First Quantum Minerals is a major copper producer with also substantial amounts of gold and nickel in its production mix. The company has invested quite heavily in growth and as the huge Cobre Panama project is nearing the end of the construction phase, First Quantum’s free cash flow will sky-rocket. First Quantum is listed on the TSX with FM as its ticker symbol, and on the London Stock Exchange with FQM as its ticker symbol.



A quick look at the first quarter results

In the first quarter of 2017, First Quantum produced a total of 132,500 tonnes of copper, which is approximately 292 million pounds, thanks to a very strong performance at its Las Cruces and Kansanshi mines, whilst it’s still ramping up the production at the new Sentinel mine. Unfortunately the company sold its copper at an average price of just $2.2 per pound which is substantially below the market price. That’s due to First Quantum’s copper hedge contracts which were completed and executed when the copper price was trading much lower.

FQM2 Source: company presentation

This obviously had a huge negative impact on the total revenue of First Quantum, as the revenue increased to just $766M, instead of the almost $900M it would have been excluding those hedges. In fact, the hedge program is the only reason why First Quantum was loss-making in the first quarter, as its bottom line showed a net loss of $114M.

Source: financial statements

The cash flow results seemed to be a bit better with an operating cash flow of $270M. However, we still need to deduct the full tax bill ($55M) from this amount, as well as the $124M in interest expenses and capitalized expenses from the equation, to end up with an adjusted operating cash flow of $100M. This wasn’t even close to being sufficient to cover the $311M in capital expenditures, and even if First Quantum would have been able to avoid the ‘cost’ of the hedge program, First Quantum would still have been free cash flow negative.

The importance of completing the Cobre Panama construction

Does this mean the company is going down? Not at all. First Quantum is currently over halfway the construction phase of the huge Cobre Panama copper project in Panama, and the majority of this year’s capital expenditures will be spent in Panama.

This should be considered to be growth capex as it definitely isn’t sustaining capex, and this has a huge impact on the planned expenses for the current financial year. Let’s have another look at the company’s official full-year guidance.

Of the total capex guidance of $1.07B, approximately 60% will be spent on growth! This means the full-year sustaining capex and capitalized stripping expenses will be just $430M, or just over $100M per quarter. This has really important implications of which the first one would be First Quantum being free cash flow positive on an adjusted and sustaining basis. Should First Quantum not have entered into that low-priced copper hedge, it would be generating an annualized free cash flow of $500M per year.

But secondly, have look at the expected investment level in Cobre Panama:

2017 and 2018 will be the final ‘tough’ years, but the total capex level is starting to trend down from this year on. Adjusting it for pre-commercial production cash flow contribution in 2019, the sustaining capex will be just $350M, or less than $100M per quarter.

This coincides with the production and cost guidance, which calls for a copper production of 600,000 tonnes per year in 2019, at an AISC of $1.80 per pound. Using a copper price of $2.6/lbs, the net free cash flow – excluding interest expenses and potentially higher taxes – will come in at in excess of $1B. Even after taking the interest expenses (which should start to trend down as First Quantum will start to reduce the leverage on its balance sheet) and higher tax payments into account, FM will be generating well over $500M per year in free cash flow.

Investment thesis

And as the net cash will start to hit its balance sheet in 2019, we would expect First Quantum to reduce its gross debt at a fast pace. In fact, a first test will be the $1.1B bond maturing in 2021, which is costing the company almost $80M per year in interest expenses. Based on our calculations, First Quantum should be in a position to repay the senior note in full, without the need to refinance it (unless it’s building the Taca Taca mine). The next two $1.1B notes in 2023 and 2025 could and should also be repaid out of the internally generated cash flow, saving the company tens of millions of dollars (and eventually hundreds of millions) per year in interest expenses.

Shareholders of First Quantum are facing a tough next 18 months as the copper hedges will continue to weigh on the revenues and cash flow, but fortunately First Quantum is fully funded for Cobre Panama with a cash position of almost $1.5B as of at the end of March.

An investment in First Quantum is pretty speculative right now, but it looks like the shareholders could be rewarded before the end of this decade.

Disclosure: the author has no position in First Quantum Minerals

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