Hudbay to build Constancia, signs stream agreement

Construction of the $1.5-billion Constancia copper mine in southern Peru is a go, and Hudbay Minerals (HBM-T, HBM-N) has signed a streaming agreement with Silver Wheaton (SLW-T, SLW-N) to help foot the bill.

Under the first streaming agreement Silver Wheaton has signed in two years, the company will acquire silver and gold production from Hudbay’s flagship 777 mine in Manitoba and from Constancia for US$750 million (US$500 million upfront), and a further US$250 million once Constancia reaches certain construction milestones.  

Along with the upfront payments, Silver Wheaton will make ongoing payments of the lesser of US$5.90 per oz. silver and US$400 per oz. gold (both subject to an inflationary adjustment of 1% beginning in the fourth year), or the prevailing market price per oz. silver and gold delivered.  

Initially Silver Wheaton will receive 100% of the silver and gold production from Hudbay’s 777 mine until at least the end of 2016 and the start of commercial production at Constancia. Once Constancia is up and running, Silver Wheaton will receive all of the silver production and 50% of the gold production from 777 and 100% of the metal from Constancia.

“In the event that Constancia fails to reach commercial production Silver Wheaton would continue to receive the metals streams from 777, as well as whatever production streams were generated from Constancia until 2020,” Stephen Bonnyman of BMO Capital Markets notes. “In 2020 the agreement provides for a reassessment, at which time, should Hudbay not be delivering silver from Constancia at 90% of the design production rate, that a pro-rata portion of the US$750-million deposit will be returned to Silver Wheaton.”

Hudbay has also arranged a US$600 million credit facility from a syndicate of Canadian and international banks.

In his research note headlined “Near-Term Pain for Long-Term Gain,” Bonnyman says he regards the deal as a “slight positive” for Hudbay that offers a lower-cost financing alternative, but lowers near-term earnings and magnifies the risk of delays in the Constancia start-up.

“While the transaction is positive from a net asset value perspective the negative impact on near-term earnings and cash flows will likely weigh on the share price in the near term,” he writes. “Unlike a project loan, in the event that the project was to hit a critical limitation and be forced to cease development or production, the cash cannot simply be repaid and the agreement terminated. By coupling the financing of Constancia to another asset, Hudbay also magnifies the risk in the near term.”

Nevertheless Bonnyman is retaining his “outperform” rating on Hudbay and his target price of $13 per share. At presstime Hudbay traded at $8.88 within a 52-week range of $7.36–13.10 per share. The company has 172 million shares outstanding.

Tom Meyer of Scotiabank is maintaining his “sector underperform” rating on Hudbay and has lowered his one-year target price on the stock to $10 from $10.50. “The new sources of funds should go a long way towards ensuring Hudbay has sufficient liquidity to continue with its development plans,” he writes in a research note. “However it does come at the expense of reduced earnings over the next four years.”

For Silver Wheaton, the deal diversifies its streaming portfolio from low-cost and long-life mines. The company forecasts its 2016 silver-equivalent production will rise from 43 million oz. to 48 million oz., including 100,000 oz. gold, an increase of 90% over 2011 totals. In 2012, silver-equivalent production would increase from 27 million oz. to 28 million oz., including 42,000 oz. gold.  

Under the deal Silver Wheaton’s initial US$500-million upfront payment will come from its existing cash balance of US$997 million at the end of the first quarter of this year.

 “The Hudbay deal ends a more than two-year hiatus for Silver Wheaton, with the transaction in-line with previous silver stream deals when comparing capex-silver equivalent ounce in context of the prevailing silver price,” Andrew Kaip of BMO Capital Markets points out in a note. He has a target price on Silver Wheaton of $40 per share. At presstime Silver Wheaton traded at $30.30 within a 52-week range of $23.11–$42.49, and has 354 million shares outstanding.

Steven Butler of Canaccord Genuity in Toronto sees the deal as positive for Silver Wheaton, reasoning in a note that “it is fairly priced and provides immediate cash flow, supports dividend growth and increases the company’s leverage to gold and silver prices.” He also notes it is an indication “that there remain opportunities for Silver Wheaton to enter into accretive silver stream deals.”

Hudbay’s underground 777 mine in the Flin Flon greenstone belt started producing zinc, copper, gold and silver in 2004, and has a reserve mine life until 2020.

Constancia is in the Peruvian province of Chumbivilcas and will be an open-pit mine. Hudbay anticipates first production at Constancia in 2014 and full production in 2015. Capital expenditures are estimated at $1.5 billion and the current mine plan envisions an annual production rate of 90,000 tonnes of contained copper in concentrate with molybdenum, silver and gold by-products. The mine is expected to have a 16-year lifespan. Once in production, it will be Hudbay’s largest mine.

Constancia also exhibits exploration potential in satellite deposits. In April the company released an initial measured and indicated resource estimate for the Pampacancha satellite deposit of 51.2 million tonnes with a copper-equivalent grade of 0.74%, which Hudbay plans to incorporate into the project mine plan. Pampacancha is 2.5 km from the proposed Constancia open pit.