Fitch Upgrades Hudbay Rating Action Commentary
Fitch Upgrades Hudbay Minerals Inc.'s IDR to 'BB-'; Outlook Stable
Wed 09 Mar, 2022 - 11:49 AM ET
Fitch Ratings - New York - 09 Mar 2022: Fitch Ratings has upgraded the IDRs of Hudbay Minerals Inc. and Hudbay Peru S.A.C. to 'BB-' from 'B+'. The Rating Outlook is Stable.
Fitch has also affirmed the first lien senior secured revolving credit facilities at 'BB+', and revised the recovery rating to 'RR2' from 'RR1', in line with Fitch's updated criteria, given the credit facilities are issued by non-U.S. borrowers. In addition, Fitch has upgraded the unsecured notes to 'BB-'/'RR4' from 'B+'/'RR4'.
The upgrade reflects Fitch's expectation for significantly improved FCF generation over the forecast horizon, driven by the significant increase in gold production from Lalor and Pampacancha, lower capex and a supportive copper and gold price environment. The upgrade also reflects Fitch's expectation that improved EBITDA generation will lead to total debt/EBITDA sustained below 2.5x.
Key Rating Drivers
Declining Leverage Profile: Fitch expects total debt/EBITDA, 2.1x as of Dec. 31, 2021, to have peaked in 2020, and to remain below 2.5x over the rating horizon, driven by higher copper and gold production and an improved price environment. Rosemont spending, not included in Fitch's forecast, will require substantial capital and could add more debt on Hudbay's balance sheet should the project move forward, although Fitch does not anticipate significant capex until 2025 or after. Fitch believes Hudbay will likely pursue a partnership for Rosemont and any other considerably large capital spending projects in order to de-risk projects and protect its balance sheet.
Hudbay has a stream agreement with Wheaton Precious Metals contemplating an upfront initial deposit of $230 million in exchange for the delivery of approximately 100% of payable gold and silver produced from Rosemont at a cash price of $450/ounce for gold and $3.90/ounce for silver. This arrangement provides upfront capital to fund Rosemont development. The company also has approximately $271 million in cash and cash equivalents, and $347 million of availability under its credit facilities as of Dec. 31, 2021. Fitch expects Hudbay to build cash on its balance sheet and pay off its gold prepay obligation to de-risk funding associated with bringing Rosemont and/or Copper World to production.
Heightened Gold Production: The New Britannia mill restart was completed with first gold production in August 2021, in concert with higher grade gold production at Lalor beginning in 2022. The combination results in significantly higher gold production, which Fitch expects will account for roughly 20% of sales in 2022 and 2023, given Fitch's price assumptions.
Annual gold production from Snow Lake, Manitoba, is expected to increase to over 180,000 ounces (from ~120,000 oz. in 2020) during the first six years of New Britannia's operation at an all-in sustaining cash cost, net of by-product credits, of approximately $788/ounce of gold, placing it in the 1st quartile of the CRU global cost curve. Fitch views the higher gold production as diversifying Hudbay's commodity exposure and benefiting FCF generation.
Improving FCF Generation: The combination of lower copper production and elevated growth capital spending resulted in relatively neutral FCF in 2021. In 2Q20, Hudbay announced it entered into a gold forward sale and pre-pay, in which it received $115 million for delivery of approximately 80,000 ounces of gold in 2022 and 2023. This transaction bolstered liquidity and pre-funded the majority of the required capital for the New Britannia mill refurbishment. Fitch expects significantly higher FCF generation, averaging around $170 million per year from 2022 through 2024, following a period of elevated capital spend, driven by higher copper and gold production and reduced growth capital spending.
Low-Cost Position: Hudbay's key mines have a first-quartile cost position and are located in low-risk mining-friendly jurisdictions in Canada and Peru. The mine plan for Constancia (Peru) supports a 16-year mine life; Lalor (Canada) supports a 16-year mine life; Pampacancha (Peru) supports a 4-year mine life; and the 777 mine (Canada) is expected to be depleted in 1H22.
Hudbay has an extensive track record of operating copper mines from exploration to production and has a number of projects in the exploration and development phases. Fitch expects annual copper production to increase around 20% to 120,000 tonnes in 2022 from 99,000 tonnes in 2021 and average around135,000/year from 2023-2024.
Exposure to Copper: Fitch believes Hudbay has meaningful commodity diversification through its gold production, and to a lesser degree its zinc production. However, the company has a longer-term focus on copper, which accounted for 54% of consolidated revenues in 2021. Hudbay estimated, as of YE 2021, a $0.40/lb change in the price of copper from the company's 2022 base case of $4.00/lb would change operating cash flow before working capital changes by $87 million in 2022. Hudbay's average realized copper price was $4.19 in 2021 compared with $2.86/lb in 2020 and $2.73/lb in 2019. Current spot prices are around $4.71/lb, which compares with Fitch's assumptions of $3.86/lb in 2022, $3.63/lb in 2023 and $3.40/lb in 2024.
High-Grade Pampacancha Deposit: Production of copper in Peru declined by approximately 36% in 2020 compared with 2019, primarily due to planned lower copper grades at Constancia and pandemic-related suspension of mining activities. Hudbay received approval in February 2020 of a surface rights agreement for the Pampacancha deposit and began mining ore in April 2021. The addition of Pampacancha, a higher grade deposit, helps offset lower grade Constancia production and results in total expected copper and gold production in Peru increasing by roughly 54% and more than five times in 2022 compared with 2020, respectively.
Rosemont Development Delayed: Rosemont is a $1.9 billion project in Arizona expected to average 112,000 tonnes of copper over the 19-year life-of-mine plan at cash costs of $1.29/lb. The Final Record of Decision (FROD), the final administrative step in the permitting process before the project can move forward to development, was received from the U.S. Forest Service (USFS) in June 2017. The U.S. Army Corps of Engineers issued the Section 404 Water Permit in March 2019 for Rosemont.
The USFS approved the Mine Plan of Operations for Rosemont in March 2019. The U.S. District Court issued a ruling on July 31, 2019, where it vacated the USFS's issuance of the FROD, suspending construction work at Rosemont. The USFS appealed the decision to the U.S. 9th District Court of Appeals, expecting a decision by YE 2021; however, a decision has not yet been reached.
Fitch has not included Rosemont production or meaningful spending over the rating horizon in its rating case, given the uncertainty in timing of completion of the court process. Fitch views Hudbay's exploration success, organic growth pipeline and its ability to offer operational expertise in a potential partnership, as providing optionality if the Rosemont project is delayed beyond expectations.
Copper World Project Potential: The 100% owned Copper World project is located in close proximity to the 100% owned Rosemont deposit (AZ), with mineralization closer to surface than Rosemont, offering the potential for a low- cost attractive operation in addition to providing synergies with Rosemont. Copper World has initial indicated mineral resources of 272 million tonnes at 0.36% copper and consists of seven deposits. Hudbay intends to release a preliminary economic assessment (PEA) in 1H22 and a pre-feasibility study in 2022 after the PEA is complete.
Fitch views the project favorably, and believes it provides some flexibility even if Rosemont is held up longer than expected. However, Fitch does not include production or capital spending, outside of relatively minimal capex to advance studies and permits, in its forecast as the project is still in early stages.
Derivation Summary
Hudbay compares favorably in size, in terms of EBITDA, and in commodity diversification, with Canadian gold miner Eldorado Gold (B+/Stable). However, Eldorado has modestly favorable projected leverage metrics. Hudbay is significantly smaller than copper producer First Quantum Minerals Ltd. (B+/Positive). However, Hudbay has a lower cost position with mines located in the first quartile compared with First Quantum's mines located in the third quartile. First Quantum also has significant exposure to higher risk jurisdictions, as roughly half of its EBITDA is generated from Zambia (rated RD), whereas Hudbay's EBITDA is generated in low-risk mining-friendly jurisdictions Canada (rated AA+) and Peru (rated BBB).
First Quantum is also less diversified and has had significantly higher leverage metrics historically compared with Hudbay. Hudbay is significantly larger, more diversified, operates mines in lower-risk jurisdictions, and has modestly lower leverage compared with copper producer Ero Copper (B/Stable). However, the companies have a similar cost position. Hudbay is larger, more diversified, more profitable, has a lower cost position and has favorable leverage metrics compared with single operating mine Canadian copper producer Taseko Mines Ltd. (B-/Stable).
Key Assumptions
Fitch's Key Assumptions Within The Rating Case for the Issuer Include:
--Production generally in line with the midpoint of guidance;
--Copper prices of $8,500/tonne in 2022, $8,000/tonne in 2023 and $7,500 in 2024;
--Zinc prices of $2,500/tonne in 2022 and $2,200/tonne in 2023 and 2024;
--Gold prices of $1,600/ounce in 2022, $1,400/ounce in 2023 and $1,300/ounce in 2024;
--Significant Rosemont and Copper World capital spending is delayed beyond the ratings horizon.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
--Reduced completion risks and funding strategy which mitigates risk associated with the Rosemont and/or Cooper World projects;