National Bank Flash - will update target prior to Q3 results Sherritt International Corporation
S (TSX): C$0.40
Stock Rating: Sector Perform
Target: C$0.70
Risk Rating: Speculative
Sherritt Finalizes Payment Agreement with Cuban Partners to Settle $362 mln of Outstanding
Receivables
Impact: Positive
After market close, Sherritt announced that it has signed agreements with its Cuban partners to settle all of its outstanding Cuban receivables over five years, beginning January 1, 2023.
We had accounted for continued deferral of outstanding receivables under our Base Case valuation for Sherritt with the present value of future cash flows from this agreement totaling at least ~290 mln (assuming minimum annual payments of US$57 mln and 8% discount rate). The formal agreement should alleviate uncertainties with respect to future contributions to Moa from the company's Cuban partners and funds are likely to be redirected to reducing debt and funding expansion of Moa - we continue to model a 15% expansion by 2025 for US$160 mln (100% basis) with an updated technical report in Q4/22 to confirm our technical assumptions.
Under the terms of the agreement, Sherritt’s Moa JV partner, General Nickel Company (GNC), has agreed to assume outstanding receivable amounts of ~$361.9 mln owed to Sherritt by Energas and Union Cubapetroleo (CUPET). This amount includes the Energas conditional sales agreement (Energas CSA) receivable of CAD$332.4 mln and trade accounts receivable from CUPET of $29.5 mln.
Repayment of these outstanding receivables will be achieved through a cobalt swap agreement:
• The Moa Joint Venture (Moa JV) will prioritize payment of dividends in the form of finished cobalt (up to 2,082 tonnes representing approximately 60% of annual production), along with any additional dividends in a given year to be distributed in
cash.
• All of these cobalt dividends, and potentially additional cash dividends, will be redirected to Sherritt as payment to settle the outstanding receivables.
• The physical product will be moved to a Sherritt warehouse in Fort Saskatchewan, from which Sherritt will sell the finished cobalt in the open market.
• The agreement reduces Sherritt's reliance on its Cuban partners’ ability to access foreign currency to repay amounts owed to Sherritt.
No interest will accrue on the Energas conditional sales agreement to ensure repayment within the five-year period. With the suspension of interest, Sherritt expects to recognize a non-cash loss on revaluation of allowances for expected credit losses on the Cuban receivables during the third quarter of 2022. Any shortfall will accrue to Sherritt in future years with interest of 8% accruing from January 1, 2023 on unpaid principal amounts that will become payable by GNC to Sherritt. We will incorporate these charges and cobalt swap agreement ahead of our Q3 preview piece in the coming days.
In addition to the above, on October 12, 2022, Cuba’s Executive Council approved the 20-year extension of the economically beneficial Energas power generation contract with the Cuban government to March 2043, which was set to expire in March 2023. The Energas facilities, which have an electrical generating capacity of 506 MW from two combined cycle plants at Varadero and Boca de Jaruco, produce electricity using natural gas and steam generated from the waste heat captured from the gas turbines.
Recall: Sherritt previously entered into an agreement with Energas (as a 1/3 joint venture partner) in 2008 to construct additional electrical energy capacity in Cuba. Under the terms of the transaction, Energas was required to repay amounts advanced in accordance with the agreement. Electricity provided by Energas is for local Cuban use and the sale of power is denominated in Cuban pesos and as result of periods of low commodity prices, increased sanctions by the U.S. Government and COVID-19 pandemic, access to foreign currency in Cuba to make payments on the CSA liability has been significantly restricted.
Our Sector Perform rating accounts for Sherritt's targeted exposure to Nickel and Cobalt improving the outlook for cash distributions from the Moa JV in the near term offset by the company's ongoing debt commitments and need for further clarity on anticipated growth initiatives at Moa. S is trading at 0.24x NAV compared with NBF base metal peers at 0.67x. Our $0.70 target is based on ascribing a multiple of 0.65x NAV.