Sherritt Plots Return To Low-Cost Glory Days

Sherritt International (S-T, SHERF-O) wants to get back to where it started — or at least where it was eight years ago.

After announcing a net loss of $592.1 million for the fourth quarter and $289.7 million for all of 2008, the company says it plans to right the ship by re-establishing itself as one of the world’s lowest-cost nickel producers.

With nickel prices hovering around US$4.30 per lb., Sherritt has its work cut out for it.

Sherritt’s selling price of US$6.18 per lb. nickel for the fourth quarter did come in higher than current spot prices, but that figure was still roughly half the sales price the company received in the fourth quarter of 2007.

Adding to investor concerns are rising cash costs for the metal’s production — they came in at US$4.59 per lb. nickel, much higher than the same period in 2007, when cash costs were US$1.27 per lb.

On a Feb. 25 conference call, Sherritt chief executive and chairman Ian Delaney said he believes production costs have peaked, and that lower commodity prices will soon translate into lower input costs.

“Costs remained high relative to nickel reference prices since short-term contract prices for critical inputs were above prevailing spot prices and costs in inventory reflected elevated prices from prior periods,” the company’s fourth-quarter financial report reads.

Delaney, however, says there isn’t much of the higher-cost inventory left to work through and he expects it will take only one quarter before the impact of lower cost inputs are felt. Furthermore, he expects input costs to fall even more as the year progresses.

But such a scenario offers a two-edged sword: in an environment where input prices are falling, commodity prices are falling too, further jeopardizing Sherritt’s bottom line.

“We know we can match production costs (to falling selling prices) as input prices come down,” Delaney said on the conference call. “We’re not at all bullish on commodity prices — I think there’s still a lot of room for them to go down — but we’re confident that as nickel prices come down, we will maintain a position we had in the year 2000 as one of the lowest-cost producers. And that knowledge is driving us to stay at Ambatovy, which is virtually identical to our project in Cuba.”

Sherritt’s mine in Cuba is the Moa joint venture — a project that helped make the company’s name in the nickel industry. As one of the lowest-cost producers eight years ago, the project remained economic despite depressed nickel prices.

And despite massive construction cost overruns at the company’s next flagship nickel project, Ambatovy in Madagascar, Delaney believes that like Moa, it will be a low-cost producer built to weather the storm of falling metal prices.

“At the last commodity cycle when nickel price went down to US$2 per pound and cobalt was at US$7 per lb. . . at that time we were one of the lowest-cost producers in the world, and we’ve done nothing to alter the equation of how we did it in the interim,” he said.

“Everyone gets a little sloppy with high prices and we know the nickel price was up over US$20 per lb. But we know the orebody in Madagascar is virtually identical to the one in Cuba and the process is identical.”

The surging capital costs at Ambatovy, however, are fostering some skepticism. The latest financial statements upgraded the estimated capital costs by over US$1 billion to US$4.52 billion from the previous estimate of US$3.2 billion.

Sherritt, however, is not alone in dealing with such ballooning figures.

Ambatovy is a joint venture with Sherritt holding a 40% interest and the rest being divided amongst Sumitomo Corp., Korea Resources Corp. and SNC-Lavalin Group (SNC-T).

In situations such as these, it’s good to have partners. Sherritt says it is getting support from the group in its efforts to determine the best way to come up with its portion of capital costs.

And while Delaney conceded that the company doesn’t yet have a plan to come up with the funds — it is likely to be worked out in the next two months — he says the key factor the company looks at when raising money is how best to preserve its liquidity.

It is true that despite the gathering clouds, the company sits with an enviable cash position and access to capital. Fourth-quarter results show the company holds cash and equivalents of $500.8 million with another $1.6 billion available to it under its credit facilities.

Further, it has no public debt coming due until 2012.

But while its cash position remains strong, its non-cash assets took a beating in the quarter as it had to take a $463.3-million goodwill impairment on Ambatovy.

The goodwill impairment has to do with the price Sherritt paid for the project above the value of the hard assets at the time. Because part of the buying price was based on discounted cash flows generated from higher anticipated metal prices and lower projected capital costs, the new cost environment required the company to reassess the project and show a non-cash loss for the difference.

“Goodwill is what it is,” Delaney said. “It’s always a thing on the balance sheet you’d like to get rid of and frankly I’m glad we’re writing it off and getting rid of it.”

Once built, Ambatovy does promise to be one of the world’s most impressive nickel and cobalt mines.

The project lies 80 km east of the capital Antananarivo, and will have a production capacity of 60,000 tonnes nickel and 5,600 tonnes cobalt per year over a 27- year mine life.

By the end of 2008, Sherritt reported that engineering at the project was 88% complete, construction was 44% complete and procurement commitments were 68% complete. It says the mechanical completion of the project will come in the fourth quarter of 2010.

The fourth-quarter losses for the company worked out to $2.03 per share, compared with year-earlier earnings of $83.5 million or 36¢ per share.

The full-year loss was $1.05 per share, down from 2007 net earnings of $370.4 million or $1.79 per share. Annual revenue came in at $1.6 billion, up from $1.34 billion.

In Toronto on the latest financials, Sherritt’s shares fell roughly 19% or 49¢ to $2.10 on 4.6 million shares traded. The company’s shares have traded in a range of $1.75-17.35 over the last 52 weeks and it has 293 million shares outstanding.