S&P: Canada-Based Copper Producer First Quantum Minerals 'B' Rating Affirmed; Outlook Stable

S&P Global Ratings today affirmed its 'B' long-term issuer credit rating on Canada-based copper miner First Quantum Minerals Ltd. (FQM). The outlook is stable. We also affirmed our 'B' issue rating on the company's senior unsecured debt.

Based on the information provided by the company, FQM's successful track record of operations in Zambia, and the amount of the company's imports and of the original import duty in question ($150 million), we do not expect the outcome of the assessment by the Zambian Revenue Authority (ZRA) to result in FQM making a payment of the magnitude requested. Equally, we don't anticipate any disruptions to FQM's operations in Zambia, which were responsible for over 70% of its EBITDA in 2017. Our base case does not currently include any potential cash outflow related to the ZRA's ongoing assessment. We note that the company's existing sources of liquidity should enable it to absorb the financial implications of paying several hundred million dollars. We understand that the dispute with the ZRA may take six months or more to reach a resolution.

Although outside of our base-case scenario at this point, we will likely take a negative rating action if a fine of more than several hundred million dollars materializes, or if the situation starts to have an impact on company's operations in Zambia, for example if exports of copper or imports of consumables and spare parts are disrupted.

On March 20, 2018, FQM confirmed that it had received a letter from the ZRA indicating that FQM underpaid import customs duties for equipment and consumables of $540 million that FQM imported for the construction of the Sentinel project over 2012-2017. We understand that the import customs duties in Zambia vary between 0% and 25%, based on the specific component. ZRA is demanding 76.5 billion Zambian kwacha (about US$8 billion), consisting of the ZRA's assessment of under-paid amounts ($150 million), penalties ($2.1 billion), and interest ($5.7 billion). The company said that it "unequivocally refutes this assessment which does not appear to have any discernible basis of calculation and will continue working with the ZRA, as it normally does, to resolve the issue." FQM's management team believes that documentation for the imports in question are in order and that at the time of reporting, the duties applied were government-approved.

Recently, the company resolved an industrial action in its flagship copper project in Panama, Cobre Panama, resulting in only minor setbacks. We view the completion of the project in 2019, and the associated cash flow generation, as a key for the existing rating, and the company's ability to deleverage over time and offsetting some of the exposure to Zambia.

Our assessment of FQM's business risk profile as fair already incorporates the risk of operating in Zambia, where royalty, tax, and electricity costs are subject to considerable uncertainty. We also take into account risks related to company's ongoing large expansion project. This is partly offset by the company's low cost position, high operating margins, and management's track record of increasing production through greenfield and brownfield projects. We also expect concentration on Zambia, which is currently responsible for over 70% of EBITDA, to reduce from 2019, when the Cobre Panama mine is expected to be commissioned.

The rating is further constrained by high leverage; the S&P Global Ratings-adjusted debt to EBITDA was 6.0x in 2017 and its heavy capital expenditure (capex) on expansion has left it with deeply negative free operating cash flow (FOCF). That said, we expect FQM's credit metrics to improve in 2018 and 2019, mainly due to higher volumes, supportive copper prices, and progress on FQM's planned landmark Cobre Panama greenfield project. We also anticipate that the company may look to take on more greenfield projects in the future.

The stable outlook reflects an expected improvement in credit metrics in 2018 and 2019, mainly due to higher volumes, including commercial production at Cobre Panama expected in 2019, and supportive copper prices.

We expect the company to sustainably maintain an S&P Global Ratings-adjusted gross debt-to-EBITDA ratio of below 5x from 2018 onward for our current 'B' rating. In our base case, we forecast a leverage ratio of 4x-5x in 2018 and 3.0x-3.5x in 2019.

We currently don't expect FQM to make material payments in relation to the ZRA's $8 billion demand.

We could downgrade FQM if the company faces operational issues or there are delays or cost overruns in the commissioning of Cobre Panama, which would affect the company's liquidity or lead to a substantial increase in leverage to above 5.0x.

A materially lower copper price could also weigh on the ratings, although this risk is mitigated by the company's hedging of about 46% of the 2018 production at $2.80/pound, on average. The rating does not factor in any dividends or material mergers or acquisitions that would lead to a substantial increase in leverage. It also does not factor in any adverse country risk developments in Zambia, where the company generates over 70% of earnings.

We could also lower the rating if a fine related to the ongoing ZRA assessment of more than several hundred million dollars materializes, or if the situation starts to have an impact on the company's operations in Zambia, for example if exports of copper or imports of consumables and spare parts are disrupted.

We could consider upgrading FQM to 'B+' once the Cobre Panama facility is fully operational, provided that the company achieves the deleveraging path we expect in our base case and maintains leverage of 3x-4x sustainably over the cycle. An upgrade would likely also require a continued good operating performance, positive discretionary cash flow generation, and sufficiently strong liquidity to withstand a sovereign default, including potential exchange controls in Zambia.

Any positive rating action would need better visibility regarding the ZRA's demand.

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