October 23, 2015 - 12:12pm EST by
2015 2016
Price: 8.17 EPS 0 0
Shares Out. (in M): 689 P/E 0 0
Market Cap (in $M): 4,271 P/FCF 0 0
Net Debt (in $M): 5,744 EBIT 0 0
TEV ($): 10,016 TEV/EBIT 0 0
Borrow Cost: General Collateral

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Sorry for the poor formatting.  If anyone knows a decent way to upload a PDF that doesn't get maimed in the formatting process, please let me know.  


Before we get started, let’s do a quick checklist to see if a First Quantum short makes sense.

·         Canadian mining company?  Check check check.  I know, I know…it should be two checks but when you put “Canadian” + “Mining” together, there is some real synergy.

·         Promotional management team? Check.  People think they are super awesome because they bought a big, money losing mine in Australia and made it make money (except it loses money now).   

·         Contrarian bet, and in fact loved by long-only community? Check.  The view has been that copper is the “best” commodity (tighter supply/demand, declining asset base) and that First Quantum is the only company delivering growth projects right as supply/demand is at its most strained over the next couple of years. 

·         Assets toward higher end of the cost curve?  Check.  The company’s existing projects are firmly in the 2nd/3rd quartile of the cost curve – and this is acknowledged by the sell-side.  Sentinel (discussed below) is in the 3rd quartile, while the company’s major development mine in Panama (opening in 2018/2019) is potentially 1st quartile (hey, it works on paper).   

·         New Project Development risk? Check.  New project opening as we speak (Sentinel), and another $6 billion development project underway (Cobre Panama). 

·         Levered? Check.  At copper spot in the mid 2s/lbs., let’s say 7x.  That’s a lot. 

·         Covenant issues? Check.  Legitimate chance of breach in early/mid 2016. 

·         Potential liquidity issues? Check.  Covenant issues probably end up exacerbating this issue as the banks tighten the reins.  

·         Bond yield conflicts with equity story? Check.  The bonds yield ~13-14% and trade in the high-70s/low 80s…while there is a C$5billion market cap).  Before some recent market-soothing commentary by management, the bonds were in the 60s.  Somebody is wrong.  You don’t have bond yields of 14%+ and equity caps that big as a % of EV. 

·         Legitimate country risk? Check.  Major assets in such delightful places as Zambia.  There have recently been massive power issues in Zambia that have impacted results at Kansanshi and the expected ramp-up of Sentinel. 

·         Commodity price dependent in midst of a potential global slowdown? Check.  50% of worldwide copper demand is from China.  Enough said. 

Well then!  At current copper prices in the ~$2.40/lbs. range (and certainly anything much below), First Quantum stock has a legitimate chance of being a zero.  That’s what generally happens to over-hyped, over-levered, development-dependent mining stocks at the tail of an economic cycle.  However, let’s just put a price target of C$3.00 to leave ourselves some room.  In any case, I spend the bulk of my analysis below evaluating First Quantum’s base business and its Sentinel project, but even I I’m wrong, there are multiple ways to win on the short side (leverage, execution risk, covenant breaches, etc.). 

First Quantum is a copper mining (some nickel, which doesn’t make money at even the EBITDA level) that owns and operates assets around the world from Zambia to Australia to Panama. 

Here are two keys to the First Quantum short: 


Base Business

First, the base business doesn’t generate much free cash flow at current levels.  After cutting through the confusing mix of metrics, run-rate EBITDA-CapEx (at spot) is probably in the ~$300-600 mm range.  This is versus an enterprise value of $10 billion.  In other words, the base business can’t possibly account for where the business trades today.  I would also note that a number of the company’s mines (Las Cruces and Guelb Moghrein being the most meaningful) have mine lives set to end in the 2020 timeframe.  These deserve valuation discounts if you’re using an EBITDA multiple (as one example).   

    Run-Rate Tonnage           EBITDA-CapEx $ Margin
    Low Mid High   Price C1+D&A* Margin   Low Mid High
Kansanshi 245 270 295   2.50 1.90 0.60   322 355 388
Las Cruces 80 80 80   2.50 2.02 0.48   85 85 85
Guelb Moghrein 38 38 38   2.50 1.61 0.89   75 75 75
Ravensthorpe - Nickel 18 18 18   4.75 5.67 (0.92)   (37) (37) (37)
Kevitsa - Nickel 8 8 8   4.75 7.14 (2.39)   (43) (43) (43)
Kevitsa - Copper 19 19 19   2.50 1.89 0.61   25 25 25
Cayeli   28 28 28   2.50 1.95 0.55   35 35 35
Pyhasalmi 14 14 14   2.50 3.13 (0.63)   (19) (19) (19)
Total   451 476 501     Segment EBITDA-CapEx 444 476 509
              SG&A     (185) (185) (185)
              EBITDA-CapEx   259 291 324
*C1 represents all major costs of mining except capex/d&a and royalties.  I've added those in to reflect more of an "all-in" cost basis
*I'm using D&A as a proxy for sustaining capex, which is arguably overly punitive          
*D&A implies ~$600 mm of capex whereas the company would probably argue sustaining is in the ~$300-400 mm range  
*However, even halving my capex estimate only takes EBITDA-CapEx to $600 mm -> this doesn't bridge the valuation gap  
            Copper Price    
          291 2.00 2.25 2.50 2.75 3.00    
          4.50 (219) 29 277 525 773    
      Nickel Price 4.75 (205) 43 291 539 787    
          5.00 (190) 58 306 554 802    

This brings us to point two, the company’s development assets: Sentinel (also known as Enterprise or Trident) and Cobre Panama.  Sentinel is being ramped as we speak, and Cobre Panama is a development project that is still in the middle of being built (including the massive capex to come – $1.5-2.0 billion more, and the execution risk that comes along with it).  I focus my analysis on Sentinel because 1) it is being ramped right now and 2) its success (or failure) is big enough to move the stock, 3) the buy/sell-side is focused on it, and 4) there is a reasonable chance it does not make any money at current copper prices.   

In evaluating Sentinel, we should compare it to two other mines in the area.