Ecora Royalties PLC (ECOR) Earnings Call Transcript & Summary

Good day, and welcome to the Anglo Pacific webcast and conference call. At this time, I would like to turn the conference over to Julian Treger, CEO. Please go ahead.

Thank you, Danna. Thank you all for your time today and your interest in Anglo Pacific. As you may know, we've been looking for a transformational acquisition for some time to address some of the challenges in our strategy. And we're delighted and very excited to be announcing a transformational transaction today, whereby we will be acquiring a cash flow-generating cobalt stream from a private equity group focused on the global natural resources sector for a cash consideration upfront of $205 million. I'm going to cover the deal at a high level. I'll then hand over to Kevin Flynn, our CFO, who will discuss the financing. Then Marc Lafleche, our CIO, will cover the cobalt market and the details of the stream. And then I'll wrap up with the implications for Anglo Pacific. Juan Alvarez, our technical wizard, is available for any technical questions, too. So turning to Slide 2. This is, by far and away, the most important transaction in Anglo Pacific Group's history and will be a new cornerstone asset for us. This single acquisition significantly repositions our portfolio, addressing 2 of our biggest strategic challenges: the runoff of our income from Kestrel in the mid-term and shifting our portfolio away from coal and materially into 21st century metals. As you know, ESG remains very important to us, and this transaction is in keeping with the strategy with a very good carbon footprint on all measures and providing exposure to the electric vehicle and batteries market. This transaction also demonstrates another point of our strong capital reallocation track record. We sold our stake in Labrador Iron Ore at highs and have recycled that into cobalt at attractive entry points, which many think are close to the lows. As you will have seen from our trading update recently, we achieved a highly impressive 60% return from our Labrador investment. And that has partially enabled us to fund the Voisey's Bay acquisition. And we look forward to delivering similar returns to our shareholders from this deal. Finally, this transaction is expected to be immediately earnings accretive and stabilizes our earnings for many years, creating a platform for long-term earnings growth. I'll now turn to Page 3 to provide more details of the transaction. So for the $205 million, we're receiving almost 23% of the cobalt produced by Vale's Voisey Bay mine. Voisey's Bay is a world-class mine based in Canada, it's got a long life of mine, and it's very well positioned in the lowest half of the industry cost curve. So we expect the mine to generate good levels of profitability through the cycle. We have a strong counterparty in Vale. As most of you will know, Vale is one of the world's largest miners with a significant presence in Canada. And it is the 100% owner and operator of the mine. This acquisition also gives Anglo Pacific rare exposure to one of the largest sources of clean cobalt outside the DRC. This is quite scarce, and we think that in time, we may be able to achieve a premium for conflict-free cobalt from customers in the West. Going to more detail. Anglo Pacific will make ongoing payments equal to 18% of the cobalt reference price for each pound of cobalt delivered, so we keep 82%, until Anglo Pacific Group has recovered the original upfront amount paid for the stream. And then the ratio switches to 22% to Vale, and we keep 78%. And that sort of structure is pretty standard for a stream. We've also -- a well-structured downside protection mechanism if the mill throughput doesn't reach 85% of targeted levels by 2025. In addition to the upfront cash consideration of $205 million, we have agreed a contingent payment structure with the vendor, which kicks in under highly attractive cobalt price scenarios, roughly from $25 to $45 for cobalt. And importantly, Anglo Pacific Group will be a beneficiary of those higher prices too. And the structure is self-financing. This involves a maximum payment of $27 million over 5 years, subject, of course, to these high cobalt prices, but also subject to minimum volumes. So we'll only be making the payments if we have the revenues. We've done an incredible amount of due diligence both in-house and with external consultants on the cobalt market, on battery metals and the Voisey's Bay operation. And we're very confident that this next step will be positive and important for the group. The acquisition should initially generate 15 -- or $16 million for the remaining 10 months of this year and then will rise to around $23 million annually as the mine expands. But obviously, if cobalt prices do what we expect, these numbers could be significantly higher. With that, I will hand over to Kevin Flynn, our CFO, to go over the funding and financial impact of the transaction. Kevin?

Thank you, Julian, and good morning, everyone. So turning to Slide #4. We put together a very comprehensive financing package in order to acquire this historic asset for Anglo Pacific. The financing package includes 3 elements. The first is we are raising just under 20% of our issued share capital through both an institutional offering and participation through an online REIT for primary bid online retail platform. We would expect the current pricing levels and FX to raise in excess of $60 million of proceeds from this placing. Secondly, we've self-financed around about 40% of the acquisition through realizing $85 million from what was previously our 7% stake in the Labrador Iron Ore Royalty company. Especially given the fact that iron ore is trading at 9-year high and the liquidity of the asset, meant that we could recycle this capital in a very effective way. It's worth pointing out that at today's prices, we're retaining exposure to approximately $30 million, which broadly equates to our profit. And this retention serves 2 main purposes: one, it provides very good income to the group, it's a high-yielding asset; but also as demonstrated with this transaction, it's also a very useful financing option for future acquisitions to come. Finally, we are entering into a new group borrowing facility with a trio of very large blue-chip Canadian banks who are market leaders in financing the North American royalty and streaming sector. And we believe that this is a very good endorsement of the quality of the assets that we're acquiring here, and indeed, of our business model. The new facility provides us with much more flexibility for future acquisitions, it's much more of an acquisition facility, allowing higher day 1 leverage ratios. Upon transacting on the Voisey’s Bay stream, we would anticipate being at around about 3x levered. But given the strong cash profile associated with this acquisition that Julian mentioned, and indeed, the cash that we generate from our other portfolio of interest, we would expect our leverage to return to around about 2x within a relative short term, 9 to 12 months. In terms of pricing, this facility is very similar to our outgoing facility. It's a LIBOR ratchet pricing mechanism based on various levels of leverage. The lowest ratchet is 275 basis points, going up to 4.5 basis points. But for Anglo Pacific, we would -- we -- our projections would show that we would anticipate being in the range of 275 to 350 bps over LIBOR. We feel very comfortable operating under these leverage ratios. Our operating restriction is capped at 3.5x. So we've got sufficient operating headroom under this facility, but also scope to draw down further for future growth. As we know, the stream is currently in production. It's immediately cash-generative and accretive to our earnings. But more importantly, this transaction provides earnings stability for the group over a longer-term time horizon, especially as we begin the point at which Kestrel will start to operate outside of our private royalty area. So this is a key feature and should enable us to continue to support longer-term shareholder returns over a much longer time horizon. Back to Julian.

Thank you, Kevin. So turning to Slide 5. As shareholders of Anglo Pacific will know, we've been very disciplined about making new acquisitions. We have very high requirements and standards, and it's very difficult to find opportunities which tick all our boxes. I'm happy to say that this transaction fits all our criteria. It transforms our commodity exposure towards battery metals in a very decisive way. Voisey's Bay is a world-class mine, which is expected to generate cash flow through cycle. We have opportunistically redeployed capital from what we think is an overvalued commodity in iron ore to something which is undervalued. We have a Tier 1 counterparty, an asset in the Tier 1 jurisdiction. The project has strong ESG characteristics, and it should generate the returns that we expect, which are in the region of 7.5% to 12%, depending upon cobalt price assumptions. And importantly, we are very bullish about the future pricing trajectory of cobalt. And on that note, I will hand over to Marc Lafleche, our CIO, to go over the electric vehicle growth and cobalt demand stories and also the Voisey's Bay mine in more detail. Marc?

Thank you, Julian. Over the past months, we have completed a tremendous amount of due diligence in relation to the cobalt commodity outlook. And simply put, the long-term fundamentals of the cobalt market appear to be extremely favorable. Starting on the demand side. The story is very much driven by the accelerating trend towards the adoption of electric vehicles. Auto manufacturers have made bold promises about transitioning to an electrified emissions-free future. Most recently, we've seen Ford and GM publicly target fully electrified vehicle fleets by 2030; and even more ambitiously, Jaguar targeting fully electrified luxury brand by 2025. This thematic is consistent amongst a number of auto manufacturers, including Volkswagen and others. And one thing is absolutely clear, should this future be realized, they will require a lot of batteries. To put some numbers around recent EV sales growth. In December 2020, year-on-year, global sales were up 50%, and European EV sales, up 260% through the year-on-year period. The European growth, in part, is driven by very supportive government policy. Similarly, demand growth in China, equally driven by a push towards a reduction in carbon emissions. And what we've seen in the new Biden administration, the fast-tracking of carbon reduction and the expectation of policy support for EV adoption. In terms of cobalt substitution risk, we've considered this very carefully, and it does appear as though the majority of OEM technology road maps are based on cobalt-containing cathodes to the 2030s. And as such, cobalt is very much expected to remain a key component of the EV cathodes. We've also considered alternate technologies substitution risk within iron phosphate batteries, hydrogen technologies, amongst many others. And in that context, cobalt demand does appear to remain extremely strong. Switching to the supply dynamics. These appear absolutely equally favorable. Supply is challenged and constrained by a number of key factors. Number one, the vast majority of global cobalt supply is produced in challenging jurisdictions. Almost 70%, the world's current supply -- on Page 7, you can see that almost 70% of supply is tied to the Democratic Republic of Congo, which is a very challenging jurisdiction to operate and does not attract as many operators as one would expect relative to mining operations in Canada or Australia. Supply of cobalt is also extremely inelastic simply due to the fact that the vast majority of cobalt is produced as a by-product. To our knowledge, there's only 1 stand-alone cobalt mine in the world. All other cobalt is produced as a by-product of nickel or copper operations. And in the context of quickly ramping up cobalt supply, the economic decision is very much intertwined with the significant capital cost and time horizon required to bring a cobalt -- copper, excuse me, or nickel mine online. Third, a good chunk of cobalt supply from the Democratic Republic of Congo appears to be subject to significant ESG concerns. And while the vast majority of operators in the Congo do not have these challenges, there does appear to be a global concern with regard to the providence of that cobalt rightly or wrongly. In the recent weeks, we've seen this investment pieces play out. Cobalt prices have improved almost 50% from very low levels, however, still remain almost 50% below peak cobalt prices seen in 2018. And going forward, we've considered in great detail what is the risk of supply from the battery recycling sector. However, one thing became absolutely clear very quickly. Similar to the scrap steel industry, for secondary supply from cobalt -- battery recycling to contribute meaningfully, one does require significant stock of batteries to recycle. And given the long lead time and life of batteries today, recycling is not expected to contribute meaningfully to cobalt supply until the middle of the next decade. Switching on to the Voisey’s Bay mine itself. As Julian mentioned, as a group, Anglo Pacific has a track record of being disciplined and conservative. But looking at this mine, it's very hard not to get excited. Simply put, the mine is a Tier 1 operation with a Tier 1 operator in a Tier 1 country. It has an established track record of production dating back to 2005. It's a low-cost operation with strong through-the-cycle cash flow generation. And it has a long mine life. Reserve base mine life extends to 2034 with further life of mine upside potential. Switching on to Page 9. On the left-hand side of the page, you can see very clearly that the Voisey’s Bay mine is extremely well positioned on the global cost curve in terms of cost, on the left-hand side of the page. And on the right-hand side of the page, something that we're extremely excited about as well in terms of our ESG footprint, the Voisey's Bay mine per unit of nickel produces amongst the lowest emissions of carbon of all global nickel mines. We think this is absolutely fantastic for the Anglo Pacific business, particularly when considered in the context of Voisey’s Bay mine industry-leading sustainability and safety track record. So I hand it back to you, Julian, now, to discuss on portfolio impact.

Okay. Great. Thank you very much, Marc. So we're now on Slide 10, and we're looking at what this really means for Anglo Pacific in terms of its makeup. And what it does, really, is materially pivots us to the 21st century commodity. So the pie chart on the left part of Slide 10, just look at our commodity exposure by portfolio value. So this is net asset value as of the end of last year and adjusted for the sale of Labrador Iron Ore. We sold roughly 75% of that and also for this acquisition. What you see here is that iron ore and coking coal together were 48% of our net asset value. They now drop on a pro forma basis to 20%. So that's a huge shift. And in contrast, battery metals go from 22% to 61% with cobalt being 46% of our asset base. So we provide enormous exposure now to cobalt through our asset figures, but we've done so without compromising our geographic exposure. We continue to be almost 100% exposed to prime jurisdictions, though OECD percentage has risen slightly. Importantly, though, the Canadian percentage has risen a lot from almost 40% to 60%. And with the addition of the 3 Canadian banks now funding us, we are going to be making a major push into the Canadian market in the coming months. We are effectively now a Canadian royalty streaming business, and Canadian investors tend to rate these stocks much more highly than we've been rated on the London market. So to the extent we can bring in further Canadian investors, we think this is a great opportunity to do so. The next slide, Slide 11, looks at the pro forma effect from a revenue basis. So this is our income. And we start with coking coal being much higher than its net asset value because Kestrel has a shorter life than most assets in our portfolio and is producing a lot of income in these years. But even there, you see battery metals, on a pro forma basis, rising up to 41% and coking coal dropping below that. For the first time in Anglo Pacific's history, the majority of our income is not going to be coming from coking coal. And if you add in the opportunity that we have to invest in Brazil nickel, which we've talked about, this very exciting battery quality nickel project in Brazil, which the U.S. government has recently funded with equity, when that comes to fruition, our income will be more than 50% from battery metals. And actually, at that time, coking coal is unlikely to be as much as 30% because it will be in the mid-20s, and Kestrel's income will have declined further by then. So we're definitely on track to become an increasingly battery metals-focused royalty and streaming company, which, I think, will attract a higher rating from investors who are excited about the growth prospects this represents. Turning to Slide 12. This looks at the capital allocation decision we made in selling out of Labrador Iron Ore to invest in the Voisey's Bay cobalt stream. And what you can see on the left side of the page is that since we invested in Labrador Iron Ore roughly 2, 2.5 years ago, the iron ore price has risen very significantly such that, as you can see on the right-top part of the page, iron ore now trades at well over twice the long-term consensus price forecast. So we think that there's definitely more downside than upside with iron ore. And when we make decisions about how to recycle the shareholder capital in a sensible fashion, effectively recycling out of coal into commodities, which we think are undervalued. We generally try and look at -- for commodities where the spot price is below what we think the long-term price will be because that's the best way of making money from investing in the mining sector. And we think that, that is the case with cobalt. As you can see in the light blue line on the left side of the page, cobalt did go up in 2018, but then it subsequently fell back to under 50% of its lows. And even though it has had a reasonably strong start to the year, particularly with some Chinese stockpiling -- and by the way, we think that it's possible in due course that the Europe will stockpile, the U.S. will stockpile and Japan will stockpile cobalt as well. The price today continues to trade below the long-term forecast of RBC, which is $27. The spot price is around $23, $24. So there's upside on that. But we think that the consensus is below where the pricing will go. We expect cobalt to meaningfully outperform in both the near and the long term. And we're excited that Anglo Pacific Group is going to be positioned as the investors' choice for future exposure to clean and ethically sourced cobalt in the U.K. market because there are no other opportunities to get almost 50% exposure to cobalt. The major players, Glencore and also Silver Wheaton, amongst others, have much bigger businesses, of which cobalt is a small proportion. So hopefully, we can become the go-to stock for people seeking conflict-free cobalt exposure. So just wrapping up on Slide 13. This is a tremendously exciting acquisition for us with the addition of a new cornerstone asset to the portfolio. It's by far and away, the most meaningful transaction we've undertaken in our history, and in one go, serves to materially reposition the portfolio and reposition us as one of the leading battery metals royalty and streaming companies globally. It posts solid ESG credentials, literally the carbon footprint of the mine is almost off the charts in a good way, and dramatically improves our environmental footprint. Also, it is immediately earnings accretive and provides a solid base for long-term earnings growth. Although we are very focused on such growth, we will continue to pay a lot of attention to returning appropriate levels of income to our investors. Importantly, we retain significant flexibility as a group going forward to deliver further meaningful growth. And we're currently looking at a number of accretive opportunities in the battery metals area, of course. And in particular, there is a base metals royalty in an OECD country, which could entail a $50 million or so upfront cash consideration. If this were to come to fruition, this could be funded through a combination of cash from our borrowing facilities and further monetization of our Labrador Iron Ore holding. So although this is a big step for Anglo Pacific and really changes our profile and positioning, it is just the first of many steps. And we are confident that there are a number of other transactions in the pipeline. We want to keep the momentum that we will have established with this deal. So thank you for your interest. I would now be keen to take any questions you might have.

[Operator Instructions] We will take our first question from Tyler Broda with RBC.

Congratulations on getting us across the line. Can I ask 2 questions? The first one, what discount rate internally do you use for this sort of transaction? Just thinking about it in terms of the benefits you get as well from an ESG perspective. And then secondly, is it possible to provide a bit more detail around the contingent liability? How does that work in practice, that $27 million?

Sure. Why don't I hand over to Marc, who's been covering the modeling of the transaction. Marc?

Okay. Tyler, in terms of discount rate, as Julian mentioned, we see the IRRs in this transaction ranging from 7% to 12% depending on what is long-term cobalt price assumption. In terms of the contingent liability, the way to think about this very much is a price-linked contingent liability subject to future cobalt prices and production, where the maximum payable over the period of 5 years could reach $27 million. That would, of course, very much depend on where cobalt prices are and cobalt prices being in excess of $40 per pound over the period, at the low end, below $25. And as you range down from $40 to $25, that payment obligation would scale back significantly.

I mean, I think, in terms of discount rates, if you think about Canada and you think about the amazing ESG profile, you could apply a lower discount rate to this. But obviously, that would be your choice, Tyler.

And we will now take our next question from Riya Kotecha with Bank of America Merrill Lynch.

I'm just wondering, how do you square having both battery metals and coal from an ESG perspective in your portfolio? Are you sort of then sellers of the coal royalties in the medium term? My second question is, are you able to confirm who the seller is?

So I think we are moving decisively with this transaction from a coal heritage to a situation where coal is becoming increasingly a sideshow for Anglo Pacific. The Kestrel royalties will decline over the course of a decade, and there should be a reasonable step down within a year or 2. So Kestrel itself will become less significant over time. Our thermal coal exposure is close to 10% at the moment. I think with further acquisitions, it will drop below 10%. We've said we're not going to make more thermal coal acquisitions, and we would be open to disposing of this at the right price. But it's obviously not the hottest part of the royalty sector at the moment. At the end of the day, some ESG funds will support a company in transition, and we clearly are. I mean, we've gone from almost having entirely coal exposure to coal being now around 20% of our portfolio by value. And that percentage will continue to decline. So people who are interested in supporting companies in transition whose carbon footprint is changing in a very significant fashion, I think, will be interested in supporting us. There will be some people for whom, even if you have 1 tonne of coal in your portfolio, it's 1 tonne too much. And those people will not be converted yet. But I hope that people see with the decisive move that we're making the statement of intent we have in terms of where we aim to get to. Sorry, your second question was?

Can you confirm who the seller is? You mentioned a private equity group, I think.

No, yes, I mean, that's not something we can publicly confirm. But it is something which is generally in the public domain at this time.

[Operator Instructions] We will now take our next question from Richard Hatch with Berenberg.

Congrats on a transformational deal. Two questions. First one, just in terms of physical metal which is available, I believe that there are some sort of stockpiles of physical metal of cobalt held by additional sort of financial groups. Can you just kind of give a bit of a flavor on sort of volumes of that? Whether you see any of that drifting into the market, whether there's any sort of risk to the price if that gets dripped into the market and at what kind of volume? It would be helpful. And the second one, it's just for Kevin, just on the dividends and the covenants. Just a point of clarification, are you comfortable that you're able to continue paying dividends through into 2021 just based on the covenants that come with debt?

Well, I mean, as I mentioned previously, I think, in contrast with the breakdown of global supply chains, the strategic nature of cobalt and the fact that China, the U.S., Europe and Japan are all going to develop their own supply chains, I think there's going to be more stockpiling of cobalt to protect the electric future and various strategic industries and countries. But I'll hand over to Marc to talk about the first question, and then we'll go to Kevin for the second. Marc?

Thanks, Julian. Richard, we can't necessarily comment publicly as to what another group may or may not do or confirm the levels that another group may or may not have. I think what we could say is that we would expect any group to behave rationally and to seek to maximize profits in relation to stockpiles, which may or may not be had. And as Julian mentioned -- and if you refer to the supply-demand balance, the forecast in terms of the net supply deficit, it does appear to be a significant supply deficit, sort of mid-decade onwards, being forecast by industry forecasters. And on that basis, one -- a group that does have strategic metals, particularly in the context of the importance of these metals to the EV supply chain, may or may not wish to keep hold of them today or monetize a portion or sell them into the future at higher price levels.

Taking your second question, Richard. We have dispensation in our facility to pay the Q4 dividend that we've recently proposed, subject to shareholder approval at the AGM. And going forward, so long as we're under 2.5x levered, there are no restrictions on dividends. And we would anticipate operating comfortably within that scope going forward. So we don't envisage any challenges to paying dividends as a result of the new exposure.

Is that even if you do the $60 million deal that you've kind of alluded to in this presentation as well?

Yes, that's right. Look, clearly, any deal we do will also generate income. So we're not going to jeopardize our ability to pay dividends with a transaction. So these things will be certainly kind of taken into account and factored in at the point that we get them.