.5 million of which relates to our second lien notes and which is paid semiannually. Deleveraging the balance sheet remains a key strategic priority for Sherritt, and we will continue to pursue opportunities to further reduce our debt.
Turning now to our key financial metrics on Slide 14, adjusted EBITDA and net earnings. You can see on this slide, both were significantly higher in Q2 2022 compared to our results from last year. And this is also the case on a year-to-date basis. In fact, both of these metrics represent our highest for a quarter since 2012. These results were driven by higher realized nickel, cobalt and fertilizer prices, which more than offset the lower production sales volumes and higher input commodity prices at our Moa Joint Venture. One thing to note is that the current adjusted EBITDA of $102 million and net earnings of $81.5 million includes a $17 million share-based compensation recovery. This was driven by the reduction in our share price, reversing most of the $27 million expense you would have seen in Q1 of this year.
If we exclude the impact of share-based compensation, we generated $85 million of adjusted EBITDA this quarter, $92 million of which is from our Moa Joint Venture and Fort Site operations, which is exceptional. I’d also like to highlight that our net earnings includes the $13.8 million gain on the repurchase of the notes I mentioned earlier.
In addition, we remain focused on reducing our overall costs. Excluding the impact of share-based compensation expense or full recovery from each period, administrative expenses decreased by 30% this quarter compared to the same quarter in the prior year and similarly on a year-to-date basis. Management continues to look for opportunities to further reduce costs.
Slide 15 illustrates the recent distribution history of amounts received by Sherritt from the Moa Joint Venture since the start of 2019. During the quarter, we received $15 million or CAD 19.2 million as our share of distributions from the Moa Joint Venture, primarily as a result of improved nickel and cobalt prices. Year-to-date total distributions from the Moa Joint Venture were $34 million or CAD 43.4 million, which exceeds the total amount of distributions received in each of the prior three years. Despite the economic headwinds heading into Q3, we continue to expect distributions to be higher in the second half of the year than the first half with higher expected nickel sales volume as we noted earlier.
Now as a reminder, the amount of dividends to be distributed to the joint venture partners is determined by the Moa Joint Venture board based on a number of factors, including available cash, anticipated nickel and cobalt prices, planned capital spend, working capital needs and other expected liquidity requirements.
Turning now to our liquidity position on Slide 16. At the end of Q2, our total liquidity was $216 million, and that was down from $237 million at the start of the quarter. As I mentioned earlier, we had strong operating cash flow with fertilizer receipts and distributions from our Moa Joint Venture, and we utilized this operating cash flow to repurchase our notes for $44.8 million. In addition, in April, we paid our semiannual interest payment on our second lien notes of $15 million. During the coming quarters, we expect to build our cash in Canada balance through the continued strong distributions from the Moa Joint Venture I mentioned earlier.
We also continue to have regular discussions with our Cuban partners to accelerate collections of our overdue receivables. As we’ve noted, this is a key action as part of our strategic priorities, an area we remain very focused on, and we’ll work with our partners to ensure we maximize collections well ahead of our first debt maturity in 2026.
That concludes my remarks. I’ll turn it back to Leon for an update on our outlook and our closing remarks.
Leon Binedell
Thank you, Yasmin. As we entered Q3, we have seen the prices of nickel and cobalt come off the highs in Q2 to a market more reflective of the underpinning physical demand for metals. Inflationary pressures, fears of recession in significant markets for nickel and cobalt and the slow reopening of the Chinese markets due to COVID and continued logistics issues and supply chains have all had a hand in making this a difficult market to navigate.
As previously mentioned, we are not changing our production or nickel cost guidance for the year. However, we are seeing cobalt production trend towards the lower end of the range as a result of high nickel to cobalt ratios in the planned mining areas. We are consequently likely to be in the higher end of the range for NDCC as a result of lower cobalt byproduct credits, coupled with lower fertilizer byproduct credits in the second half of the year.
The one guidance item we are updating is our sustaining capital spend, logistics and order delays as well as lower contractor availability has resulted in a slower-than-expected implementation of our capital program. We are reducing our share of sustaining capital spend to CAD 60 million from CAD 75 million. And just to remind you, these costs are fully funded within the Moa Joint Venture. As mentioned earlier, there is also no change to our growth spending guidance for the Moa JV or the guidance for power production or unit costs.
To conclude, I want to thank you for your time today. As you have heard, Sherritt had a strong Q2, delivering robust financial results on the back of strong nickel, cobalt and fertilizer prices. We expect to build on Q2’s momentum through 2022 and beyond, given that the long-term outlook for each of the commodities we produce remain favorable despite near-term volatility and headwinds. It is why we have decided to take a balanced approach towards pursuing growth while deleveraging our balance sheet.
Just as a reminder, we expect to release our 2021 sustainability report in Q3. You’ll be able to access this from our website. We look forward to share more details following the release of our sustainability report and informing you on the cost and phasing of the expansion projects at our next quarterly call. Operator, I’d like to now open the call to questions at this time.
Question-and-Answer Session
Operator
Mark Preston
Okay. Thank you, operator. Then with that, I guess…
Operator
I apologize, Mr. Preston, we do have a question now. No, I’m sorry. I do apologize, sir.
Mark Preston
Okay. Then we’ll bring this to a close. And I want to thank everybody for joining in today, and we hope that you have a good day, and…
Leon Binedell
Yes. Thank you, everyone, for dialing in for your interest in Sherritt, and we look forward to speaking to you in the future.
Operator
Thank you. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines.
Be the first to comment