Fitch Rates First Quantum Minerals’ New Notes Final ‘B-‘

Fitch Ratings has assigned Canada-based First Quantum Minerals Ltd’s (FQM; B-/Stable) new 6.875% USD1.5 billion notes due 2027 a final senior unsecured rating of ‘B-‘. The Recovery Rating is ‘RR4’.

The notes are senior unsecured obligations of FQM, and rank pari passu with and benefit from the same guarantor group (representing around 38% of consolidated EBITDA) as the existing notes. Fitch notes that senior secured bank debt and the streaming agreement linked to Cobra Panama rank ahead of the senior unsecured bonds. The proceeds from the notes will be used towards (i) the repayment of USD650 million existing revolving credit facility (RCF); and (ii) the redemption in full of the company’s outstanding USD850 million 2022 notes.

Gross debt is expected to remain broadly unchanged following completion of the transaction as proceeds will be applied towards repayment of existing financial indebtedness. The notes extended the company’s maturity profile and have improved liquidity.

FQM’s ‘B-‘ Long-term Issuer Default Rating is underpinned by solid operational performance across operations and production growth in Panama that will add geographic diversification away from Zambia, which has proved to be a challenging operating environment. An improving cost position, higher volumes and rebound of copper prices will finally facilitate free cash flow (FCF) to turn positive in 2H20 and create deleveraging capacity. The rating factors in the high debt levels and comparatively weak credit metrics of the group.

KEY RATING DRIVERS

Cobre Panama Ramping Up: The large greenfield project Cobre Panama reached commercial production in September 2019. The project has annual design throughput capacity of 85 million tonnes of ore a year, which will expand to 100 million tonnes in 2023. Cobre Panama will produce over 300,000 tonnes of copper per year in 2021-2022 contributing around 40% of total group production.

Cobre Panama was put on preservation and maintenance from April to July due to coronavirus restrictions and has since resumed normal operations. Its production guidance for 2020 was revised to 180,000-200,000 tonnes of copper, down by around 100,000 tonnes from the initial pre-pandemic level.

Leverage Within the Guidance: We forecast funds from operations (FFO) gross leverage to remain within 5.0x-5.5x during 2020-2021, comfortably within the guidance for the rating. We expect 2020 EBITDA to be around USD2.0 billion due to a 14% rise in copper output as Cobre Panama’s production increases and a gain from hedges of over USD100 million. We expect that FCF will turn positive in 2H20 in the absence of further pandemic disruptions and supported by growing copper price and that generated cash will be used for debt repayment.

Fitch expects earnings to incrementally grow in 2021-2022 and FCF in the range of USD130 million-USD400 million a year due to the forecast copper price rebound and a continuous rise in production in Panama. Fitch expects the company will be able to moderate FFO gross leverage below 5x by end-2022. FQM’s management has publicly committed to a reduction in net debt/EBITDA towards 2x (before adding the Franco-Nevada streaming agreement to debt).

Copper Bolstered by China: Global demand for copper is recovering quicker than previously expected. This is thanks to healthy consumption in China due to an economic stimulus package and demand from construction as well as improving market sentiment. In the rest of the world, demand will be subdued, CRU forecasts that refined copper consumption will decrease by 3.2% in 2020 with a 4.3% recovery in 2021. In the medium term, the market is likely to be closer to balance.

Country Ceiling: We apply a multiple-countries approach to determine the applicable Country Ceiling, which is Panama’s at ‘A’. With the Cobre Panama ramp-up, FQM’s earnings will be more evenly spread between geographies. FQM derived over 70% of earnings from its operations in Zambia in 2019. Panama’s contribution will rise towards 60% in 2023 when Cobre Panama’s full capacity is reached.

Over the rating horizon, EBITDA from Panama more than sufficiently covers FQM’s cash interest expense of USD550 million-USD600 million. In 2020 the contribution from Panama will be below 30%. However, together with EBITDA from Las Cruces (Spain) this will cover interest expenses.

Challenging Environment in Zambia: FQM faces uncertainties when committing long-term capital in Zambia such as regular disputes with local partners and government bodies over contract terms and tax calculations, and frequent changes in taxation. Historically the company has also had to coordinate production schedules with downtime of power supply, while higher water and lake levels have eased risks around power supply disruptions for now.

During 2020 there has been little impact on the company’s operations. Over 2019, Zambia increased royalty rates for copper and introduced a gold export levy, the latter was later suspended. 20% of VAT on power and 30% on fuel has become non-deductible, which has a pre-tax cost impact of approximately USD16 million for 2020.

Mid-Point Cost Position: CRU estimates that FQM’s mining operations are on average close to the mid-point of the global business cost curve. CRU expects that production at Cobre Panama will lower FQM’s cost position over time. Even reasonable growth assumptions for electric vehicles are forecast to create an increase in demand for copper and a rise in prices, as indicated by our copper price assumptions. As a result, increasing production and improved cost position should support cash-flow generation in the medium term.

Medium-Term Horizon for Large Projects: FQM continues to undertake exploration at copper deposits Haquira in Peru and Taca Taca in Argentina, both of which will require substantial development capex. Exploration expenditure is discretionary and the final investment decision for both projects is still several years away. FQM plans to expand Kansanshi mine to increase annual throughput from 25 million ton to 52 million ton per year and increase mine life to 24 years. This project will require additional USD650 million capex spent in two years from 2H23. We do not factor these projects into our rating case.

Management has committed not to embark on new growth projects before making progress with strengthening the balance sheet (with a target of net debt/EBTIDA of 2x as reported by FQM).

DERIVATION SUMMARY

FQM is focused on copper and ranks among the top 10 global producers. It is smaller and less diversified than its major peers, Freeport-McMoRan Inc. (BB+/Stable) and Southern Copper Corporation (SCC, BBB+/Stable). FQM has a global mid-ranking cost position for business costs in comparison with SCC’s first quartile position. Over 70% of EBITDA came from Zambia in 2019, which we view as a challenging operating environment for mining companies. However, its country exposure improves as production in Panama increases, with earnings contribution from Zambia declining towards 40% over the longer term.

FQM’s financial profile is weaker than that of peers. FFO gross leverage was 7.5x in 2019 due to high capex for Cobre Panama and the negative impact of fiscal tightening in Zambia. We forecast that gross leverage will remain elevated in 2020-2021.

Compared with Hudbay Minerals Inc (B+/Stable), FQM is larger in scale, but has a higher cost position on the cost curve and weaker credit metrics.

KEY ASSUMPTIONS

Fitch’s Key Assumptions Within Our Rating Case for the Issuer

– Copper price (USD/tonne) at 5,850 in 2020, 6,000 in 2021, 6,200 in 2022, 6,400 in 2023 and 6,700 long-term; gold price (USD/oz) at 1,700 in 2020, 1,400 in 2021 and flat at 1,200 thereafter;

– Production in 2020 as per management guidance with output at Cobre Panama gradually ramping up to above 300,000 tonnes as planned;

– Capex reduction as non-core and expansion projects are put on hold, average annual capex in the next three years at USD700 million- USD800 million;

– Increasing dividend pay-out from 2022 once FFO gross leverage has decreased to well below 5x;

– No changes in the tax regime in Zambia from the current state

KEY RECOVERY RATING ASSUMPTIONS

The recovery analysis assumes that FQM would be considered a going-concern in bankruptcy and that it would be reorganised rather than liquidated.

Fitch has applied a discount of 20% to a going concern EBITDA of around USD1,963 million.

A 5.0x multiple was used to calculate the post-reorganisation enterprise value (EV), which factors in peer comparison and FQM’s exposure, albeit decreasing, to Zambia.

The senior secured RCF is assumed to be fully drawn.

Secured debt reflected in the waterfall was USD2.5 billion of a combined RCF and term-loan bank facility, and USD1.3 billion of a streaming agreement with Franco-Nevada related to the Cobre Panama project.

Senior unsecured debt reflected in the waterfall was USD6.3 billion consisting of bonds, a USD285 million Kalumbila facility and USD200 million of deferred acquisition consideration related to a 10% stake acquisition in Cobre Panama from LS-Nikko Copper Inc.

After deduction of 10% for administrative claims, our waterfall analysis generated a ranked recovery in the ‘RR4’ band, indicating a ‘B-‘ instrument rating. The waterfall analysis output percentage on current metrics and assumptions was 46%.

RATING SENSITIVITIES

Developments That May, Individually or Collectively, Lead to Positive Rating Action/Upgrade

– Successful ramp-up of the Cobre Panama project and/or improvement in market conditions leading to FFO gross leverage below 5.0x on a sustained basis

– Return to sustainable positive FCF generation together with reduction of gross debt

Developments That May, Individually or Collectively, Lead to Negative Rating Action/Downgrade

– FFO gross leverage sustained above 6.5x

– Operational issues in Panama or Zambia further delaying the expected increase in cash flow generation and improvement in credit metrics

– Measures taken by the governments of Zambia or Panama that adversely affect cash flow generation or the operating environment

-Weakening of the liquidity profile

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

LIQUIDITY AND DEBT STRUCTURE

Strong Liquidity: At end-June 2020, FQM’s unrestricted cash balances were USD882 million and we expect that FCF in 2H20 will be marginally positive at around USD50 million. This covers USD910 million short-term debt. The company’s USD1.2 billion RCF was fully utilised.

USD1.5 billion proceeds from the new notes will be used to repay USD650 million of the RCF, hence providing headroom under the facility. USD850 million proceeds will be used to repay the outstanding 2022 bond in full. This will increase the maturity of RCF and Kalumbila facility by one year, to December 2022. Consequently, financial flexibility and liquidity position improved as a result of issuance and the company is now funded until December 2022. Fitch expects positive FCF of USD130 million in 2021.

ESG Considerations

The highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on Fitch’s ESG Relevance Scores, visit www.fitchratings.com/esg.