Sherritt brings discipline to the business

At its annual general meeting on May 12 in Toronto, Sherritt International (TSX: S; US-OTC: SHERF) chairman Harold (Hap) Stephen dismissed a disgruntled shareholder’s criticism about the nickel producer’s languishing share price and claim that management “needed new blood.”

“We’re very proud of what management has achieved,” Stephen said of Sherritt’s track record in 2014, and so far this year.

Among Sherritt’s achievements, Stephen said, were selling the coal operations for a total consideration of $946 million (“which we believe is a long-term, strategically good move, so that we can focus on our skills and priorities”); dramatically reducing and restructuring debt; ramping up its world-class Ambatovy nickel mine; and expanding its Cuban oil and gas business.

“The one thing management hasn’t achieved is drive up world nickel prices or maintain high oil prices, and we are not going to hold that against them,” he continued. “So on behalf of the board, we think management has done a great job this year.”

Despite poor commodity prices, Sherritt made “some great and visible changes,” David Pathe, Sherritt’s president and CEO, noted in a presentation before the meeting’s question and answer session. Topping that list was refocusing on what it does best.

“We’ve embraced the fact that our roots are in nickel, our expertise is in nickel and our growth is in nickel,” he said, pointing out that Sherritt has been in the nickel business for nearly 90 years and operates two nickel joint ventures: the Moa mine in Cuba and related nickel-cobalt refinery in Fort Saskatchewan, Alta.; and Ambatovy in Madagascar. The two operations have a combined capacity to produce nearly 90,000 tonnes of nickel annually.

In March, after starting commercial production in January, Ambatovy reached a production milestone, operating at 90% of its nameplate capacity for 90 days — three months ahead of schedule. “Ambatovy has been one of the most successful ramp-ups of a high-pressure, acid-leach facility in the world,” Pathe said.

Sherritt has also lowered costs at both operations. In the first quarter the company’s net direct cash costs at Moa, where the company recently celebrated its twentieth anniversary, came in at US$4.36 per lb., while at Ambatovy net direct cash costs declined to US$5.74 per lb. (In a later interview with The Northern Miner, Pathe said that at 100% capacity, cash costs at Ambatovy could be between US$3 and US$5 per lb., depending on the price of input commodities.)

“Volatility in the nickel market explains our focus on being a low-cost producer,” Pathe said. “We continue to work to drive costs down further, including the construction of a new acid plant at Moa and continued increases in production at Ambatovy.”

In Cuba, Sherritt has also extended the life of its energy business. In its oil division, Sherritt extended one of its existing production-sharing contracts until 2028, and signed contracts for two new blocks that have 25-year terms and together encompass more than 1,200 sq. km in the same area that the company is already producing.

“In late 2014, the reality of lower global oil prices played out, challenging many oil producers, including some of the larger oil companies,” Pathe pointed out. “However, as we produced oil at less than US$9 per barrel, we are well positioned to weather difficult markets and can sustain positive margins throughout the cycle.”

Sherritt has also strengthened its balance sheet after stating last year that it planned to reduce debt and proactively manage a series of debentures that were maturing in 2015. In October, the company entered into transactions that reduced debt by $425 million and refinanced the 2015 debt maturity to 2022. The company now faces no debt maturity until 2018, and combined with previous debt repayments of $365 million, slashed debt in 2014 by $790 million, Pathe said. (Sherritt’s total loans and borrowings in 2014 were a little over $1.8 billion, in a decrease of over 25% from 2013.)

Cost-cutting has been a priority as well. “We weren’t just focused on the balance sheet,” Pathe said. “We looked at the organization as a whole to determine where we could make real and meaningful change.” Sherritt sold its corporate office, from which it will record a gain of $19 million. The company also reorganized the way it works, resulting in a 24% decrease in administrative costs so far in 2015.

“Commodity prices have not been kind to us, and we will always be tied to the performance of those markets,” Pathe said, noting that he, like many other shareholders, was not happy with the company’s share price performance last year. “But I can assure you that we are taking strong, decisive and well-thought-out actions to be well-positioned to take advantage of anticipated increases in commodity prices.”

Nickel fundamentals remain attractive, however, “and there is some cause for optimism,” he said.

“Initially, supply is expected to contract, primarily from the anticipated decline in nickel pig iron production in China,” he explained. “Separately, nickel consumption has grown at a compound annual growth rate of 4% from 2002–2014. This means that another 75,000 tonnes of nickel are needed annually just to meet the growth in demand.”

The mining executive also noted that there was no short-term solution to accommodate the nickel supply gap.

“As we’ve seen at Ambatovy, it takes years and a tremendous amount of capital to secure permits, build and ramp-up new mining facilities,” he said. “Across the industry, we do not see the level of activity needed to meet the incremental nickel demand forecast for the next five years. This will be constructive for the price of nickel and advantageous for Sherritt.”

To put Sherritt’s exposure to nickel in perspective, Pathe calculated that every dollar increase in the price of a pound of nickel is worth upwards of $100 million in cash flow for the company this year.

Pathe said that up until 2007, Sherritt’s share price generally outperformed the nickel price. Since 2007, however, it has underperformed the nickel price.

The reason for the underperformance, he said, was Ambatovy. “Mega projects of this scale take years to conceive, build and ramp up,” he explained. “Throughout that time — and it’s now nearly eight years in our case — investment is made with no return. But projects like ours have a lifespan of over 40 years from early feasibility work until the end of the mine life, and we are on the cusp of positive cash flow from Ambatovy for the first time since its inception. Production is increasing, and hopefully at a time when we will see higher nickel prices.”

In an interview with The Northern Miner after the AGM, Pathe elaborated on recent changes in Cuba, including a new investment law that has cut taxes on Moa from 45% to 22.5%, on oil and gas from 30% to 22.5% and on power from 30% to 15%.

“They’ve been working on the new foreign investment law for 18 months to two years before they introduced it,” he says, adding that Sherritt had worked with the Ministry of Energy and Mines and the Ministry of Foreign Investment and Trade.

“They want to make themselves a more attractive place for foreign investment,” he says, “and we’re going to realize s
ome of the benefits.”

When asked if he expects more competition after U.S. President Barack Obama’s announcement in December that he would like to relax travel and trade restrictions, Pathe said those changes will take time.

“You’ll see more interest in Cuba in the months and years ahead, but I think people need to appreciate that this is a process that is still going to take time.”

He noted that after Obama’s proclamation, “there was much celebration and our stock ran up quite dramatically, but then we gave up most of those gains back in January, as people realized change here is still slow and incremental.”

Pathe points out that to really open and transform the Cuban and American relationship there are two pieces of legislation that need to change, the actual trade embargo and the Helms-Burton Act, which punishes U.S. allies who trade with and invest in Cuba.

“Obama said profound things, like the embargo hasn’t achieved its aims … but those more fundamental steps to make real changes like ending the embargo and lifting Helms-Burton require acts of Congress, rather than those from the executive branch of the president,” Pathe concludes. “So I think you’ll see incremental change, and this will take on an air of irreversibility, but it’s going to be a political process that is going to take time.”