Wednesday, March 21, 2007

Quadra - When the hedge is over

Quadra is a $350 million, fully diluted, market cap mining company with a producing mine with 2007 production guidance:

  • 125 million pounds of copper,
  • 60,000 ounces of gold,
  • no guidance on molybdenum, 260,000 lb in 2006.
They have just obtained financing to build a second mine for start-up in 2008, guidance 28 million pounds, increasing to 75 million pounds in 2009, bringing the fully diluted number of shares up to 42.7 million. Additionally they have plans to develop a third mine in Chile which will produce 300 million pounds.

    Last year copper prices peaked at $3.99/lb and they have come down, slaughtering the earnings for most copper mines. Take Goldcorp, market cap 19.7 billion, earnings crumbled to 11c/share in Q2 from 50c/share in Q4 -- in Q2 Goldcorp's copper earnings accounted for 65% of their total earnings, and enabled them to claim -$123/oz production costs on gold, all from a mere 46,700 lbs of copper sales.

    For 2006 Quadra's eps was a mere $0.87, indeed, while Goldcorp was producing its record earnings, Quadra was losing money. Quadra made a hedge, and the hedge ended up costing Quadra $143.9 million in derivative expenses. The average LME price for copper in 2006 was $3.05, but Quadra's average price was $1.32/lb less, $1.73/lb, because of the hedge. $143.9 million in lost income amounts to $3.53/share. After taxes it means that $2.18/share of earning potential was lost to a bad hedge. Without the bad hedge, eps for 2006 would have been in the $3+/share range.

    Quadra has shipped the last of its hedged copper and will clear the last of its hedge loss this quarter.

    Think of the end of the hedge as an enormous cut to costs. Their income for 2006 was $393 million, and out of that came this enormous $144 million hedge cost, or 37% of their revenue.

    Another problem that Quadra had was lower than expected recovery rates, a mere 61% on copper until the last two weeks of December, where it increased back to the 70-80% recovery rate. This problem appears to have resolved now, but it also lowered overall production for 2006.

    So, Quadra is going into 2007 with a double leverage potential on earnings, an enormous reduction in expenses, and improved production rates. At $3/lb for copper, $375 million, at $650 for gold, $39 million, and perhap $5 million for their molybdenum, for 2007 revenue of about $419 million, and no $144 million hedge expense.

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