Lundin Mining: An Exciting Growth Story

Introduction

Lundin Mining (OTCPK:LUNMF) [TSX:LUN:CA] just reported its Q1 2023 financial results. Overall, it was a strong start to the year, with most assets performing within expectations and production costs declining on the back of lower diesel and electricity prices.

The company has also expanded its already exciting growth pipeline. The development of the recently acquired Josemaria project in the highly prospective Vicuña district has just started. In addition, Lundin has closed a second acquisition, by buying a controlling interest in the Caserones mine at an attractive valuation. Caserones is an already producing asset of roughly the same size as Josemaria. It offers the significant advantage of being immediately accretive, and it is also strategically located not far away from both Candelaria and the Vicuña district. Interestingly, the same district hosts two other exceptional deposits owned by two junior companies that are also part of the Lundin group and could become takeover targets for Lundin Mining. Lundin Mining could thus become a true copper giant, with world-class assets concentrated geographically in the central Andes and leveraging infrastructure efficiencies between its different deposits.

With copper prices partially recovering from the brutal selloff of last summer, Lundin's share price has enjoyed a significant rally, rising almost 30% year-to-date and 45% since I first recommended the company. Though now less attractive on a relative basis, I continue to see Lundin as a top-quality, long-term holding in my portfolio and look forward to potential pullbacks as buying opportunities.

Q1 2023 results

Lundin released its Q1 results this week, reporting production of 103 thousand tonnes of copper-equivalent metal, tracking in line with its full-year guidance of 400 thousand tonnes.

Copper production increased by 9% quarter-over-quarter to 61.5 thousand tonnes, thanks to an increase in processed ores from Candelaria. Production at Chapada declined quarter-over-quarter, due to lower head grades and recovery rates. However, this decline was in line with expectations, as Chapada went through the rainy season. Overall, copper production tracks ahead of the full-year guidance of 236 to 260 thousand tonnes.

Zinc production also increased significantly, by about 10% quarter-over-quarter. This increase was driven by continued strong performance from Zinkgruvan and by increased throughput at Neves-Corvo thanks to the further ramp-up of its zinc expansion project (ZEP).

Nickel production came in on the soft side, declining quarter-over-quarter to 3,700 thousand tonnes. The decline was the result of expected lower grades at Eagle. Even with the slower start of the year, the company reiterated its full-year guidance of 13 to 16 thousand tonnes.

Gold production was strong at 36 thousand ounces, tracking in line with the annual guidance of 140 to 150 thousand ounces.

Turning to the financial metrics, Lundin Mining generated over $750 million in revenue, of which 70% due to copper, 13% to zinc, 8% to gold, 6% to nickel, and the rest to other byproduct metals. Copper sales were boosted by a $40 million adjustment compared to the previous quarter (Lundin is used to report part of its sales at provisional prices, which are often subject to final adjustments during the following reporting period). Adjusted EBITDA came in at over $335 million, operating cash flow at $235 million and free cash flow at over $70 million. Lundin was in a modest net debt position of $35 million by the end of the quarter, with available liquidity of approximately $1.7 billion via a revolving facility. The balance sheet is therefore in pristine condition.

During 2022, the company saw its margins contract, as base metal prices declined, while production costs rose driven by inflationary pressures. It is therefore encouraging to see that during Q1 production costs declined by around 7% to $420 million. In particular, the company benefited from a 50% reduction in electricity costs at Candelaria, thanks to the renegotiation of a new long-term contract starting in January 2023. Electricity costs more than halved at Neves Corvo, as prices eased from last year's record levels in Portugal.

Capital expenditures are tracking well with respect to the full-year guidance of $700 million, with $160 million already incurred during the first quarter, of which $90 million alone is for advancing the Josemaria project.

Josemaria project

Josemaria is a large scale copper-gold deposit currently under development. It was acquired in April 2022 and is located in the San Juan Province of Argentina, within the world-class Vicuña district. The Vicuña district is a new emerging giant copper-gold district in the central Andes, between Chile and Argentina. Within a radius of 15 kilometers, the Lundins have made three major discoveries: Filo del Sol, which is being advanced by Filo Mining (OTCQX:FLMMF), Los Helados by NGEx Minerals (OTCPK:NGXXF) [NGEX:CA], and finally Josemaria, which belonged to Josemaria Resources, later acquired by Lundin Mining. A fourth major copper deposit may also be present at Potro Cliffs, based on the exceptional drill results announced by NGEx Minerals in April 2023.

Once developed, Josemaria is expected to add more than 150 thousand tonnes of copper production per year. Total capital expenditures are estimated to be north of $4 billion, of which $700 million originally planned for this year. Based on comments during the conference call, it is likely that the CapEx will actually be lower than expected in 2023, as the company has just bought a controlling interest in the already developed Caserones mine. Overall, Josemaria is a long-term and expensive project, but with attractive economics and the possibility to benefit from infrastructure efficiencies with Candelaria.

Caserones mine acquisition

The big news since the start of the year has been the acquisition of a controlling interest in the Caserones mine from JX Nippon Mining & Metals Corporation. The mine is located in Chile, 160 kilometers from Candelaria, at an altitude of 4,500 meters above sea level. It is a big porphyry copper-molybdenum deposit, currently producing 125-130 thousand tonnes of copper per year, at a very competitive AISC of $2.54/lb in 2022. Historically, the mine has been plagued by all kinds of issues, from bad weather to increased labor costs, development delays and a series of technical problems during the ramp-up phase, so that its output has been consistently below its target production of 150 thousand tonnes per year. Because of the complexity of the project, it is likely that Caserones was somewhat of an unwanted asset for JX, which might explain why Lundin Mining was able to snatch it away at an attractive valuation.

Looking closer at the details of the transaction, Lundin Mining has agreed to buy 51% of Lumina Copper, the operator of the Caserones mine and a wholly owned subsidiary of JX. Lundin will pay an upfront cash consideration of $800 million, plus a further $150 million in six annual installments. In addition, Lundin has also obtained the option to buy an additional 19% interest for $350 million, over the 5-year period starting one year after the closing of the deal. Overall, Lundin may end up with 70% of Caserones at a price of $1.3 billion. This number is a significant discount compared with the $4.2 billion in capital expenditures that JX had to pay to develop the project in the first place.

With inflationary pressures raising the costs of new projects and political turmoil making the permitting process more complex, I speculated in the past that copper may end up outperforming copper miners in aggregate over the next decade. It is therefore interesting to see Lundin decide to buy new immediately available copper production. The asset is certainty a good addition to the existing portfolio. It contributes right away to free cash flow generation (even if the pro-rata contribution from Caserones is relatively low at $50 million per year based on 2022 results). It offers potential synergies with Candelaria's operations via common supply, logistical and management strategies. It provides significant upside, both via operational improvements that Lundin's management plans to introduce and exploration potential. In fact, the producing asset also comes with a significant land package in a highly prospective district, as proved by nearby discoveries.

One reason for skepticism might be the increased stress put on the balance sheet. However, even after the acquisition of Caserones, Lundin's leverage remains conservative. The net debt / operating cash flow ratio can be projected to be around 1 by the end of the year. This estimate is based on the fact that the latest disclosed net debt position stood at $93 million and assumes that $800 million will be withdrawn from the revolving facility to finance the Caserones transaction. Lundin will therefore be in a net debt position of approximately $890 million, compared with expected operating cash flow of around $1 billion. Overall, I believe it is a net positive to see the company leveraging its robust balance sheet to buy now further exposure to copper at an attractive valuation, especially if one believes that copper is in a secular bull market.

Conclusions

Lundin Mining has a world-class portfolio of long-life assets, with exposure to strategic metals critical to the energy transition, and an exciting growth pipeline.

In my opinion, the main risks are political in nature, since its main copper assets are located in Argentina and Chile. Such risks include a new taxation regime less favorable to miners, or outright expropriation via forced nationalization. The probability is low, though non-zero. One should also consider the fact that Lundin's portfolio is geographically diversified. If for instance Chilean copper production were severely curtailed for political reasons, the price of copper would likely spike and the rest of the company's portfolio would act as a partial hedge to compensate the loss. Lundin's projects are also technically challenging and capital intensive, so that inflationary pressures remain a risk factor. In the short-term, the share price might be negatively impacted by weakness in the copper market, fueled by recessionary fears and a slower than expected recovery in China.

Despite these risks, I continue to see Lundin Mining as an attractive company, with great leverage to copper prices, a capable management and an ambitious strategy. Personally, I believe the current price does not offer a significant enough margin of safety after the recent rally, but I plan to accumulate on potential pullbacks.

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