HBM - Hudbay Minerals: A Leveraged Copper Play

Summary

• Copper prices may be heading north again as China reopens and supply challenges persist.
• Hudbay Minerals is projecting significant production growth into 2023-24, supported by higher grades in Peru and higher throughput and Au recoveries in Canada.
• The company offers one of the leanest cost structures, due to by-product rich deposits.
• Due to its considerable usage of debt and promising growth prospects, Hudbay offers investors significant leverage on the copper price.

Pressure has been building up on the copper market for quite some time. The recent price decrease in 2022 in conjunction with rising OPEX have put a lot of producers under pressure, cutting their free cash flow and decreasing internally generated funding for expansion. Meanwhile, copper inventories are trending lower and China is easing its COVID-zero policy, paving the way for uptick in demand. This may be an indication of the perfect storm brewing for copper and serious price appreciation of the metal of electrification in 2023. There are companies that are greatly positioned to take advantage of such a development and I believe Hudbay Minerals ( HBM ) is one of them, as it has relatively low production costs and is expected to increase its production in the next two years.

Copper market outlook

Recently, Goldman Sachs released an update on its market expectation regarding the copper market in 2022. The investment bank has raised its price target for the metal to US$11k/tonne (approx. US$5.00/lbs) from US$9k/tonne as it's now expecting a supply deficit, compared to a surplus in its previous forecast. On top of that, while the market prices for copper were falling in 2022, the inventories were trailing down, reaching its lowest levels since decades.

The on top of the operating costs inflation, the supply side of the equation is being challenged by issues with the authorities of some countries. For example, in September a local government in the Philippines has canceled the permit of the Tampakan copper-gold project, which was expected to bring 375k tonnes of copper annually to the market. Another hostile move by the authorities was made days ago in Panama where First Quantum Minerals ( FQVLF ) had its mine in Panama being shut down by the government, due to disagreement of the terms of a new deals regarding royalties.

On the demand side, the reopening of China is expected to lead to pressure as the country increases its consumption of copper. This environment could be perfect for copper producers, who have significant leverage on the metal and are poised to reap the benefits of a price increase.

Company overview

Hudbay Minerals is a mid-tier copper-gold producer with operating assets in Peru and Canada and development projects in the US. Copper dominates the mineral mix as it contributes for about 60% of revenues, while gold brings about of revenue. The mineral mix is completed with other metals like zinc, silver and molybdenum, as Hudbay's properties are quite polymetallic in nature.

The capital structure of the company is relatively simple with 261.9M of shares outstanding and no warrants. The ownership mix is quite diverse with institutions having a dominant position. Insider ownership is quite low at below 0.3%, but skin in the game for managers is achieved through stock based compensation.

Production growth

2022 have been quite important for Hudbay in terms of the company's operations. In June 2022, the 777 mine in Flin Flon, Manitoba, Canada has been depleted and closure activities began. However, at the same time the expansion of the Snow Lake project, following the completion of the new Britania mill. The workforce from the closed project is going to be transitioned at Snow Lake in order to support the expanding operations there.

At the same time, operations in Peru are also expanding as Hudbay is ramping up Pampacancha - a high grade satellite deposit to the main Constantia project. It has to be noted that the Canada assets are more gold-heavy, while those in Peru are predominantly producing copper.

The significant production growth is also expected to have meaningful impact on the company's results, as 2023 estimated EBITDA is projected at US$724M, while the following year the indicated number is even higher at US$795M.

Low cost producer

Due to the rich polymetallic nature and of the flagship Peruvian assets, especially when Pampacancha in added into the mix, the operations there benefit from high by-product credits, which lowers net cash costs.

This allows Hudbay to position itself in the lowest copper producer quartile in terms of costs.

Leverage on the copper price

The leverage of Hudbay comes from two main factors. Firstly, the company has considerable debt position of US$1.2B on its balance sheet, which comprised of two US$600M bond issues, maturing in 2026 and 2029. For comparison, the market cap of the company is a bit above the total interest bearing debt at US$1.3B.

The other element of leverage on the copper price comes from the significant resource base of the company. In addition to the two operating projects, the two development projects in the USA, located in Arizona and Nevada. This makes the NAV profile of Hudbay very sensitive to the copper price, as the company itself indicates that a 10% move in the spot price of the metal yields 40% move in the NAV. This offers a great opportunity for investors who are bullish on copper and want to gain leverage on the copper price through equities.

Share price and valuation

The leverage that Hudbay has on the copper price could be also observed by looking at the YtD performance of the company in comparison to the United States Commodity Index Funds Trust - United States Copper Index Fund ( CPER ), which tracks the price of the commodity. HBM is down more than 30% since the beginning of the year, roughly double the decline of CPER.

Looking at the projected EBITDA for 2023 of US$724M, this would put the forward EV/EBITDA of the company at below 3.5x, which is pretty low for a mining stock, given the sector average of around 7, so an increase in the copper price could trigger a significant appreciation of HBM's shares.

Risks

Interest rates risk

While Hudbay is using significant leverage, the debt of the company is at a fixed interest rates, so in the short term interest rates movement are not that challenging for the company. However, later on when the 2026 debt comes due and the expansion projects may need loan financing the cost of debt will be quite important.

Political risk

While Hudbay is diversified across jurisdictions, the flagship asset is located in Peru, which is in amidst a political crisis , following the detention of the country's president. In addition, while the development projects are in the US, which has strong property rights, permitting a project there may be a quite slow and full of bureaucratic hurdles.

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