Sherritt International Corporation (OTCPK:SHERF) Q3 2022 Earnings Conference Call November 3, 2022 10:00 AM ET
Company Participants
Lucy Chitilian – Director, Investor Relations
Leon Binedell – President, CEO & Director
Yasmin Gabriel – CFO
Conference Call Participants
Gordon Lawson – Paradigm Capital
Operator
Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Sherritt International Third Quarter 2022 Results Conference Call and Webcast. [Operator Instructions]. I would like to remind everyone that this conference call is being recorded today, Thursday, November 3, 2022, at 10 a.m. Eastern Standard Time.
I will now turn the presentation over to Lucy Chitilian, Director, Investor Relations. Please go ahead.
Lucy Chitilian
Thanks, operator, and good morning, and thanks, everyone, for joining us today. Before we begin, I just want to make mention of a couple of items. As you know, we released our Q3 results last night. And as all our disclosure materials, including the presentation, MD&A and financial statements are available on our website as well as on SEDAR.
In addition, yesterday, we also announced to purchase our second — our junior and second lien notes. As is customary during today’s call and webcast, we will be using a presentation that is available on our website and on the Investor Relations section. We will be referencing page numbers so you may follow along.
We will also be making forward-looking statements and references to certain non-GAAP financial measures. Non-GAAP measures and their reconciliations to the most directly comparable IFRS measures are included in the appendix to the presentation. Forward-looking statements and disclosures related to such items are found on Slide 3 of our presentation.
With me today are Sherritt’s Chief Executive Officer, Leon Binedell; and Chief Financial Officer, Yasmin Gabriel, who will be reviewing our results in detail. Following Yasmin and Leon’s discussion, we will open the call up to questions. I would also welcome any questions after the meeting.
With that being said, it is my pleasure to pass the call along to Leon.
Leon Binedell
Thank you, Lucy. Good morning, everyone, and thank you for joining us today. In our third quarter, we made significant advances on our strategic priorities while maintaining strong operating results. We had strong adjusted net earnings and adjusted EBITDA, both up substantially over the prior year, driven by higher nickel and fertilizer sales volumes and realized prices.
We finalized a transformative 5-year payment agreement with our Cuban partners to settle $362 million of outstanding receivables. Sherritt’s Board approved an additional USD 50 million on our expansion plans on a 100% basis. The Cuban authorities approved the extension to the Energas power generation contract by 20 years, and we issued our 2021 sustainability, climate and tailings management reports as well as our sustainability scorecard outlining our performance on ESG matters.
I will provide an overview of our operations and expansion plans, and Yasmin will provide commentary on our financial highlights, our recent cobalt swap arrangement to settle the Cuban receivables, and comment on our debt repurchase we announced last night with our Q3 results, and I will conclude with an update on ESG matters and our near-term outlook before we address any questions.
We will start the operations overview with the Moa JV Q3 production for finished nickel and cobalt versus the prior year as outlined on Slide 6. Sherritt’s share of finished nickel production for the quarter was 4,443 tonnes, which was 53% higher compared to the prior year quarter, while finished cobalt production of 419 tonnes was 25% higher compared to the prior year period. These increases were primarily a result of the timing of our annual refinery plant maintenance shutdown which occurred in the second quarter of this year, while it was delayed into the third quarter of last year due to the impact of the COVID pandemic.
On a more comparable basis, excluding the impact of the timing of the shutdown year-over-year, nickel production was 6% higher on a year-to-date basis, covering the first 3 quarters of the year over the same period of the last, while cobalt production was mildly low primarily due to higher nickel-to-cobalt ratio in the feed mix into the refinery. The lower cobalt in the feed mix will continue into the fourth quarter and we, therefore, anticipate cobalt production to come in around the bottom end of our guidance range, while nickel is anticipated to be well within the guidance provided.
As we discussed last quarter, logistics-related challenges in transporting finished production to customers experienced in the second quarter continued throughout the third quarter. Outlined on Slide 7 is the comparison of production versus sales. The temporary order deferrals for nickel generally reconciled through the third quarter, largely related to a more cautious restocking approach taken by consumers, after the resumption of economic activity in China, following the recent 0 COVID lockdown policies being lifted. But the positive consumer sentiment of increased economic activity in China was tempered by continued recessionary and global inflationary fears as well as a reduction of steel manufacturing in Europe due to the significant increase in energy costs and energy uncertainty.
Affected sales orders were partially offset by higher netback sales to other markets and sales to new customers. On a year-to-date basis, finished nickel sales were lower than production. However, in the third quarter, we started to drive our inventory down to more typical levels, and expect to reach target inventory levels by the end of the year for nickel. Finished cobalt sales volumes for both the third quarter and on a year-to-date basis continue lower than production with the contraction in the consumer electronics sector compared to 2021, contributing to reduced lithium cobalt oxide demand. Given that this is a near-term issue, we expect cobalt inventory to reduce to more typical levels by the end of Q1 2023. The lower cobalt sales volumes related to nickel is having a negative impact on our near-term direct — net direct cash cost, or NDCC, which I will cover on the next slide.
The net direct cash cost at the Moa joint venture increased by 49% to $6.76 per pound compared to $4.53 per pound in Q3 of 2021, as outlined on Slide 8. The higher NDCC was primarily due to higher mining, processing and refining, or MPR, costs year-over-year as outlined in the slide, and lower cobalt byproduct credits, as mentioned, due to the low cobalt sales volume in the quarter relative to the sales volume of nickel. We have seen a significant reduction in sulfur prices in the back of the quarter, but we’ll only see the benefit of this later in Q4 once higher cost inventories are wound down.
While cobalt revenue was only marginally lower in the current quarter over the prior year, the cobalt credit in NDCC was 38% lower as a result of lower cobalt sales relative to the high nickel sales volumes. We sold 13 pounds of nickel for every pound of cobalt in Q3, when a normal ratio is more 9:1. We expect that the cobalt byproduct credit should normalize as we sell our inventory down over the coming 2 quarters. With elevated nickel sales in the fourth quarter, we see this ratio revert back to normal levels in 2023, but we’ll see a reversal in Q1 2023.
The impact of higher NPL costs and lower cobalt byproduct credit was partly offset by higher net fertilizer byproduct credit. On a year-to-date basis, NDCC was $4.39 per pound compared to $4.30 in 2021, despite the significant increases in input prices, mainly on the back of increased byproduct credits year-over-year. As a result of the softening cobalt and fertilizer prices in the third quarter relative to the first half of the year, coupled with the logistics issues related to delivery of cobalt sales, we updated our NDCC guidance to a range of $4.50 to $5 per pound. As we only see our cobalt inventories fully unwind in early 2023, while nickel inventories are expected to unwind in Q4, continuing the elevated nickel sales volumes relative to cobalt.
Turning to our Power division on Slide 9. Power production in Q3 was 139 gigawatt hours of electricity, up 26% from 110 gigawatt hours produced in the comparable period of 2021, primarily as a result of timing of maintenance activities year-over-year and access to increased gas volumes for power production for this year. Accordingly, the higher production resulted in a lower operating unit costs in the quarter.
We are excited that we received approval for the extension of our power generation contract through 2043. The extension of this economically beneficial contract support Sherritt’s ongoing investment in Cuba with the extension of the Energas payment agreement, which Yasmin will elaborate on, and we expect to receive distributions from Energas on a timely basis over the coming 5 years.
For 2023, we are continuing discussions with our Cuban partners to develop even additional gas supply for our Boca facility. This is a key strategic priority for this business going forward, and we hope to have approvals for this by early 2023. The additional supply could double the production from the Boca facility by 2024 and provide much-needed additional source of electricity in Cuba, which has been suffering from a chronic shortage of electricity recently.
That concludes my remarks on operations.
This quarter, we are pleased to announce that our Board has approved the next phase of our expansion plans at the Moa Joint Venture, as outlined on Slide 11. As part of our disciplined approach to pursue only the most valuable brownfields growth objectives, we narrowed the scope of our expansion investment to the most critical components resulting in an estimated cost of only USD 50 million on a 100% basis.
As a reminder, this amount is expected to be funded by the joint venture itself, and not by Sherritt. We anticipate spending on growth capital to be spread evenly over a 2-year period. The joint venture expects to fund this capital primarily from operating cash flows, but will seek external funding for select components of the expansion plan.
With the previously approved slurry preparation plant project well underway, the estimated combined cost of the 2 phases of expansion is approximately USD 77 million on a 100% basis. With the market focus on EV batteries, we see an opportunity to focus our strategy on increasing production of intermediate products that will enable us to fully utilize the existing capacity at the refinery and consider direct sales of intermediate product into the EV battery supply chain.
This phase of the expansion will focus on increasing mixed sulphide intermediate production, or MSP, and consist of the completion of the Leach Plant Sixth Train, the Fifth Sulphide Precipitation Train and construction of additional asset storage capacity at Moa. The completion of the SPP, or Slurry Preparation Plant, which is expected to be completed in early ’24, and the second expansion phase just announced will be completed by the end of 2024, as previously indicated. A total increase in MSP is estimated at 20% of current production, or an additional 6,500 tonnes of contained metal, resulting in a combined capital intensity of approximately USD 13,200 per annual tonne of increased nickel content.
One thing that is new to Sherritt is that we estimate that 2/3 of this increased production will be processed into finished nickel and cobalt, while the remaining 1/3 could be sold as an intermediate product, or MSP, directly from Moa into the EV supply chain.
In the next slide, we summarize this impact of — on production relative to 2021. As you can see in the schematic, for illustrative purpose, on Slide 12, 2021 finished nickel and cobalt production was 34,756 tonnes. With the full expansion at Moa by the end of 2024, we expect to increase MSP by approximately 20% of this amount. This equates to approximately 6,500 tonnes of contained nickel and cobalt. Current refinery capacity is approximately 38,200 tonnes of metal output. In order to accommodate the increased MSP without additional investment in the refinery, we expect that 2/3 of the MSP will be processed into finished nickel and cobalt using the existing capacity, and we expect to sell 1/3 of the MSP as an intermediary product directly into the EV battery supply chain.
In order to accommodate the refining of the additional MSP production from Moa, some lower-margin, third-party feed will likely be reduced. Therefore, Sherritt expects that its net finished nickel and cobalt production will increase by approximately 10%. Any balance will be sold as MSP intermediary product. We will continue to optimize refining operations to enhance capacity, however, do not anticipate any additional capital investment in this time.
Moving to Slide 13. Starting with the SPP project underway. Currently, we have completed 80% of the civil construction and 96% of the contracts for supply of materials and services have been awarded. The structural steel and prefabrication is ongoing, and erection will commence in November, along with field assembly of major equipment.
To the end of Q3, USD 10.7 million on a 100% basis of growth capital has been committed and prioritized on long lead items and equipment, construction supplies and civil and mechanical construction.
In regards to the Moa processing expansion work, in Q3, a detailed engineering review of the Leach Plant Sixth Train was completed to confirm the engineering work done in the initial expansion phase a decade ago. The first stage of the feasibility study for the leach plant was approved by Cuban authorities allowing for the ordering of long lead items. The final stage of the feasibility study, encompassing the full project scope, is near completion as is required for final Cuban authority approval for the project. We anticipate this approval in time to meet the plant project schedules. Bids are being solicited for long lead items for the Leach Plant Sixth Train, thus ordering can commence as part of the preliminary approval already in place.
Basic engineering will commence in Q1 of next year for the Fifth Sulphide Precipitation Train and the additional acid storage capacity. As a reminder, the SPP remains on budget and schedule for completion in early 2024, and is expected to deliver a number of benefits, including reduced ore haulage distances, and as a result, lower carbon intensity from mining, and increasing our annual MSP production by 1,700 tonnes. I’m pleased with the progress we are making, and encouraged that we will meet our expansion time lines.
The work to complete the economic cut-off grade and the new life of mine development continues at the Moa mine. As outlined on Slide 14, in Q3, the resource model classification and pit optimization activities were completed. The final development of the life of mine is in progress, and we expect mine plan sequencing and reserve estimates to be completed in Q4. The economic cut-off grade and life-of-mine analysis using these latest methodologies show very good progress towards extending the current life of mine to beyond 2040. We continue to engage with Cuba’s Natural Resource Agency, and expect alignment on the mine execution plan using these new methodologies in Q4. Development of a National Instrument 43-101 and peer review will occur during Q4 and early Q1. The final draft of the 43-101 is expected to be released in Q1 of next year.
That concludes my remarks on operational performance and our expansion plans. I’ll now turn the call over to Yasmin to review our financial results.
Yasmin Gabriel
Thanks, Leon. Turning now to our key financial metrics on Slide 16, adjusted EBITDA and net earnings. Our adjusted EBITDA in Q3 of $37.4 million was 113% higher than last year. This was driven by higher nickel and fertilizer sales volume and realized prices and the timing of our annual maintenance shutdown, as Leon noted earlier. Despite the higher adjusted EBITDA, we did recognize a net loss from continuing operations in the quarter.
This loss was primarily due to the impact of a $48.5 million noncash loss on revaluation of the ACL related to the Energas conditional sales agreement. This is primarily as a result of the suspension of interest over the 5-year period of the cobalt swap agreement, which I’ll expand on shortly. On an adjusted basis, removing the impact of this noncash adjustment, we had adjusted net earnings from continuing operations to $13.9 million, compared to an adjusted net loss of $13.4 million, representing a 204% increase.
On a year-to-date basis, primarily as a result of higher nickel, cobalt and fertilizer revenue, we had adjusted net earnings from continuing operations of $95 million compared to an adjusted net loss from continuing operations of $28.7 million for the same period last year, representing an increase of 231%.
Turning now to our liquidity position on Slide 17. At the end of Q3, our total liquidity was $229 million, up from $216 million at the start of the quarter. Strong operating cash flow, mostly related to higher fertilizer receipts, more than offset the timing of the Moa Joint Venture distributions and capital spending of $10.4 million. Since quarter end, we received a $20.6 million Moa Joint Venture distribution and expect additional distributions in the balance of the year.
We continue to expect our distributions in the second half to be higher than the first half, which was $43.4 million. Subsequent to the quarter, at the end of October, we paid a semiannual interest payment on our second lien notes of $13.2 million. We did not meet the mandatory redemption of the second lien notes in October.
Although we met that excess cash flow condition, we did not meet the minimum liquidity condition as defined in the indenture agreement, primarily as a result of the timing of dividends from the Moa Joint Venture. Our current available liquidity and expected cash flow provides an opportunity for us to pursue growth, including our narrowed expansion strategy at the Moa Joint Venture, while also continuing efforts to reduce debt to achieve balance sheet strength.
Now shifting to Slide 18. As we disclosed on October 13, we finalized a transformative agreement with our Cuban partners to settle the $362 million of total outstanding Cuban receivables over a 5-year period, putting an end to the long-standing repayment uncertainty related to these receivables. Under the agreement, which takes effect on January 1, 2023, the Moa Joint Venture will prioritize payments dividends in the form of finished cobalt to each partner up to an annual maximum volume cobalt with any additional dividend in a given year to be distributed in cash. All of our Cuban partners share of these cobalt dividends and potentially additional cash dividends will be redirected to Sherritt as payment to settle the receivables until the annual maximum of cobalt volume and dollar amount limit has been reached. Once we receive the cobalt, we’ll sell it into the open market.
The primary benefits to the agreement are that we now have a reasonable certainty that the full amount will be settled over the 5-year term of the agreement as it’s no longer dependent on our Cuban partner’s ability to access foreign currency. We’re confident that cash flows of USD 114 million will be delivered annually through the sale of cobalt, half of which will be used to settle the amount receivable. We expect to receive the majority of the payments prior to the maturity of the second lien notes in November 2026, as you can see on this slide. And it provides an opportunity for accelerated collection of the receivables if the market value of cobalt increases. Now in exchange for these benefits, Sherritt agrees to forego interest over the repayment period of 5 years on conditions that the full amount is received within this time frame as an incentive. This resulted in the noncash loss we recorded this quarter, which I mentioned earlier. For further detail on the mechanics of cobalt swap agreement can be found in both our press release and MD&A.
On Slide 19, you’ll see that concurrently, we finalized an extension to the Energas payment agreement, which we refer to as the Moa swap. This mechanism, which has now been placed for several years, allows for the monthly exchange of local currency at Energas for foreign currency at the Moa Joint Venture. The local currency is used by the Moa Joint Venture to fund local operating expenditures in Cuba. The foreign currency is paid directly to Sherritt by the Moa Joint Venture to facilitate foreign currency payment for Energas’ operating and maintenance costs and to pay dividends to Sherritt. I’d like to highlight that this annual USD 50 million will be received in addition to the USD 114 million expected to be received under the cobalt swap agreement.
Finally, as many of you would have seen yesterday, we announced another offer to repurchase our junior and second lien notes for an aggregate cash consideration of up to $50 million. Our strong 2022 results, along with our expected cash flow, creates further opportunity to project and achieve balance sheet strength, while also remaining committed to advancing our expansion plans, the scope of which has been narrowed to the most critical components. The transaction in June, along with this offer, provide our noteholders with options to receive cash sooner. Under terms of the offer, which are consistent with our previous offer this year, we’ll repurchase all tender junior notes at a fixed price of $520 per $1,000 principal amount, plus a 3% premium for those tendered before the initial expiration date. If any funds remain after the purchase of junior notes, we have the option to purchase tender second lien notes by way of a modified debt option.
We encourage you to review supporting documents available on our website and SEDAR for further details should you wish to participate. That concludes my remarks. I’ll turn it back to Leon for an update on ESG 2022 outlook and provide closing remarks.
Leon Binedell
Thank you, Yasmin. As you would have seen, we released our 2021 sustainability report during the quarter. Highlights are outlined on Slide 22. Our sustainability framework is intrinsically embedded into our overall business strategy which is focused on growing and optimizing our existing operations, maximizing value to our shareholders, employees and communities, and building our brand as a preferred supplier of critical minerals.
We continue to progress on our commitments to achieving net zero greenhouse gas emissions by 2050 by obtaining 50% of our energy from renewable sources by 2030, reducing nitrogen oxide emissions intensity by 10% by 2024 in the near term. We are also making good progress on increasing the number of women in the workforce to 36% by 2030.
As you can see from the slide, we continue to focus our attention and resources on ensuring the safety of our employees and communities as well as building an organization that is focused on diversity, inclusion and gender equality, while at the same time addressing our environmental responsibilities by advancing a road map to achieve a just energy transition by 2050.
Looking ahead to the rest of the year, our guidance, as outlined on Slide 24, for nickel and cobalt production remains unchanged. However, based on the expected nickel to cobalt ratio in the feed to the refinery which we mentioned, finished cobalt production for the year is expected to be around 3,400 tonnes. The recent softening of cobalt and fertilizer prices and logistics issues related to delivery of cobalt sales suggest that our NDCC guidance range will be between USD 4.50 a pound and $5 per pound. This is slightly above our previous guidance.
Our guidance for sustaining spending on capital remains unchanged. However, we have revised our guidance for growth spending on capital at the Moa JV to $10 million from $19 million previously as a result of the narrowed scope and the deferral of some spending into 2023.
In regards to Power, production guidance was increased based on the improved performance for the 9 months to end of Q3, and was increased to 525 to 550 gigawatt hours for the full year due to the increased availability of gas supply. As a result of the increased power production and delays in delivery of some parts and supplies into Q1 ’23, the unit cost guidance range for power has decreased to $22 to $23 per megawatt hour.
I want to thank you for your time today. And in conclusion, on Slide 25, as you have heard, Sherritt had strong and busy Q3, and we continue to make progress in meeting key strategic priorities for the year. We signed the agreement to address our Cuban receivables, launched a further debt repurchase last night. We approved the expansion plans at Moa JV. We received approval for the extension of our power generating contract to 2043. And we signed the Energas payment agreement, which helps support ongoing business as well as provide a mechanism by which Sherritt can receive dividends on a timely basis.
Finally, we released our 2021 sustainability report which continue to show peer leading safety performance, showcasing contributions of almost $1 million to community investment projects while we experienced no security incidents involving allegations of human rights abuses at any of our operations, and we completed an LME accreditation audit confirming no child or labor — forced labor in any of our supply chains.
Operator, I would like to open the call to questions at this time. We encourage everyone with questions not being addressed in this call to contact Investor Relations following this call. Operator, over to you.
Question-and-Answer Session
Operator
[Operator Instructions]. First question comes from Gordon Lawson at Paradigm Capital.
Gordon Lawson
Congratulations on another great quarter. Could you just elaborate for me please, just to be clear, are you no longer expecting to make upgrades or debottlenecking work at Fort Saskatchewan or any work on the autoclaves?
Leon Binedell
What we’re currently anticipating, Gordon — thank you for participating — is to spend additional investment capital at Moa exclusively, while we continue to work operationally to debottleneck and enhance operations at the refinery. At this time, we do not see any need for additional capital investment to expand capacity at the Fort Site.
Gordon Lawson
Okay. And there’s — does that include the autoclaves?
Leon Binedell
Indeed. And so because we believe there is sufficient payability of intermediate products, we do not see the need to make any additions at the refinery at this time to process all of the MSP from Moa, but the majority of it will still continue to be processed through the refinery, utilizing existing capacity.
Gordon Lawson
Okay. So this is more in line with the accruing development of the battery market. Is that correct?
Leon Binedell
That is correct, yes.
Gordon Lawson
Okay. And I’m sorry I missed it, but could you please elaborate on what was said on the credit issues that’s been from the Moa payments and if there are any penalties from this?
Leon Binedell
Sorry, could you repeat that, Gordon?
Gordon Lawson
There were — there’s a statement regarding credit issues for the debt as a result of missed Moa payments. Could you just please elaborate on that and whether or not there are expected penalties from this?
Yasmin Gabriel
I think you’re referring to the mandatory redemptions?
Gordon Lawson
Yes.
Yasmin Gabriel
So the mandatory redemptions are based on excess cash flow, but our minimum liquidity at the time, and that would have been based on October. At that time, we wouldn’t have had the minimum liquidity. And no, there wouldn’t be any penalty that this depends on, both excess cash flow and minimum liquidity requirements at that point in time.
Operator
[Operator Instructions]. We do have a question from [indiscernible].
Unidentified Analyst
Yes, on behalf of shareholders, I think this is a very impressive movement forward in the activities that you’ve accomplished this past quarter. I mean it’s quite amazing and gives a lot of stability to the company, particularly the balance sheet. However, I did want to raise the issue of executive compensation publicly.
My concern is as a long-term shareholder and others since November 3, 2017, 5 years ago, our shares have decreased in value from $1.40, down to a low of almost $0.10 and presently around $0.40 plus. This represents a loss of shareholder value of $400 million, more or less. At that time, 5 years ago, the Board substituted the existing executive bonus compensation system of awarding share options which align management with shareholders directly and reverted to a cash bonus system based on RSUs, which do not align with shareholder value.
At present, if shares returned to the 2022 high of $0.65, Sherritt is obligated to pay executive compensation at this time of $30 million. And if they return to the 2017 level 5 years ago, they would be obligated to pay almost $90 million.
As a shareholder, I’m concerned that these cash bonuses are paid by a cash-for company and directly reduce per share profit by $5 million per $0.10 share price increase. This has a huge impact on shareholders, a negative impact on shareholder value by reducing the price earnings ratio and thus, the share price.
Leon Binedell
John? John?
Unidentified Analyst
Yes. My question is the existing RSU compensation system would — is destructive for shareholder value. When is Sherritt going to revert — the question, when is Sherritt going to revert to the option share-based bonus system on the books to properly align executive compensation with shareholder interest?
Leon Binedell
Thank you for your question, John. We appreciate your concern. At our AGM, we did commit to do a review of executive compensation. That review is ongoing. And we have disclosed the implication of our current plans to the market, and you rightly pointed out what those implications are. We would happily engage with you one-on-one to talk through these options and what we have been doing about this at the appropriate time once we’ve completed our current work on executive compensation.
What I would like to highlight is that we continue, as you pointed out rightly, that we’re building the sustainability of this business. We’ve addressed our balance sheet risk, to a large degree, with the transactions we’ve concluded in the last quarter or so, and we continue to focus on improving the balance sheet and delivering value to our shareholders.
Operator
Thank you. At this time, I will turn it back over for closing comments.
Leon Binedell
Thank you, operator. Thank you, everyone, for attending our call today for the third quarter. We appreciate your interest in the company. We want to encourage our noteholders to take a look at the press release from yesterday and to consider our repurchase offer. If you have any questions, please feel free to give us a call. Lucy is always standing by to answer questions.
Lucy Chitilian
Thank you, operator, and we’ll hand the call back over to you.
Operator
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating, and we ask that you please disconnect your lines.
Be the first to comment