Currency hedges hit earnings in Australia

A local currency that had lost a fifth of its value against the U.S. dollar might have been expected to help local commodity producers make near-windfall profits, as costs stayed static and revenues tracked the greenback upward.

Welcome to the 21st century.

With an Australian dollar at US52, low metal prices, and sophisticated derivative books, a number of Australian mining companies have found themselves in a deep hole, dug with the best of intentions.

Lead and zinc producer Pasminco has been the highest-profile casualty of dollar hedging. The company put its mines, including the huge Century operation in northwestern Queensland, up for sale in July amid heavy market selling. The market was responding to speculation that Pasminco would not meet immediate payments and to a May ratings cut to speculative levels by credit rating agency Standard & Poors. Added to that, a year-long decline in Pasminco’s share price brought tax-loss sellers out at the corporate year-end.

In March, Pasminco sold its 49% interest in the Ernest Henry mine, east of Mt. Isa, to majority holder MIM Holdings. But by April, Pasminco management was denying rumours that the company was technically insolvent, even though there was still an A$115-million cheque on the way from MIM.

The sale of the mining assets, meant to preserve the company as a smelter and refiner, was part of a restructuring of the company’s A$1.3 billion in long-term debt. Pasminco had about A$200 million in working capital and a book value of A$1.5 billion.

At the centre of Pasminco’s woes is a hedge book valued at a negative A$867 million. At the financial year-end in June 2000, the book included some A$3.5-billion in sold currency puts with strike prices averaging near US64.4, and A$3.3 billion in bought calls with strike prices averaging near US68.1. The strategy was supposed to protect revenue if the exchange rate rose above US68.1, at the cost of forgoing additional revenue if the Aussie fell below US64.4.

Foreign exchange losses at the end of 2000, the company’s half-year point, had run to A$42 million, even before the Aussie reached its low of US48.3 in April. That loss was enough to turn an A$88-million operating profit into an interim net loss of A$37.3 million. In June, Pasminco warned that a similar loss would be reported for the second half.

Pasminco has delayed the release of its year-end financials, ostensibly to ensure that the proposed restructuring is properly taken into account. Chief Executive Officer Greig Gailey, however, found it necessary to deny speculation that the results were delayed so that Pasminco would have more time to talk to its lenders.

The restructuring would mean the sale of Century, widely considered the best zinc deposit south of Red Dog, the storied Broken Hill mine in New South Wales, the Elura mine in New South Wales, and the Rosebery mine in Tasmania. In better times for zinc, the portfolio would be attractive.

Broken Hill is much-reduced from the old days, but the Old Coathanger still sported a resource of at 16.6 million tonnes grading 7.4% zinc, 3.9% lead and 41 grams silver per tonne at the end of 2000, and an established infrastructure and community around it.

Century’s resource, in all categories, stood at 102.4 million tonnes at grades of 12.2% zinc, 1.7% lead and 45 grams silver.

Added to that is the undeveloped resource at Dugald River, between Mt. Isa and Ernest Henry, where drilling has outlined 58.7 million tonnes grading 11% zinc, 1.8% lead and 34 grams silver.

The only company to have publicly acknowledged an interest in buying the assets is Noranda (NRD-T), which owns a 75% interest in the Lady Loretta zinc project 100 km southeast of Century. Teck-Cominco (TEK-T) and Anglo American (AAUK-Q) have also been mentioned as possible takers.

MIM Holdings might have been thought to be the natural purchaser, given its strong base in the Mt. Isa camp. But the big base metal producer had its own foreign-exchange problems. MIM reported net earnings of A$104.6 million for the year ended June 30, down from A$166.6 million in the year ended in June 2000, even as annual revenue went up to A$3.8 billion from A$3.4 billion. Increases in operating profit to the tune of A$289 million came from its copper and coal divisions — but MIM lost A$200 million betting against the greenback.

With A$186 million in cash and just over A$900 million in receivables, MIM could find Century — valued at between A$850 million and A$1.5 billion — a little hard to swallow.

Australian miner Perilya has been looking at a consolidation of the mines in the Broken Hill camp, which could involve a deal with both Pasminco and Consolidated Broken Hill.

The price tag on Century alone could clear off the hedge book liability, but the other assets would probably not fetch much more than A$200 million. So it was perhaps not surprising that Pasminco was forced to issue a denial that its Port Pirie, Cockle Creek and Hobart smelters were also up for sale. The sale of the Australian smelters would have left Pasminco with only its Clarksville, Tenn., smelter in the U.S. and the Budel Zink zinc plant in the Netherlands.

Sons of Gwalia‘s takeover offer for PacMin, the Teck-Cominco subsidiary that owns the Tarmoola and Carosue Dam mines in Western Australia, would combine the balance sheets of two other companies with red ink in their hedge books (T.N.M., Sept. 3/01). Sons of Gwalia had already announced it would be paying US$200 million to cover hedge commitments by the end of 2002, and would have to pay a further US$175 million annually into existing hedge contracts beyond that time. PacMin has not disclosed its hedge exposure, but at the end of June 2000, its foreign-currency hedge was A$2.9 million out of the money, and it had a A$25-million negative value in its gold book.

The suspicion remains that the combination may be meant to allow the two hedge books to be combined and rescheduled to reduce the liabilities now attached to the two companies.

Currency hedge books are also a factor in the merger talks between gold producers Delta Gold and Goldfields.

Delta’s hedge book showed a mark-to-market value of negative A$111 million at the end of March — near the bottom for the Aussie dollar. It had also bet wrong on the gold price, and was showing a negative value of A$121 million on that book.

June’s year-end figures showed Delta with earnings of A$52 million on revenue of A$416 million; in the previous year, it had lost A$115 million on revenue of A$327 million.

Goldfields, in which South African house Harmony Gold (HGMCY-Q) holds a 23% interest, had done better, with only an A$87-million liability from dollar hedges and a positive mark-to-market value on its gold hedges. It made A$48 million on revenue of A$358 million in the year ended in June, up from a profit of A$26 million made in the previous year on revenue of A$308 million.

Newcrest Mining reported a mark-to-market hedge book value of negative A$436 million at the end of June 2001. Its gold and copper hedge books were underwater by a further A$173 million and A$85 million, putting the total value of Newcrest’s hedges at negative A$694 million.

In contrast, the Australian industry’s gold hedge position has been shrinking, with the Australian Gold Council reporting 38 million oz. hedged at an average US$305 per oz. at the end of June, down 2 million oz. from the end of March. About a quarter of the decline can be accounted for by Normandy’s unwinding of 507,000 oz., and both Delta and Newcrest reduced their hedges substantially.

While Australian producers have generally been seen as the most aggressive hedgers in the gold market, the hedge books cover only 46% of reserves.