Compania Minera Milpo

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1 Feb13 Mar13 Apr13 May13 Jun13 Jul13 Aug13 Sep13 Oct13 Nov13 Dec13 Jan14 Feb14 EQUITY RESEARCH Initial Coverage February 27th 2014 Alberto Arispe Edder Castro Head of Research Analyst (511) (511) Mining Industry Fair Value Compania Minera Milpo PEN 2.75 BUY Cia. Minera Milpo S.A.A. (LSE: MILPOC1) Zinc Play with potential diversification towards copper Equity's Fair Value (PEN MM) Share's Fair Value (PEN) Recommendation Market Capitalization (PEN MM) Share's Market Price (PEN) Shares Outstanding* (MM) Upside ADTV LTM (PEN) Range 52 weeks YTD Change Dividend Yield LTM Trading 3, Kallpa Securities SAB initiates coverage of Compania Minera Milpo Buy S.A.A. (Milpo) with a buy recommendation. Our PEN 2.75 fair value (FV) per MILPOC1 share is 29.8% above its PEN 2.12 price, as of closing of 2.12 February 26th , , % Milpo is a polymetallic mining company which operates 3 mines in Peru (Atacocha, El Porvenir and Cerro Lindo). Aside its mining units, the company has an interesting copper and zinc Greenfield portfolio (Magistral, 0.5% Hilarion and Pukaqaqa), and a copper brownfield portfolio (Chapi and 0.0% Ivan). Additionally, it is part of Votorantim Participacoes S.A., which has a 50.1% stake over Milpo s common shares. 482, LSE (*) Include 1,099 MM common shares and 11.6 MM investment shares ADTV: Average daily traded volume LTM: Last twelve months Source: Bloomberg, Kallpa SAB Financial Ratios e 2015e We value Milpo using a Discounted Cash Flow to the Firm methodology with a 10.37% discount rate and a 1.5% long term growth rate. We project the company s financial statements in an 8 years period which identifies two stages: , where Atacocha s operations culminate in the last year and the subsidiary is liquidated; and , where El Porvenir and Cerro Lindo mines are the only mining units that operate (the base for our perpetuity period). P / E P / BV EV / EBITDA Debt / EBITDA EBITDA / Interest expen. EPS (USD) ROE ROA % 6.6% % 7.7% % 7.4% EV: Market Cap. + Preferred Equity + Total Debt Cash & Cash eq. Source: SMV, Kallpa SAB Chart Nº 1: MILPOC1 vs. Zinc Spot PEN USD/Lb MILPOC1 Zinc Spot It is worth mentioning that our FV includes In Situ values from the project portfolio (Greenfield and brownfield), and that we apply penalties to the resources in accordance to their classifications (10% to measured resources, 20% to indicated resources and 30% to inferred resources). This, since resources are related to lower certainty levels with regard to their exploitations, and to average mineral grades. The value from these projects represents 19.2% of our FV or PEN 0.53 per share. As of closing of 2013, Milpo s net income increased 238.7% YoY, since it increased El Porvenir mine s production capacity (from 5,100 to 5,600 TPD) and Cerro Lindo s production capacity (from 10,500 to 15,000 TPD). This strategy compensates the fall in global prices for base and precious metals, as well as the production paralyzation of copper cathodes. In 2014, the company will seek an operating integration between Atacocha and El Porvenir mines, both located in the region of Cerro de Pasco, in order to reduce costs. Additionally, the company will continue its exploration campaign in order to increase the mineral inventory from its operating mines as well as its projects. In this way, it may increase the life of mine of its current operations and propitiate the economic viability of its Greenfield and brownfield projects Considering these factors, we have estimated a PEN 2.75 fair value per MILPOC1 share. Hence, we give a buy recommendation. Source: Bloomberg

2 Company's financial summary INCOME STATEMENT (USD MM) Net Sales Cost of Sales Gross Income Amortization of Intangibles Sales Expenses Administrative Expenses Other Expenses, net Operating Income Net Interest Expenses Income Before Taxes Taxes Net Income Minority Interest Attributable to Milpo Shares Outstanding Average (MM) Earnings per share EPS (USD) Depreciation & Amortization EBITDA e 2015e BALANCE SHEET (USD MM) e 2015e Cash & Cash Equivalents Accounts Receivable Inventory Other short term assets Current assets Fixed Assets, net Other Long Term Assets Non Current Assets Total Assets 1, , , Short Term Debt Accounts Payable Short Term Provisions Current Liabilities Long Term Debt Long Term Provisions and Deferred Taxes ,111 1,111 1,111 Non Current Liabilities Equity Attributable to Milpo Minority Interest Total Liabilities + Equity 1, , ,221.0 MARGINS AND GROWTH RATES Gross Margin Operating Margin EBITDA Margin Net Margin Sales' Growth Operating Income's Growth EBITDA's Growth Net Income's Growth e 2015e CASH FLOW (USD MM) e 2015e 38.6% 39.9% 40.0% Net Income % 19.5% 19.1% Depreciation & Amortization % 40.0% 40.7% Changes in Working Capital % 12.1% 11.6% Other Adjustments % 4.5% 0.3% Operating Cash Flow % 4.0% 1.7% Investment Cash Flow % 11.2% 2.1% Financing Cash Flow % 26.9% 4.0% Free Cash Flow FINANCIAL RATIOS Current Assets / Current Liabilities Inventory Turnover (days) Debt / Equity Debt / EBITDA Dividends per share (USD) ROE ROA ROIC e 2015e CHART N 2: SHAREHOLDERS AS OF AUGUST % 18.7% % 17.1% 16.2% 8.3% 6.6% 7.7% 7.4% 12.3% 11.4% 11.3% 50.1% Peruvian Pension Funds Votorantim Group Carvel Inc. Others VALUATION e 2015e P / Sales P / E CHART N 3: FAIR VALUE'S COMPOSITION EV / EBIT % EV / EBITDA P / BV % 4.9% Direct operations MANAGEMENT 6.2% Magistral Victor Gobitz Colchado CEO Hilarion Persio Morassutti Eugenio Ferrari Graham Speirs Drummond CFO Mineral Resources Corp. Manager Projects Corp. Manager 80.8% Pukaqaqa Chapi Sulphides Edward Medina Barcena Cerro Lindo mining unit Manager Jose Luis Alcalá Valencia Pasco mining operations Manager, Kallpa SAB Initial Coverage 2

3 Index I. Investment thesis: Buy... 4 II. Compania Minera Milpo S.A.A i. ii. iii. iv. v. vi. vii. viii. ix. Company's description 6 Operating mining units 7 Mineral inventory: Reserves and resources 7 Brownfield project portfolio 9 Greenfield project portfolio 9 Production 11 Net sales 11 Cost reduction strategy 12 Tax regime 12 III. Valuation 13 i. Production 13 ii. Price vector 14 iii. iv. v. vi. vii. viii. Operating costs 14 CAPEX 15 Indebtedness 15 Discount rate 16 Risks 16 Catalysts 17 IV. Scenario analysis 18 V. Sensitivity analysis 19 VI. Multiple Analysis 20 VII. Annex 1: Financial Statements 21 Initial Coverage 3

4 I. Investment thesis: Buy i. 100% Peru risk: Currently, the company operates 3 mining units: Atacocha and El Porvenir, both located in the region and province of Pasco; and Cerro Lindo, located in the province of Chincha (region of Ica). These 3 mining units are polymetallic deposits which are characterized for being underground mines. Given this, the continuity of Milpo s operations is subject to environmental, social and tax regulations imposed to the mining industry by the Peruvian government. Additionally, the country s political conjuncture and economic performance might impact the company s results. ii. Exposure to zinc: Although Milpo is considered a polymetallic mining company, approximately 50% of its income correspond to the zinc content of its concentrates. In terms of relevance, it is followed by copper (considering copper cathodes and concentrates) and silver with 30% and 14% stakes, respectively. The remaining stake correspond to lead. It is worth mentioning the positive view that analysts have over lead and zinc prices (approximately 60% of the company s income) for next years. The positive perspective over zinc and lead prices is due to a decrease in the global supply by mine shutdowns in Canada, Australia and Ireland; and to a higher demand directed to the automotive industry, respectively. With regard to copper price, it will be subject of China s economic performance, since China is the main copper purchaser worldwide. iii. Higher scale of operations improves financial margins: In 2013, Milpo culminated the projects regarding capacity expansions in El Porvenir mine (a 10% increase to 5,600 TPD), and Cerro Lindo mine (a 43% increase to 15,000 TPD), both related to a USD 200 MM CAPEX. These projects increase the company s operations scale, generating productivity improvements that are reflected in higher financial margins. In this way, 2012 s operating margin passed from 9.4% to 19.5% in In the same way, 2012 s EBITDA passed from 34.2% to 37.6% in It is worth mentioning that this was achieved in spite of the fall in metal prices reached in 2013, and to the paralyzation of copper operations regarding the production of copper cathodes. iv. A life of mine longer than 10 years: The life of mine from Atacocha, El Porvenir and Cerro Lindo, considering only their reserve inventories (updated as of 2012), is 1 year, 5 years and 7 years, respectively. However, considering only reserve inventories result in a conservative measure for the life of mine. However, if considering the reserve and resource inventories, operations in Atacocha, El Porvenir and Cerro Lindo will continue for 8 years, 19 years and 13 years, respectively. Despite the fact that the company s mineral inventory allows to maintaining the same production level for at least until 2019 (we estimate that in 2019 Atacocha will have consumed its mineral inventory and the subsidiary will be liquidated), the company will keep on investing in exploration activities in order to replace and to increase its reserve and resource inventory. In this way, the company will ensure the continuity of its operations in the future. v. An interesting project portfolio: Milpo differentiates its project portfolio in brownfield and Greenfield projects. Brownfield projects are Chapi (Moquegua, Peru) and Ivan (Antofagasta, Chile), which are copper mines paralyzed since 2012 by a reduction in head grades towards unprofitable exploitation levels. These mining deposits were exploited by two Milpo s subsidiaries: Minera Pampa de Cobre S.A. and Minera Rayrock Antofagasta Ltd., respectively. During 2013, the company focused its efforts in exploring such mining deposits as well as nearby prospects in order to find promising mineralization zones. Greenfield projects, which are located in Peru, are Hilarion (zinc), Magistral (copper) and Pukaqaqa (copper). These prospects are potential mining units that will support the company s future growth. As well as with brownfield projects, the company carried out exploration activities in 2013, seeking to reclassify inferred and indicated resources into reserves. vi. Social risk and environmental sanctions: As of closing of January 2014, the company does not have environmental conflicts reported in Defensoria del Pueblo. Additionally, Milpo focuses part of its resources in social development initiatives regarding education, healthcare and nutrition purposes, in districts where the company develops its mining activities. Consequently, we do not anticipate potential social conflicts that would affect the company s operations, hence our valuation. Initial Coverage 4

5 With regard to the possibility of receiving sanctions from environmental issues, in August 29th 2012, there was a leakage of sediments from a sedimentation pond in Atacocha mining unit, which released sediments into Huallaga River. However, the event was 100% fixed in September 1st 2012 thanks to a developed contingency plan. vii. Support from Grupo Votorantim: Milpo is part of Votorantim Group through Votorantim Metais Ltda., which is Milpo s major shareholder with a 50.1% stake. This Brazilian group has presence in 22 countries and operates in cement, metal, steel, energy, agro industry and financial industries, among others. Initial Coverage 5

6 II. Compania Minera Milpo S.A.A. i. Company's description Compania Minera Milpo S.A.A. was founded in April 6th It was constituted in order to carry out the exploration, exploitation and commercialization of lead, zinc and copper concentrates in its own mining deposits. Its operating mining units are located in Peru (the regions of Pasco and Ica). El Porvenir mining unit is the polymetallic deposit with which Milpo began operations in Then, the company directed its efforts to diversify its metal portfolio. Consequently, it began operations in two copper mines: Ivan (1999) and Chapi (2006). Finally, the company sought to obtain a higher scale through the opening and the acquisition of two additional polymetallic mines, Cerro Lindo (2007) and Atacocha (2008), respectively. Chart N 4: Compania Minera Milpo S.A.A.'s timeline 1949: Milpo's foundation (El Porvenir) 1999: Ivan's beginning of operations 2006: Chapi's beginning of operations 2007: Cerro Lindo's beginning of operations 2008: Milpo acquires 68.5% of Atacocha. 2010: Votorantim acquires 44.4% of Milpo. 2012: Temporary stoppages in Iván and Chapi. In August 5th 2010, the company formed part of Economic Group Votorantim, which obtained a 44.4% indirect stake over Compania Minera Milpo S.A.A. s class A shares. Currently, Grupo Economico Votorantim is Compania Minera Milpo S.A.A. s major shareholder with a 50.1% stake. Grupo Votorantim s current presence in Milpo is appreciated in the following organization chart: Chart N 5: Grupo Votorantim's organization chart Votorantim Participaciones S.A % Votorantim Industrial S.A. 91.9% Votorantim Metais Ltda. 99.9% Votorantim Metais Zinco Others 68.5% Votorantim Invest. Lat. America (VILA) 100.0% Votorantim Andina S.A. (VASA) 99.7% Votorantim Metais Cajamarquilla S.A % 100.0% 100.0% Minera Rayrock Antofagasta Ltd. Minera Pampa de Cobre S.A. Minera El Muki S.A. 50.1% Compañía Minera Milpo S.A.A % Milpo Andina Peru 88.2% Compañía Minera 100.0% S.A.C. Atacocha S.A.A. Minera Atasilver S.A.C., Kallpa SAB Recently, in February 10th 2014, Compania Minera Atacocha S.A.A. merger with Minera Atasilver S.A.C. in order to reduce administrative expenses inherent to the existence of 2 juridical persons. Initial Coverage 6

7 ii. Operating mining units Chart N 6: Operations and projects Geographical location a) El Porvenir Mining Unit Magistral Antamina Hilarión Atacocha Uchucchacua (BVN) El Porvenir Colquijirca (El Brocal) UEA Chungar (Volcan) San Gregorio (El Brocal) Santander (Trevali) Rondoní (Volcan) Yauricocha (Sierra Metals) Corihuarmi ( Minera MRL) Cerro Lindo Toromocho (Chinalco) Cobriza (Doe Run) Pukaqaqa Julcani (BVN) It is a polymetallic underground mine located 4,200 meters above sea level, which operates in the region of Cerro de Pasco since It is considered Peru s deepest underground mine and one of the deepest mines in Latin America, the extraction is carried out 1,250 meters below the ground surface. The mineral extraction is carried out in its own concentrating plant through a flotation process, which produces zinc, lead a copper concentrates with silver content. Currently, the concentrating plant has a 5,600 TPD capacity (its capacity was 5,100 TPD until 2011). Milpo's Mines Greenfield Projects Milpo Operating Mines Projects/Explorations, Kallpa SAB Antapite (BVN) Mina Justa (Minsur) This mining unit is adjacent to Atacocha mining unit (which also belongs to Milpo). Additionally, it is located near polymetallic mines from other important Peruvian mining companies (El Brocal and Volcan, among others). b) Atacocha Mining Unit It is a polymetallic underground mine located 4,050 meters above sea level, which operates in the region of Cerro de Pasco from It was acquired by Milpo in November 2008 and it produces zinc, lead and copper concentrates with silver content. Currently, this mining unit operates through a treatment plant at a 4,400 TPD capacity. Given the nearness between its operations and those from El Porvenir mining unit, the company will develop the integration of its operations in 2014, in order to reduce costs. c) Cerro Lindo Mining Unit It is Grupo Milpo s most efficient mine and it began operations in July It is a polymetallic underground mine located 1,820 meters above sea level, which operates in the region of Ica (province of Chincha). It produces zinc, lead and copper concentrates with silver content, through a flotation process carried out in its treatment plant. The mine began operations in 2007 with a 5,000 TPD capacity. In 2011, its capacity was doubled to 10,000 TPD; and in late 2012, it reached a 15,000 TPD capacity related to a USD 175 MM CAPEX. iii. Mineral inventory: Reserves and resources The reserve and resource inventory from Grupo Milpo s mining units is updated as of If considering the total reserve and resource inventory and the mining units installed capacities, it is calculated that the company s operations are able to continue for more than 10 years. However, it is expected that the production will decrease in 2019, given that Atacocha will operate until that year, in accordance to our estimations. Initial Coverage 7

8 Atacocha has a 1 year life of mine (2014) only if considering its reserve inventory. However, if considering the total reserve and resource inventory, its life of mine would extend up to 8 years (2012). This due to the limited reserve inventory, which represents 15% of its total mineral inventory. Given the mine s short operating horizon, during 2013 the subsidiary focused an important part of its resources towards exploration expenses, seeking to increase the mining unit s life of mine. Additionally, this mine has the best zinc, lead, copper and silver grades among Grupo Milpo s operating mining units. Table N 1: Reserve and resource inventory as of 2012 Atacocha Atacocha Mining Unit Reserves MT %Zn %Pb %Cu Ag Oz./MT Total reserves 2,049, Resources MT %Zn %Pb %Cu Ag Oz./MT Measured resources 77, Indicated resources 3,947, Total resources (a) 4,025, Inferred resources (b) 7,599, Total de resources (a + b) 11,625, Total reserves and resources 13,674,651 Reserves' cut off NSR: USD/MT Source: Atacocha El Porvenir has a 5 years life of mine, only if considering its reserve inventory (2018). However, if considering its total reserve and resource inventory, the life of mine would extend up to 19 years (2032). Of the mining unit s total mineral inventory, reserves represent 21.9%; while inferred resources (minerals with the lowest exploitation certainty) represent 42.1%. Table N 2: Reserve and resource inventory as of 2012 El Porvenir El Porvenir Mining Unit Reserves MT %Zn %Pb %Cu Ag Oz./MT Total reserves 8,737, Resources MT %Zn %Pb %Cu Ag Oz./MT Measured resources 5,381, % 0.96% 0.27% 1.92 Indicated resources 9,004, % 0.54% 0.36% 1.25 Total resources (a) 14,385, Inferred resources (b) 16,786, Total de resources (a + b) 31,172, Total reserves and resources 39,910,333 Reserves' cut off NSR: USD/MT Cerro Lindo has a 7 years life of mine, only if considering its reserve inventory (2020). However, if considering the total reserve and resource inventory, its life of mine would extend up to 13 years (2026). Of the mining unit s total mineral inventory, reserves (minerals with the highest exploitation certainty) represent 47.2%; while inferred resources represent 14.6%. Table N 3: Reserve and resource inventory as of 2012 Cerro Lindo Cerro Lindo Mining Unit Reserves MT %Zn %Pb %Cu Ag Oz./MT Total reserves 35,577, Resources MT %Zn %Pb %Cu Ag Oz./MT Measured resources 19,670, % 0.34% 0.83% 0.92 Indicated resources 9,163, % 0.28% 0.77% 0.84 Total resources (a) 28,834, % 0.32% 0.80% 0.90 Inferred resources (b) 10,987, Total de resources (a + b) 39,822, Total reserves and resources 75,399,977 Reserves' cut off NSR: USD/MT Initial Coverage 8

9 iv. Brownfield project portfolio a) Chapi Mining Unit This mining unit began operations in 2006 and it belongs to Minera Pampa de Cobre S.A., which is Milpo s subsidiary (100% stake). It is a mining deposit located in the province of Sanchez Cerro, region of Moquegua, which used to produce copper cathodes. However, operations in this mining unit are temporally suspended from November 2012, since it reached a limited mineral inventory which did not support a profitable operation. Currently, exploration works have been carried out in San Jose and Chapi Sulphides copper projects, near San Jose plant (Chapi). Of the latter, there is information regarding its resource inventory. Additionally, Milpo is exploring several nearby copper prospects: Pampa Negra, Calendaria, Cambar, Justicia, El Fiscal and Angostura. Table N 4: Reserve and resource inventory as of 2012 Chapi Sulphides Chapi Sulphides* project Reserves MT %Cu Total reserves % Resources (*) MT %Cu Measured resources 74,425, % Indicated resources 118,840, % Total resources (a) 193,265, % Inferred resources (b) 28,976, % Total resources (a + b) 222,242, % Total reserves and resources 222,242,529 (*) Referential cut off grade Cu: 0.30% b) Ivan Mining Unit This mining unit began operations in 1999 and it belongs to Minera Rayrock Ltda., which is Milpo s subsidiary (100% stake). It is a mining deposit located northeast of Antofagasta (Chile) at a 750 meters above sea level altitude. This open pit mine used to produce copper cathodes through its own refinery. However, it suspended its activities in April 2012, since it did not have enough economic reserves. The latter is a consequence of a decrease in mineral grades and an increase in operating costs. Currently, exploration works have been carried out in Sierra Medina and Sierra Valenzuela copper projects. It is expected that Milpo will publish an estimated resource inventory for these 2 projects in 2014; after culminating exploration studies, additional drillings, underground topographic cartographies, and complying international standards. Additionally, Milpo has explored Pias and Antena prospects in such Chilean region. v. Greenfield project portfolio a) Magistral project It is a copper molybdenum porphyry, located in the northeast extreme of Cordillera Blanca. It is located 140 kilometers from the port of Chimbote (province of Pallasca, region of Ancash) and its altitude ranges between 3,900 and 4,400 meters above sea level. Exploration drilling campaigns have been carried out in Magistral from This project was acquired through an international bid carried out by Proinversion, which awarded the concessions (13,150 hectares) that belonged to Inca Pacific Resources Inc. The project is in pre feasibility stage and it is focused on updating the feasibility study carried out by its previous owner. Additionally, it was carried out a drilling campaign in 2013, which aimed to increase resources, to reclassify inferred and indicated resources, and to investigate the depth and extension of the mineralized body. Initial Coverage 9

10 Table N 5: Reserve and stock inventory as of 2007 Magistral Magistral project Reserves MT %Cu %Mo Total reserves % 0.000% Resources* MT %Cu %Mo Measured resources 108, % 0.056% Indicated resources 86, % 0.047% Total resources (a) 195, % 0.052% Inferred resources (b) 55, % 0.023% Total resources (a + b) 250, % 0.046% Total reserves and resources 250,954 (*) Referential cut off grade Cu: 0.40% b) Hilarion project It is poly metallic project which has confirmed the presence of zinc, lead, copper and silver concentrates. It is located 80 kilometers southeast Huaraz (region of Ancash) and its altitude ranges between 4,500 and 5,200 meters above sea level. Additionally, the following prospects are located within the project s surface (8,152 hectares): El Padrino, Caupijanca, San Martin, Puntahuay and Solitajanca. Currently, the project is in pre feasibility stage and it is focused on reclassifying inferred and indicated resources with diamond drillings from surface and underground works. Table N 6: Reserve and resource inventory as of 2012 Hilarion Hilarion project Reserves MT %Zn %Pb %Cu Ag Oz./MT Total reserves % 0.00% 0.00% 0.00 Resources* MT %Zn %Pb %Cu Ag Oz./MT Measured resources 7,881, % 0.94% 0.04% 1.35 Indicated resources 12,194, % 0.69% 0.04% 0.99 Total resources (a) 20,076, % 0.79% 0.04% 1.13 Inferred resources (b) 21,562, % 0.51% 0.09% 0.9 Total resources (a + b) 41,638, % 0.65% 0.06% 1.01 Total reserves and resources 41,638,904 (*) Referential cut off grade Zn: 3.50% c) Pukaqaqa project It is a skarn type copper, gold and silver deposit. It is located 11 kilometers northeast the city of Huancavelica (region of Huancavelica) and it presents variable altitudes between 4,000 and 4,700 meters above sea level. Additionally, the following prospects are located within the project s surface (11,102 hectares): Bella Sol, Acerococha, Carlotita and Rumimaki. Currently, like in other Greenfield projects, drilling campaigns have been developed in order to reclassify inferred and indicated resources with diamond drillings. Table N 7: Reserve and resource inventory as of 2012 Pukaqaqa Pukaqaqa project Reserves MT %Cu Ag g/mt Au g/mt Total reserves % Resources* MT %Cu Ag g/mt Au g/mt Measured resources 70,065, % Indicated resources 139,818, % Total resources (a) 209,884, % Inferred resources (b) 70,659, % Total resources (a + b) 280,543, % Total reserves and resources 280,543,595 (*) Referential cut off grade Cu: 0.30%. Initial Coverage 10

11 vi. Production Milpo produces zinc, lead and copper concentrates with silver content. However, it is worth mentioning that it used to produce copper cathodes in Ivan and Chapi mines. The company s production has been growing year on year due to expansion projects carried out in its mining units. Consequently, zinc, lead, copper and silver production increased 7.9%, 12.8%, 8.7% and 2.1% annually between 2010 and 2013, respectively (see details in Table 8). As of closing of 2013, Cerro Lindo is Grupo Milpo s most important mining unit, producing more than 50% of zinc and copper production, and more than 40% of silver production. El Porvenir mine stands out by representing 37% of the company s lead production, the highest stake for this metal among the group s mining units. Chart N 7: 2013e's production by mining unit vii. Table N 8: Production by metal (DMT)* e Zinc Lead Copper 191,830 21,269 26, ,274 21,899 31, ,157 22,915 38, ,007 34,388 37,340 Silver** 5,676,849 4,810,042 4,753,000 6,159,465 (*) DMT: Dry metric tons (**) Silver production is expressed in ounces. Net sales 100% 80% 35% 47% 55% 60% 87% 37% 40% 27% 28% 20% 28% 25% 17% 9% 0% 4% Zinc Lead Copper Silver Atacocha El Porvenir Cerro Lindo The company s sales have grown 6.2% in average during the last four years ( ). This is principally due to the production increase previously explained. The volume sold from zinc and lead concentrates increased 15.6% and 10.5% in average annually from However, the volume sold from copper cathodes decreased 30.5% in average during the last 4 years due to lower production levels in Ivan and Chapi mines, by lower mineral grades. Table N 9: Volume sold (DTM) (DMT)* Zinc Cc. 264, , , ,756 Lead Cc. 39,135 38,273 40,198 58,324 Copper Cc. 194, , , ,368 Copper Cathodes 6,417 12,799 7,537 1,493 (*) DMT: Dry metric ton Table N 10: Sales by products (USD 000') Zinc Cc. 168, , , ,919 Lead Cc. 78, , , ,791 Copper Cc. 238, , , ,643 Copper Cathodes 80, ,688 59,274 10,811 TOTAL 566, , , ,164 Taking into account the mineral content, zinc is the most important metal since it represents approximately 50% of the company s sales (2013), followed by copper and silver with 30% and 15% stakes, respectively. Taking into account mining units, Cerro Lindo represented approximately 65% of the company s income in 2013, while El Porvenir and Atacocha represented 20% and 15%, respectively. Chart N 8: Sales by metal Chart N 9: Sales by mining unit 100% 80% 60% 40% 20% 0% 9% 15% 9% 2% 14% 13% 15% 16% 28% 25% 30% 26% 5% 7% 4% 5% 48% 40% 41% 49% % 80% 60% 40% 20% 0% 9% 15% 9% 2% 40% 43% 51% 64% 28% 25% 26% 21% 22% 18% 15% 14% Zinc Lead Copper Silver Copper Cathodes Atacocha El Porvenir Cerro Lindo Chapi e Iván Initial Coverage 11

12 viii. Cost reduction strategy The company has been implementing policies focused on a cost reduction through the optimization of productive and administrative processes, and through the development of new projects which aim to improve current productivity levels. With regard to the optimization of productive and administrative processes, Compania Minera Atacocha S.A.A. took over Compania Minera Atasilver S.A.C. (in accordance to what was agreed in the General Annual Meeting held in December 10th 2013), in order to reduce certain administrative expenses inherent to the existence of two juridical persons. Additionally, the company will execute an operating integration plan between Atacocha and El Porvenir mining units, both located in the region of Pasco. This strategy seeks to decrease administrative expenses and to generate synergies in the productive processes from both operations. With regard to the development of new projects that will improve current operations productivity, Atacocha will implement Pique 447 project in order to reduce mineral transport costs inside the mine. That is to say, it will transport mineral through an elevator rather than using heavy machinery. It is expected to culminate this project in early 2H2014. ix. Tax regime In September 28th 2011, through Ley N and 29789, it was established the Impuesto Especial a la Mineria IEM (Special Mining Tax) and the Ley de Regalias Mineras (Mining Royalties Law), which came into force from Both payments take as a basis the quarterly operating income and propose a tax scale by ranges in accordance with the period s operating margin. Subsequently, it was approved Ley N and there were defined the parameters for the Ley del Gravamen Especial de la Mineria GEM (Special Mining Tax Burden Law). This law only applies to those mining companies that had a valid tax stability contract on the date of approval of both the Special Mining Tax Law and the Mining Royalties Law. Given that on the date of approval of both laws, Cerro Lindo had had a tax stability contract, this mining unit is subject to the payment of GEM. On the other hand, Atacocha and El Porvenir mining units are subject to the payment of IEM and mining royalties. Initial Coverage 12

13 III. Valuation We value Milpo using a Discounted Cash Flow to the Firm methodology with a 10.37% discount rate and a 1.5% long term growth rate inherent to our perpetuity. Our projection is for 8 years (2022), where 2 stages are identified: The first stage goes from 2014 to 2019, a year in which Atacocha s reserves and resources are totally consumed and the subsidiary is liquidated. The second stage (the perpetuity s basis) is 2020 and 2021, where only El Porvenir and Cerro Lindo mining units operate. It is worth mentioning that when Atacocha is liquidated, we assume a 25% penalty over its accounts receivable and inventory value, the accounts payable are fully paid, the net fixed assets residual value is cero, and the costs regarding the mine s shutdown are executed. Additionally, we value the company s projects (Hilarion, Magistral, Pukaqaqa and Chapi Sulphides) with an In Situ methodology, considering In Situ copper and zinc prices of USD/Lb and USD/Lb , respectively. It was applied a 10% penalty over measured resources, a 20% penalty over indicated resources and 30% penalty over inferred resources, in each of the valued projects. Table N 11: Milpo's valuation through DCF Cash flow (USD 000') + EBIT Taxes + Depreciation & Amortization CAPEX Working capital + Atacocha's terminal value* Cash flow to the firm ,783 59, ,812 86,026 35,061 89, e 146,374 38, , ,000 14, , e 143,938 38, , , , e 150,987 40, , , , e 149,782 40, , , , e 110,559 28, , , , e 107,921 27, , , ,763 60, e 69,988 16, , ,000 6,197 46, e 68,650 15, , , ,960 (*) Liquidation of assets disbursements regarding the mine's shutdown Equity's valuation Direct operations Equity's valuation WACC 10.37% FV Direct operations (USD 000') 877,994 Firm's value (USD 000') 971,892 FV Magistral (USD 000') 67,461 Debt (USD 000') 377,471 FV Hilarión (USD 000') 40,248 + Cash (USD 000') 342,406 FV Pukaqaqa (USD 000') 53,656 Minority Interest (USD 000') Equity's value Direct operations (USD 000') 58, ,994 FV Chapi sulphides (USD 000') Equity's FV (USD 000') Exchange rate 46,692 1,086, Equity's Fair Value (PEN 000') 3,051,807 Common shares Common shares* Investment shares TOTAL Shares outst. Adj. stake % Equity FV 1,098,962, % 3,024, ,616, % 27, ,110,579, % 3,051,807 (*) Class A common shares have a 15% premium due to voting rights. This effect is included in the adjusted stake (%). Source: Kallpa SAB Consequently, we estimate a PEN 2.75 fair value (FV) per common share (MILPOC1) and a PEN 2.34 FV per investment share (MILPOI1), considering a 15% premium for common shares due to voting rights. Additionally, it is worth mentioning that our FV excluding the value from its projects is PEN That is to say, 80.8% of the calculated FV is obtained from direct operations. Below, we present details from our main assumptions: i. Production Our estimations regarding future zinc and lead production have a stable trend up to On the other hand, we anticipate that copper and silver production will have an increasing trend during next years due to higher mineral grades. From 2020, one year after Atacocha s shutdown (in accordance to our estimations), the company will present an important production decrease. Initial Coverage 13

14 Chart Nº 10: Zinc and Lead Est. production MT MT Chart Nº 11: Copper and Silver Est. production MT MM Oz. 350, , , ,000 Zinc Lead (Right axis) 45,000 40,000 35,000 45,000 42,500 40,000 Copper Silver (Right axis) ,000 30,000 37, , , ,000 25,000 20,000 35,000 32, , e 2014e 2015e 2016e 2017e 2018e 2019e 2020e 2021e 15,000 30, e 2014e 2015e 2016e 2017e 2018e 2019e 2020e 2021e 4.50 Source: Kallpa SAB Source: Kallpa SAB ii. Price vector According to Kallpa SAB s policies, our price vector is updated semiannually and it is projected in a 5 years period ( ). Additionally, the price level considered in the last year (2018) reflects the long term level that we estimate for each metal. Finally, our price vector shares the same trend as that of prices estimated by the analysts consensus (there are only considered updated estimations in the last 2 months), but being more conservative. Additionally, we use the long term price level from 2019, since the price vector s horizon is shorter than the projection period s horizon. Table N 12: Estimated price vector e 2015e 2016e 2017e 2018e Silver (USD/Oz.) Copper (USD/Lb.) Zinc (USD/Lb.) Lead (USD/Lb.) Source: Bloomberg, Kallpa SAB With regard to base metals, copper price has a negative trend due to the beginning of operations of several copper projects; that is to say, the global supply will increase, and it is expected a stable demand during the next years which is highly correlated to the Chinese economy s growth. On the other hand, zinc and lead prices present an upward trend which is explained by a reduction in the global supply during the next years, and by a higher demand in the automotive industry, respectively. With regard to silver price, Milpo s only precious metal, we expect that the average price will reach USD/Oz from However, we anticipate that precious metal prices will be volatile this year due to a reduction in the program of repurchase of assets carried out by FED. A sample of this volatility was observed in December 18th 2013 and January 29th 2014, dates which announced USD 10,000 MM cuts in the repurchase of assets carried out by FED. iii. Operating costs As of closing of 2013, Milpo s consolidated cash cost reached USD/MT 34.9, while last year s average was USD/MT That is to say, the average consolidated cash cost decreased 3.0% YoY (2012 s average cash cost was USD/MT 36.1). This is explained by an increase in installed capacities from El Porvenir and Cerro Lindo, and by a tariff renegotiation with suppliers before a context with lower metal prices. By mining unit, Atacocha s cash cost has continuously decreased from 3Q2013. It decreased 14.5% YoY in average during 2013, until reaching USD/MT 44.3 as of closing of 4Q2013. El Porvenir s cash cost has not decreased significantly from 4Q2012 to 4Q2013. It only decreased 0.5% YoY, but it stands out the decreasing trend in costs from the peak registered in 1Q2013. Finally, Cerro Lindo s cash cost reached USD/MT 30.7 as of closing of 4Q2013, Grupo Milpo s lowest cash cost. However, it is worth mentioning the decreasing trend registered in 2013 (see details in Chart 12). Initial Coverage 14

15 We expect that the cash cost will slightly decrease within our projection in 2015, due to the operating integration between Atacocha and El Porvenir mines, to lower administrative expenses as a consequence of the merger between Compania Minera Atacocha S.A.A. and Minera Atasilver S.A.C., and to the construction of Pique 447 which will reduce transport and energy costs in Atacocha mine. Additionally, we project a 5.0% cost adjustment in 2018 (long term period in our price vector) and a 2.3% new adjustment in 2020 due to the cessation of operations in Atacocha mining unit, the mine with the highest cash cost in Grupo Milpo. Chart Nº 12: Cash cost by mining unit USD/MT Chart Nº 13:Estimated consolidated cash cost USD/MT T12 2T12 3T12 4T12 1T13 2T13 3T13 4T13 Atacocha El Porvenir Cerro Lindo e 2015e 2016e 2017e 2018e 2019e 2020e 2021e Source: Kallpa SAB, Milpo Source: Kallpa SAB, Milpo iv. CAPEX To date, it is known the Greenfield and brownfield projects that belong to Milpo s portfolio, but it is still unclear which of them will be the company s focus of interest. That is to say, the company does not have CAPEX and production estimations for any of these projects. Hence, we project that the company will only invest in maintenance for fixed assets (machinery, equipment, buildings, etc.) as well as for intangibles (increase in mining concessions and exploration expenses). Chart Nº 14: Estimated CAPEX USD MM 250 Maintenance CAPEX e 2015e 2016e 2017e 2018e 2019e 2020e 2021e Source: Kallpa SAB, Milpo v. Indebtedness The company s debt as of closing of 2013 is conformed by international bonds (USD 350 MM), bank loans and financial leasing operations. The debt s book value is USD MM. Given that Milpo s cash generation capacity has increased due to the implementation of its expansion projects, in spite of the fall in metal prices, we do not anticipate that its debt level will increase during the next years. We expect that from 2015, 100% of Milpo s debt will correspond to the corporate bonds issued in March Consequently, we project that the debt/ebitda ratio will gradually decrease until 2017 (by an increase in depreciation as long as the mines antiquity increases). From 2018, that ratio will reach approximately 1.25, explained by a fall in metal prices. For the same reason, the EBITDA/Interest expenses ratio will decrease from 2018 (see details in Chart 15). Initial Coverage 15

16 Chart Nº 15: Indebtedness ratios Debt/ EBITDA EBITDA/ Int. expen Debt/EBITDA EBITDA/Int. exp e 2015e 2016e 2017e 2018e 2019e 2020e 2021e Source: Kallpa SAB 14 vi. Discount rate We estimate a 10.37% discount rate (WACC), which results from assuming a 4.50% risk free rate (which includes a 3.00% risk free rate from mature markets and a 1.5% country risk) and a 6.5% risk premium. We estimate a 1.68 leveraged beta, which is the weighted average of betas from base metal and precious metal mining companies. Consequently, we obtain a 15.45% COKe. Finally, we assume a 4.29% COKd, which is the weighted average from different kind of debts that the company maintains as of closing of Chart N 16: WACC's breakdown WACC 10.37% COKe 15.45% E/(D+E) 60.00% COKd 4.29% D/(D+E) 40.00% (1T) 70.00% Rf 3.00% Beta 1.68 Risk premium 6.50% Country risk 1.50% Source: Kallpa SAB vii. Risks a. Volatility in metal prices: It is expected a higher volatility in metal prices in 2014, since FED will finish the cuts in the program of repurchase of bonds initiated in late This might affect the company s results. b. Operating risks: There is a possibility that the annual production level decreases due to strikes, or due to the exploitation of zones with lower mineral grades. Additionally, there is a risk that the Management s efforts directed to decrease costs do not achieve the expected results (USD/MT in 2015). c. Social risk: In the mining industry, there is always the possibility of social conflicts and Milpo is not the exception of the rule (in current mining units as well as in projects and prospects). However, the company has not had significant problems with the communities where it has carried out mining activities in the last years, and it does not have social conflicts reported in Defensoria del Pueblo. d. Sanctions regarding environmental issues: Given that it is still unknown if Atacocha must pay a fine for the leakage of sediments that occurred in August 2012, there is a possibility that the company has to pay a monetary penalty regarding such event. Initial Coverage 16

17 e. Guidance 2014 s publication: It is still pending Milpo s announcement with regard to this year s guidance, which will occur as soon as the Conference Call regarding 4Q213 s results is carried out. Consequently, the estimations might change, depending on the company s plans. viii. Catalysts a. Progresses in projects and prospects: According to the project portfolio s annual progress, the possibility that the company develops any of these projects will increase. The latter will allow the inclusion of such projects within the Discounted Cash Flow to the Firm valuation; that it to say, they will cease to be valued with an In Situ methodology (a more conservative methodology). Additionally, if any of the current prospects includes an interesting mineral inventory, the company may consider the prospect within its project portfolio. The latter would be positive for the fair value, since the prospect would be valued through In Situ or Discounted Cash Flow to the Firm methodologies. b. Higher cost savings: Our cash cost estimations are conservative since they only contemplate a USD/MT 0.5 fall in 2015, since most measures will reduce operating and administrative costs in Atacocha mining unit (Grupo Milpo s least efficient subsidiary). However, if better synergies are obtained, the company s financial margins and profitability might improve. c. An increase in the long term debt: One assumption within our valuation is that the company will not need to obtain additional debt in the next years since its cash generation capacity will be fair enough. Nevertheless, this assumption might change as long as the projects statuses progress. In the event that the company s cash generation capacity is not fair enough to cover the projects CAPEX, the company will need to increase its debt stock. This will increase the debt s weight within the long term equity s structure, our discount rate would be lower, and it would have a positive effect over the equity s present value. d. Increase in reserves and resources: The company will keep on directing its resources towards exploration activities, which will allow to increase the life of mine from its direct operations, and to increase the mineral inventory from expansion projects. Consequently, In Situ values from projects (Greenfield and brownfield) might increase, generating positive effects over our FV. Initial Coverage 17

18 IV. Scenario analysis We sensitize the main key variables in our valuation model in order to carry out the following scenario analysis a. Baseline Scenario FV PEN 2.75: Under this scenario, we assume a 10.37% discount rate (WACC) and a USD/Lb long term zinc price. Finally, we assume that due cost reduction policies (operating and administrative costs) carried out by Management, the cash cost would reach USD 34.5 in 2015 and it will maintain such level up to 2017 (one year before our long term period) b. Optimistic Scenario FV PEN 3.52: Under this scenario, we reduce our discount rate (WACC) in 100 basic points (9.37%), and we consider a PEN/Lb long term zinc price. Finally, due to cost reduction policies (operating and administrative costs) carried out by Management, the cash cost would reach USD 33.5 in 2015 and it will remain constant until 2017 (one year before our long term period). c. Pessimistic Scenario FV PEN 2.16: Under this scenario, we increase our discount rate (WACC) in 100 basic points (11.37%) and we consider a PEN 0.85 long term zinc price. Finally, we assume a USD 36.0 cash cost in 2015, assuming that the policies implemented by Management will not have the so awaited effect, and quite the contrary, there will be inflation pressures over costs. Such cost level will remain constant until 2017 (one year before our long term period). Chart Nº 17: Scenario analysis USD Pessimistic Scenario USD/MT treated 36.5 Zinc LT USD/Lb WACC +100 pbs Baseline Scenario WACC 100 pbs Zinc LT USD/Lb USD/MT Treated 33.5 Optimistic Scenario Source: Kallpa SAB Initial Coverage 18

19 V. Sensitivity analysis Our fair value is calculated over the base of assumptions that are assumed by the analyst. However, investors can evaluate variations in this fair value before changes in the main assumptions such as our discount rate, our long term growth rate and our estimated long term zinc and silver prices. Table N 13: FV's sensitivity to discount rate (WACC) and to long term growth (g) WACC / g 0.00% 0.50% 1.00% 1.50% 2.00% 2.50% 3.00% 8.37% % % % % Source: Kallpa SAB Table N 14: FV's sensitivity to long term copper price (USD/Lb.) and to long term zinc price (USD/Lb.) Copper LT / Zinc LT Source: Kallpa SAB Initial Coverage 19

20 VI. Multiple Analysis Table N 15: Mining companies comparable to Milpo Company Compañía Minera MILPO SA Peru BHP Billiton Ltd Australia 178, Teck Resources Ltd Canada 12, Assore Ltd Sth. Africa 5, Boliden AB Sweden 4, Volcan Cia Minera SAA Peru 1, Nyrstar Belgium 690 n.d. n.d Minmetals Land Ltd Hong Kong Sociedad Minera El Brocal Peru 386 n.d Cia Minera Atacocha SA Peru 38 n.d Average 20, Source: Bloomberg, Kallpa SAB Country Market Cap. (USD MM) P/E 12M P/E 2014 EV/EBITDA 12M EV/EBITDA 2014 P/BV ROE ROA Dividend Yield % 6.6% n.d % 10.4% 4.1% % 2.7% 3.9% n.d % 29.0% 1.4% % 3.2% 3.9% % 7.7% 3.3% % 5.8% 5.4% % 1.3% 1.1% % 1.5% 1.3% n.d % 12.9% n.d % 4.1% 3.1% Chart Nº 18: P/E 2014 vs. EV/EBITDA 2014 EV/EBITDA Market Cap. Chart Nº 19: ROE vs. ROA ROA 40% Market Cap. 12 Assore 30% Volcan Boliden El Brocal Minmetals Milpo Atacocha P/E % Boliden Volcan Assore 10% Minmetals Milpo 0% 10% El Brocal Atacocha 20% 30% 20% 10% 0% 10% 20% 30% 40% ROE Source: Bloomberg, Kallpa SAB Source: Bloomberg, Kallpa SAB Milpo has a 9.19x estimated P/E 2014, quite below the average from identified comparable companies (14.27x). In the same way, it has a 2.78 estimated EV/EBITDA 2014, while the industry s average is 5.50x. Both multiples register an upside above 55.0%; that is to say, this methodology s upside exceeds the 29.8% upside obtained through the fundamental analysis (Discounted Cash Flow to the Firm methodology). Initial Coverage 20