Copper World Risks And Cost Pressures Will Weigh On Long Term Outlook

Catalysts

About Hudbay Minerals

Hudbay Minerals is a diversified Americas focused mining company producing copper, gold and other metals from operations in Canada, Peru and British Columbia, with a large growth project at Copper World in the United States.

What are the underlying business or industry changes driving this perspective?

• The Copper World joint venture with Mitsubishi concentrates future capital and execution risk into a single large United States project. Any permitting delays or cost pressures tied to long lead engineering work and pre sanction spending could pressure future cash flows and delay the expected uplift in revenue.
• Hudbay is pushing ahead with integrated project development at Copper World, including higher front end spending on engineering and long lead items. This increases the exposure of future earnings and returns to potential construction cost inflation and schedule slip.
• The plan to materially increase copper exposure, with more than 70% of future consolidated production and revenue expected to come from copper, leaves the business more sensitive to any downturn in copper demand growth. This would feed directly into revenue variability and margin pressure.
• The accelerated stripping and mill upgrade program at Copper Mountain requires several years of elevated investment and operational fine tuning. Any further equipment issues similar to the SAG1 incident, or slower than anticipated throughput ramp up, could weigh on net margins and EBITDA from that asset.
• The multi year build out of exploration and mine life extensions in Snow Lake and Talbot, while positive for resource inventory, ties up capital and management attention. If new feed does not convert into economic reserves on the current timetable, it could constrain longer term earnings growth relative to expectations.

Assumptions

How have these above catalysts been quantified?

• This narrative explores a more pessimistic perspective on Hudbay Minerals compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Hudbay Minerals's revenue will grow by 6.5% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 27.5% today to 15.1% in 3 years time.
• The bearish analysts expect earnings to reach $448.8 million (and earnings per share of $0.98) by about August 2029, down from $678.2 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $1.1 billion.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 38.1x on those 2029 earnings, up from 17.3x today. This future PE is greater than the current PE for the CA Metals and Mining industry at 15.7x.
• The bearish analysts expect the number of shares outstanding to grow by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.03%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The company reports cash costs of US$0.42 per pound and sustaining cash costs of US$2.09 per pound of copper, with full year cash cost guidance ranges in Peru, Manitoba and British Columbia reaffirmed and even tightened, which supports the view that margins can stay resilient even through disruptions, a positive for net margins and operating earnings.
• Management highlights over US$1.04b of liquidity, including US$611 million in cash, a net debt to EBITDA ratio of 0.5x and ongoing debt reduction, which gives the company financial flexibility to absorb setbacks and still fund projects, reducing the risk of financial stress on earnings and cash flows.
• The Copper World joint venture with Mitsubishi brings in US$600 million of funding, reduces Hudbay’s future equity contribution on the project to an estimated US$200 million and defers major capital outlays to 2028 at the earliest, which lowers project funding risk and can support long term production growth, revenue and cash generation from copper.
• Operations in Peru, Manitoba and British Columbia continue to operate within or near production guidance ranges despite wildfires, social unrest and mill maintenance, and management refers to strong gold grades at Pampacancha and Manitoba along with a diversified copper and gold mix, which supports the potential for stable or growing consolidated revenue and EBITDA over a longer horizon.
• The company is investing heavily in long term growth through the Copper World feasibility study, the accelerated SAG2 mill project at Copper Mountain and its largest ever exploration program in Snow Lake and Talbot, which, if successful, could extend mine lives and raise production, supporting future revenue, earnings and potentially higher free cash flow.

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Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Hudbay Minerals is CA$34.65, which represents up to two standard deviations below the consensus price target of CA$42.38. This valuation is based on what can be assumed as the expectations of Hudbay Minerals's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of CA$52.42, and the most bearish reporting a price target of just CA$34.65.
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2029, revenues will be $3.0 billion, earnings will come to $448.8 million, and it would be trading on a PE ratio of 38.1x, assuming you use a discount rate of 8.0%.
• Given the current share price of CA$36.65, the analyst price target of CA$34.65 is 5.8% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.