ZRA’s tax bill gets FQM a Negative Outlook from Moody’s Rating Agency

Zambia Revenue Authority’s tax bill of of $8 billion has earned First Quantum Minerals Limited a negative outlook from the rating agency Moody’s

In a report released this week to the media, Moody’s said that while it affirmed the B3 corporate family rating (CFR), the B3-PD probability of default rating (PDR) and the B3 senior unsecured rating of First Quantum Minerals Ltd (FQM), the agency concurrently, changed the outlook to negative from stable.

The agency cited said that the negative outlook reflected the uncertainty of the magnitude of a potential settlement outcome with the ZRA and the timing of such in the light of limited financial resources to manage any material settlement.

Below is the full report

Moody’s affirms FQM’s B3 corporate family rating; outlook changed to negative

London, 27 March 2018 — Moody’s Investors Service has today affirmed the B3 corporate family rating (CFR), the B3-PD probability of default rating (PDR) and the B3 senior unsecured rating of First Quantum Minerals Ltd (FQM). Concurrently, Moody’s has changed the outlook to negative from stable.

“While we have recently recognized improved fundamentals of the global copper market and our expectation of materially rising EBITDA generation in 2018, the change of the outlook to negative reflects the risk associated with the assessment of the Zambia Revenue Authority (ZRA) for import duties, penalties and interest on consumables and spare parts of 76.5 billion Zambian kwacha equivalent to around USD7.9 billion”, says Sven Reinke, Senior Vice President and Moody’s lead analyst for FQM”.

RATINGS RATIONALE

FQM has confirmed that it has received a letter from ZRA noting an assessment for a liability of 76.5 billion Zambian kwacha equivalent to USD7.9 billion. Moody’s understands that the vast majority of the liability is related to penalties (equivalent to USD 2.1 billion) and interest (equivalent to USD 5.7 billion) rather than an actual potential import duty of around USD150 million on USD 540 million of goods imported by FQM between January 2012 and December 2017. FQM has stated that on some of the around 23,000 separate items in question there might have been an incorrect level of import duties applied, higher and lower than required. The company unequivocally refutes the assessment by the ZRA and questions the basis of the calculation.

The negative outlook signals that the company could be downgraded should a potential settlement have a material impact on FQM’s financial profile and liquidity position. The uncertainty of a potential settlement and the timing of such comes at a difficult time for FQM as the company has currently elevated leverage and high capital expenditure cash outflow both mainly related to the Cobre copper greenfield project in Panama. Accordingly, FQM has in Moody’s view currently only limited financial capacity for a large settlement payment.

FQM’s B3 corporate family rating also reflects the company’s solid fundamental position as a medium-sized, high-growth copper producer operating two large scale, high-quality, low-cost mines in Zambia, and several smaller mines in other jurisdictions. The company increased its copper production to 574 kt in 2017 compared to 539 kt in 2016 However, adjusted EBITDA improved only by 18% in 2017 to $1.1 billion despite copper prices having rallied by around 30% over the course of 2017 as EBITDA generation was affected by $568 million of hedging losses. For 2018 Moody’s expects FQM to increase EBITDA by around 40% to $1.6 billion, taking into account the company’s existing hedging arrangements at significantly higher prices than in 2017 and Moody’s copper price assumption of $2.75/lb for 2017, compared to current copper spot price of $3.10/lb.

In 2018, FQM continues to invest heavily into its Cobre greenfield copper project in Panama that it expects to bring on stream in 2019. The company has recently raised the project cost guidance to $6.3 billion from $5.7 billion previously and also increased its exposure to the project as it raised its ownership of the asset to 90% from 80%. FQM acquired LS-Nikko Copper Inc’s 10% stake in Cobre for $664 million of which $485 million will be paid in five instalments over a four-year period starting in 2018. FQM stated that a further $1.56 billion need to be invested to complete the Cobre project. The large investment plan will keep FQM’s capex high in 2018 and we expect the company to generate negative free cash flow of around $0.8 billion in 2018. However, once the Cobre project comes online and capex declines materially, free cash flow should turn strongly positive enabling FQM to deleverage rapidly in the absence of any new substantial projects.

FQM recently issued $1.85 billion of senior unsecured notes to repay some of its existing debt and to fund the large investment program. While the funding transaction has improved the company’s liquidity position and debt maturity profile, we expect that FQM’s adjusted leverage remains high this year. However, our forecast for EBITDA growth of around 40% this year (based on our copper price assumption of $2.75/lb) offsets the rising adjusted debt level and should result in adjusted debt/EBITDA falling from 7.7x at the end of 2017 to 6.1x in 2018 and further to around 5.1x in 2019.

During the expansion phase in Panama, FQM’s credit profile, remains constrained by the high metal, operational and country concentration, with about three quarters of 2018 EBITDA expected to be generated by two large copper mines in Zambia.

RATIONALE FOR THE NEGATIVE OUTLOOK

The negative outlook reflects the uncertainty of the magnitude of a potential settlement outcome with the ZRA and the timing of such in the light of limited financial resources to manage any material settlement. However, the outlook would likely be stabilized should FQM be able to settle the tax dispute without any material payment to the ZRA. Under such a scenario, the stabilization of the outlook would be justified by FQM’s improved liquidity position and the better profitability trajectory taking into account the stronger copper market fundamentals. A stable outlook would also require Moody’s continued expectation that FQM’s financial profile will strengthen, with adjusted leverage falling below 6x in 2019 and that the company will sustain a solid liquidity position.

LIQUIDITY POSITION

FQM has significantly improved its liquidity position with recent issuance of notes at a total amount of $1.85 billion. The new notes repaid a $700m term loan and the balance was used to fully pay down the utilization under the $1.5 billion RCF, which matures in December 2020. In the absence of any material tax settlement with the ZRA, the RCF together with the balance of unrestricted cash and cash equivalents of $702 million at the end of 2017 will enable FQM to fully fund the Cobre project taking into account the latest capex guidance. In addition, FQM has now only very limited debt maturities of less than $100 million in 2018 and 2019 which removes any debt refinancing needs until the end of 2020.

WHAT COULD CHANGE THE RATING — UP/DOWN

A stronger financial and operational profile, reflected in sustained positive FCF generation and reduced leverage, with adjusted debt/EBITDA below 4.5x, as well as strong execution and substantial de-risking of Cobre Panama project would support the upgrade of the CFR. A greater share of cash flow from projects outside of Zambia would be a requisite for an upgrade as well. The upgrade of the ratings will require FQM to sustain strong liquidity position.

Failure to timely reduce deleverage as a result of significant delays or cost overruns on the Cobre Panama project or a material financial settlement with the ZRA, with adjusted debt/EBITDA remaining above 6.0x, as well as weaker liquidity position would put negative pressure on B3 CFR.

PRINCIPAL METHODOLOGY

The principal methodology used in these ratings was Global Mining Industry published in August 2014. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

First Quantum Minerals Ltd (FQM), headquartered in Canada and listed on the Toronto Stock Exchange, is a medium size mining company with a large operation in Zambia (B3 stable), which represents the large part of the company’s earnings. In Zambia, FQM manages Kansanshi, a large and low-cost copper and gold deposit, as well as Sentinel a new low cost mine. FQM also operates a number of smaller mines in different countries. FQM has a 90% interest in Cobre Panama, one of the world’s largest copper deposits, in Panama (Baa2 positive). In 2017, FQM generated revenues of around $3.3 billion ($2.7 billion in 2016) and Moody’s adjusted EBITDA of around $1.1 billion ($0.9 billion in 2016).