Fitch Affirms Hochschild Mining's IDRs at 'BB '; Outlook Stable
KEY RATING DRIVERS
Deleveraging Expected Due to Inmaculada:
The company's 'BB+' ratings and Stable Outlook reflect Hochschild's expected deleveraging to around 3.5x total debt/EBITDA in 2015, 2.5x in 2016 and below 2.0x thereafter on a consolidated basis following the successful start-up of operations at Inmaculada during June 2015. Fitch anticipates close to 7 million oz of new low cost production of higher grade silver equivalents during the second half of 2015 (2H15) from this new mine, increasing to around 12 million to 13 million oz per year from 2016 onwards. Total consolidated silver equivalent production will increase to about 29 million oz in 2015, rising to around 34 million oz in 2016, compared to 22 million oz in 2014.
Spike in Leverage Temporary:
Hochschild reported very high leverage ratios during the first half of the year with total debt to latest 12 month (LTM) EBITDA of 6.5x and net debt to LTM EBITDA of 5.4x as of June 30, 2015. Elevated leverage ratios followed the 18% decline in the average price of silver and 42% decline in production from Pallancata since 1H14 that coincided with the completion of the company's investment in Inmaculada. The final total cost for this project is estimated at around \\$450 million with Hochschild's debt levels correspondingly high at \\$540 million as of June 30, 2015. Production from Inmaculada, that has a lower cost of production and higher average ore grade than the company's other mines, will significantly contribute to reducing Hochschild's leverage ratios by year-end 2015.
New Volumes will Augment EBITDA:
The company's consolidated LTM EBITDA declined to \\$85 million with a margin of 21% as of June 30, 2015 compared to \\$194 million with a margin of 33% for the same period of 2014. This decline illustrates the average price of silver falling by 31% from \\$24/oz in 2013 to \\$16.50/oz in 1H15 with a lagging decrease in production costs exacerbated by lower production volumes from Pallancata. Fitch's base case indicates approximately \\$70 million of additional EBITDA being generated by the silver equivalent production volumes from Inmaculada augmenting the next six months of production from existing operations resulting in a full year EBITDA of around \\$150 million in 2015. Fitch's base case indicates EBITDA of around \\$210 million in 2016 and almost \\$270 million in 2017.
Continued Cost Reduction:
Partially offsetting the silver and gold price declines has been Hochschild's continued focus on cost reduction, with the company reporting an all-in sustaining cost of production of silver equivalents of \\$15/oz in 1H15, a decline of 9% compared to 1H14, and a target of \\$13-\\$14/oz for the full year aided by the contribution from Inmaculada. The 6% depreciation of the Peruvian Nuevo Sol against the USD during 1H15 has also benefited the cost position of the company due to 50% of its operating costs and capex being denominated in the local currency and the other half in USD. This dynamic is slightly improved in Santa Cruz in Argentina with approximately 60% of operating costs and capex denominated in Argentinian Pesos that has depreciated against the USD by 5% during the semester. Lower fuel prices have also aided production and operating costs.
Positive Free Cash Flow (FCF) Expected in 2016:
Fitch expects Hochschild to generate FCF of around \\$40 million in 2016 and \\$60 million in 2017 following FCF of negative \\$114 million in 2015 as the company completes Inmaculada, allowing it to reduce debt from current levels. The company announced no dividends in 2015 and will reassess in 2016. FCF has been negative since 2012 due to a number of acquisitions and investments exacerbated by declining precious metal prices. The company-changing acquisition of the 40% interest held in Inmaculada and Pallancata held by IMZ in 2013 for \\$270 million, financed by cash from asset sales, additional debt, and \\$73 million of equity, took Hochschild's ownership to 100% for these two low-cost projects. This strategy is set to bear fruit amidst a period of low silver prices.
Additional Debt Incurrence Covenant:
Hochschild has a 3.0x gross debt to EBITDA incurrence covenant ratio relating to the company's 7.75% senior unsecured notes issued by Cia Minera Ares. Due to this ratio being breached as of 1H15 it limits the company's ability for additional borrowing to 10% of its consolidated net tangible asset base. As of 1H15, this translates to maximum total debt permitted of \\$550 million. Total debt as of 1H15 was \\$540 million, a peak due to Inmaculada, expected to decline to around \\$520 million in 2016 when FCF returns to positive post-investment and \\$490 million as of 2017. The company has also renegotiated its bank covenants until 2017 providing it with additional headroom under a prolonged low silver price scenario.
Significant Exposure to Argentina:
Hochschild's San Jose mine in Argentina currently represents about 40% of the company's production of silver equivalents and 30% of its EBITDA. Hochschild owns 51% of Santa Cruz, San Jose's operating company, is the sole operator, and fully consolidates the mine. On a proportional basis for Hochschild's 51% ownership in Santa Cruz, the company's total debt to EBITDA ratios would be 4.1x in 2015, 2.8x in 2016, and 2.0x in 2017. Inmaculada's production is expected to dilute San Jose to represent about 30% of production and 20% of EBITDA by 2017. Excluding San Jose's EBITDA completely from Hochschild's consolidated financial profile, Fitch expects a total debt to EBITDA ratio of 4.7x in 2015, declining swiftly to 3.2x in 2016 and 2.2x in 2017, consistent with through-the-cycle leverage levels.
Santa Cruz Dividends Extracted:
Hochschild is a key net exporter for the Government of Argentina, allowing it to extract dividends from the country following payment of a 10% dividend tax at the official exchange rate. The company has been able to successfully repatriate dividends from Santa Cruz on this basis historically. Due to the volatility in the geopolitical landscape in Argentina, the ability to extract dividends could change in the future.
Pallancata Exploration Developments:
Hochschild has reported the preliminary findings of a new ore vein, Pablo, at Pallancata, that has the potential to bolster the company's credit profile significantly. Drill holes indicate it has similar composition to the Angela vein at Inmaculada but is approximately 25% wider, with similar length, and with a higher average ore grade. Due to the vein being located within Hochschild's boundary of operations at Pallancata, existing operational and environmental licences allow for swift access to the vein through the construction of a new ramp. Preliminary expectations of building the ramp are approximately \\$2 million, compared to \\$450 million to access and produce from the Angela vein. Existing production facilities at Pallancata are expected to process the new ore from Pablo resulting in extremely low AISC estimated at around \\$8/oz of silver equivalents. This may be achievable by late 2016 or early 2017. Further studies are taking place that will provide more accurate data over the next couple of months.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Hochschild include:
--Average silver price of \\$15.72/oz in 2015, \\$14.50/oz in 2016, \\$15.00/oz in 2017;
--Average gold price of \\$1,164/oz in 2015, \\$1,200/oz thereafter;
--Consolidated silver equivalent production of 29.7 million oz in 2015, 34.7 million oz in 2016 and 39.5 million oz in 2017.
RATING SENSITIVITIES
Inmaculada is Key:
Hochschild's ratings could be downgraded or result in a Negative Outlook following lower than forecasted sales volumes from Inmaculada that could keep production costs relatively elevated, negatively affecting the capital structure of the company in the medium term. Lower sales volumes from Peru would also exacerbate already significant exposure to Argentina, currently a volatile jurisdiction. Financial performance consistently worse than Fitch's base case, such as sustained total debt to EBITDA leverage above 3.5x, with longer than expected negative FCF post-Inmaculada completion in 2015, could also result in a negative rating action.
Positive Rating Momentum:
Significantly diluting the company's exposure to Argentina could result in a rating upgrade or Positive Outlook. Continued reduction in production costs to remain profitable through the precious metal pricing trough, alongside reduction in leverage with sustained total debt to EBITDA ratios below 2.0x, would also be requisites under this scenario.
LIQUIDITY
Sufficient Cash Position:
Hochschild exhibits sufficient liquidity headroom with cash and marketable securities of \\$84 million as of June 30, 2015. Short-term bank debt of \\$97 million was partially refinanced with \\$15 million due in June 2016 and \\$35 million due in July 2016 at which point Inmaculada will have achieved full-scale production levels with cash increased correspondingly. Short-term debt of \\$25 million is due in December 2015, payable from cash. Committed credit lines are not available in Peru. As per the local practice, the company has access to approximately \\$70 million of additional undrawn credit lines as of June 30, 2015. Additional liquidity is expected to be made available through the company's major shareholder and/or banking partners, should it be required.
FULL LIST OF RATING ACTIONS
Fitch affirms the following ratings:
Hochschild Mining Plc
--Foreign Issuer Default Ratings (IDR) at 'BB+';
--Local currency IDR at 'BB+'.
The Rating Outlook is Stable.
Compania Minera Ares S.A.C.
--Senior unsecured debt rating at 'BB+'.
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