Volcan Compania Minera S.A.A.

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1 Aug13 Sep13 Oct13 Nov13 Dec13 Jan14 Feb14 Mar14 Apr14 May14 Jun14 Jul14 Aug14 EQUITY RESEARCH Update August 21th, 2014 Alberto Arispe Edder Castro Head of Research Analyst (511) (511) Mining Industry Volcan Compania Minera S.A.A. Fair Value PEN 1.30 HOLD Volcan Cia Minera (LSE: VOLCABC1) Lower margins and a delay in Oxides reduce the FV Equity's Fair Value (PEN MM) Share's Fair Value (PEN) Previous Fair Value May 2014 (PEN) Recommendation Market Capitalization (PEN MM) Share's Market Price (PEN) Shares Outstanding (MM)* Potential Appraisal ADTV LTM (PEN 000') Range 52 weeks YTD Change Dividend Yield LTM Trading ADTV: Average daily traded volume LTM: Last twelve months Source: Bloomberg, Kallpa SAB Financial Ratios P / E P / BV EV / EBITDA Debt / EBITDA EBITDA / Interest exp. EPS (USD) ROE ROA Source: SMV, Kallpa SAB Source: Bloomberg 5, Hold 5, , % 1, % 2.1% LSE (*) Include 1,633 MM class "A" common shares outstanding, which quote at PEN 1.70 per share. Chart N 1: VOLCABC1 vs. Zinc spot PEN VOLCABC e 2015e % 4.6% 7.3% 6.3% 2.3% 3.8% Zinc Spot USD/Lb Kallpa Securities SAB updates Volcan Compania Minera S.A.A. (LSE: VOLCABC1) changing its recommendation from buy to hold. Our PEN 1.30 fair value (FV) per VOLCABC1 share (lower than our PEN 1.51 previous FV) is 13.2% above its PEN 1.15 market price, as of closing of August 20th, We update Volcan s model in order to include financial results as of 2Q2014 and 2014 s updated guidance. We use a Discounted Cash Flow to the Firm methodology and a 10.24% discount rate. Additionally, we project in a 5 years horizon and we assume a 2.0% perpetual growth rate, linked to the annual exploration expenses. What changed in our model? We delayed Silver Oxides project s startup until 1Q2015. This due to an extension in the sampling stage by nonanticipated operating issues. Previously, we considered that the project started up production activities in 2Q2014 and that it operated at a 100% installed capacity during 2H2014. We adjusted our estimates including the behavior registered in 1H2014. We observe that the major relative importance of concentrates from third parties within sales (26.0%), related to the trading business, and the deterioration of commercial terms so far this year, have reduced the financial margins significantly. Additionally, we observe that it is difficult to register a decrease in production costs (cash cost) higher than the obtained during last 12 months, with the exception of Silver Oxides project (a USD/MT 40.0 estimated cash cost). We reduced our perpetual growth rate from 2.5% to 2.0%. Although the company has a wide and interesting project portfolio (Pared Oeste, Zoraida, Oyama, Carhuacayan, and Palma, among others), these projects are coursing early exploration stages. Additionally, their potential profitability has decreased due to the context regarding metal prices. It is worth mentioning that the In Situ component within our fair value is 8.0%. That is to say, the FV excluding the value from brownfield projects would reach PEN 1.20 per share. For these reasons, and considering the market price as of August 20th, 2014, we change our recommendation over Volcan s shares from buy to hold, with a PEN 1.30 fair value.

2 Company's financial summary INCOME STATEMENT (USD MM) Net sales Cost of sales Gross income Sales expenses Administrative expenses Other expenses Operating income Net interest income Net gain by derivative instruments FX Gain (Loss) Earnings before taxes Taxes Net income Shares Outstanding Average (MM) Earnings per share EPS (USD) Depreciation & Amortization EBITDA e 2015e BALANCE SHEET (USD MM) e 2015e 1,163 1,115 1,292 Cash and Cash equivalents Accounts receivable Inventory Other short term assets Current assets Fixed assets, net 1,895 1,972 1, Other long term assets Non current assets 2,012 2,089 2,107 Total assets 2,887 2,869 2,936 1 Short term debt Accounts payable Other short term liabilities Current liabilities ,917 2,917 2,917 Long term debt Other long term liabilities Non current liabilities Net equity 1,451 1,466 1,549 Total liabilities + Equity 2,887 2,869 2,936 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 31.9% 19.3% 23.9% Net income % 11.4% 14.9% Depreciation & Amortization % 24.4% 28.5% Changes in working capital % 6.0% 8.5% Other adjustments 1.3% 4.1% 15.9% Operating cash flow % 52.5% 51.1% Investment cash flow % 26.1% 35.1% Financing cash flow % 61.3% 63.3% Free cash flow FINANCIAL RATIOS Current assets / Current liabilities Inventory turnover (days) Debt / Equity Debt / EBITDA EBITDA / Interest expenses Payout ratio Dividends per share (USD) ROE ROA ROIC e 2015e CHART N 2: SHAREHOLDERS VOLCAAC1 AS OF % 30.0% 40.0% % 4.6% 7.3% 6.3% 2.3% 3.8% 8.9% 4.1% 6.2% 8% 26% 8% 11% 47% LETTS FAMILY EMPRESA MINERA PARAGSHA S.A.C. BLUE STREAK INTERNATIONAL N.V. SANDOWN RESOURCES S.A. OTHERS VALUATION P / Sales P / E EV / EBIT EV / EBITDA P / BV MANAGEMENT Juan Ignacio Rosado José Cuadros Obando Jorge Murillo Nuñez Roberto Maldonado Astorga César Farfán Bernales José Estela Ramírez Felipe Injoque Espinoza, Kallpa SAB e 2015e CHART N 3: SALES BY METAL AS OF 2Q % % 47% CEO CPO CFO 4% COO 10% Regional Explorations Manager Energy Manager Social Responsibility Manager GOLD SILVER COPPER LEAD ZINC 2

3 Table Nº 1: Production and volume sold Metal Silver % % Copper % 2.40 Zinc % Lead % 18.4 (*) Silver production units are expressed in MM Oz. (**) Zinc, lead and copper concentrates, and bulk silver. 120% 100% 80% 60% 40% 20% 0% 2Q14 Production (000' MT)* Chart Nº 4: Sales by mining unit Volume sold (000' MT)** 2Q13 Var. (%) 2Q14 2Q13 Var. (%) USD 279 MM 2% 7% 50% 7% 53% 11% 34% 36% 2Q2014 USD 374 MM 2Q % 14.2% % Chungar Cerro de Pasco Yauli Alpamarca Oxides 2Q2014: Alpamarca started up operations, but it did not avoid a decrease in results Volcan Compania Minera S.A.A. (LSE: VOLCABC1) published results as of 2Q2014. The company generated earnings per share (EPS) for USD 0.004, in line with our USD estimate. Additionally, it was pretty lower than the USD EPS registered in 2Q2013, since the company distributed stock dividend (9.0% of the previous shares outstanding) and due to a USD MM extraordinary income from hedging derivatives. The main differences with regard to our estimates occurred due to the following reasons: i. A higher cost of sales (+5.6% with regard to our estimates) impacted the gross margin: The gross margin was 17.6%, lower than the 23.2% estimated for 2Q2014. This was specifically due to higher costs from services rendered by third parties, energy and others, which increased +9.1% YoY. Meanwhile, net sales and the depreciation were in line with our estimates (1.6% and 0.9%, respectively). ii. Other income for USD 12.8 MM reduced the gap with regard to our estimates registered up to the operating income (6.0%): This is explained by the USD 7.5 MM net gain obtained from the sale of Belo Horizonte hydroelectric station (Huanuco), carried out during the quarter. Let us recall that the project was sold in USD 31.5 MM. Chart Nº 5: Sales by origin 120% USD 279 MM 100% 23% 80% USD 374 MM 13% With regard to 2Q2013 s results, the net income decreased 78.3% YoY from USD 94.0 MM in 2Q2013 to USD 20.4 MM in 2Q2014, which occurred due to the extraordinary income by hedging derivatives above mentioned. However, if excluding such extraordinary income, the net income would have decreased 56.8% YoY. This is principally due to a decrease in silver prices (23.4% YoY) and to a lower scale registered in Cerro de Pasco UEA. 60% 40% 20% 77% 87% Additionally, it is worth mentioning that during the quarter the new AlpamarcaRio Pallanga UEA reached 100% of its installed capacity, and it was informed that the Silver Oxides project will take what remains of 2014 in order to reach such capacity use, due to operating factors. 0% 2Q2014 Own production 2Q2013 Third parties Below, we present details from 2Q2014 s results (see additional details in page 5): Chart Nº 6: Sales by metallic content 120% USD 279 MM USD 374 MM 1% 0% 100% 3% 3% 11% 10% 80% 60% 47% 38% 40% 20% 39% 48% Net sales decreased 25.4% YoY during the quarter. However, there was a USD MM income by hedging derivatives from silver in 2Q2013. If excluding such effect, the sales would have increased 5.8% YoY. The sales performance excluding extraordinary items is explained by the jointly behavior of the following factors: i. Lead, copper and silver prices decreased 4.6% YoY, 2.8% YoY and 23.4% YoY, respectively. This behavior affected both the value from own concentrates and the value of concentrates from third parties commercialized during the quarter. 0% 2Q2014 2Q2013 Silver Zinc Lead Copper Gold 3

4 Table Nº 2: Production costs by UEA UEAs (USD/MT) Alpamarca Consolidated Table Nº 3: Investments 2Q14 2Q13 Var. (%) Yauli % C. de Pasco % Chungar % NOTA: "" implies a nonsignificant ratio % ii. iii. The treated volume increased 18.3% YoY, which allowed copper and silver productions to increase 11.7% YoY and 23.0% YoY. This is due to Alpamarca UEA s operations startup and to a higher treated tonnage in Yauli and Chungar. However, zinc and lead productions decreased 0.7% YoY and 11.4% YoY, respectively, due to a lower mineral treatment in Cerro de Pasco and to a decrease in the treatment of minerals from third parties in Yauli (55.3% YoY). The volume of fine concentrates from third parties increased significantly in 2Q2014. In this way, the sales of concentrates from third parties represented 22.3% of total sales in 2Q2014, above the relevance shown in 2Q2013 (10.0%). (USD MM) 2Q14 2Q13 Var. (%) Operating units % Regional explorations % Expansion projects % TOTAL % Gross income decreased 67.9% YoY due to a considerable decrease in sales (25.4% YoY), explained by: i) a 23.4% YoY decrease in silver prices; and, ii) a USD MM income by hedging derivatives included in 2Q2013 s sales. Additionally, the gross margin decreased from 41% YoY to 18% YoY, explained by the higher stake of concentrates from third parties in total sales. Chart Nº 7: Indebtedness ratios 3.0x 16.2x 15.8x 2.5x 15.0x 2.6x 2.0x 13.3x 1.9x 1.5x 1.4x 1.0x 0.9x 0.5x 0.6x 11.0x 0.0x 2T13 3T13 4T13 1T14 2T x 16.0x 15.0x 14.0x 13.0x 12.0x 11.0x 10.0x However, the cost per treated metric ton reached USD/MT 63.5, that is to say, 10% YoY below the registered in 2Q2013. The latter is the result of internal measures such as the energetic efficiency program, the reduction of maintenance costs, and the rationalization of expenses from support areas. Operating income decreased 71.3% YoY, in line with the decrease registered up to the gross income. Additionally, it was registered a USD 11.7 MM gross gain as other income, corresponding to the sale of Belo Horizonte hydroelectric station project. The company s EBITDA decreased 53.6% YoY, which was in line with the decrease registered up to the operating income. Net debt/ebitda EBITDA/Intest exp. (Right axis) Net income decreased 78.3% YoY, in line with decreases registered in previous result lines. CAPEX decreased 26.0% YoY, principally due to lower investments in the Silver Oxides project and in the new AlpamarcaRio Pallanga UEA, partially compensated by higher investments in the Rucuy hydroelectric station and in the ParagshaFracoise 220KV transmission line. 4

5 2Q2014's Income Statement INCOME STATEMENT (USD MM) 2Q2014 2Q2013 YoY 1Q2014 QoQ Acc. '14 Acc. '13 YoY Net sales Cost of sales Gross income Gross margin Sales expenses Administrative expenses Other expenses Operating income Operating margin Interest income Interest expenses FX Gain (Loss) Earnings before taxes Taxes Net income Net margin Shares Outstanding Average (MM) Earnings per share EPS (USD) Depreciation & Amortization EBITDA EBITDA margin % % % % % % % 3, % 25.4% 4.0% 67.9% 4.3% 11.2% % 71.3% 43.4% 41.0% 78.5% 78.9% 78.3% 84.1% 14.4% 53.6% % % % 2, % 14.1% 15.2% 9.4% 9.0% 40.4% % 54.4% 32.3% 28.1% 183.0% 45.1% 23.4% 102.7% 26.6% 13.2% 30.3% % % % 3, % % % % 3, % 13.8% 10.6% 57.0% 14.7% 15.2% 940.8% 65.0% 22.5% 13.8% 72.4% 68.8% 73.8% 77.5% 11.1% 44.3% 2Q2014's Results and Kallpa SAB's estimates INCOME STATEMENT (USD MM) 2Q2014 2Q2014e Var. % 2014e P 2014e N 2015e P 2015e N Net sales Cost of sales Gross income Gross margin Sales expenses Administrative expenses Other expenses Operating income Operating margin Interest income Interest expenses FX Gain (Loss) Earnings before taxes Taxes Net income Net margin Shares Outstanding Average (MM) Earnings per share EPS (USD) Depreciation & Amortization EBITDA EBITDA margin NOTE: "" implies a nonsignificant ratio. P: Previous estimates N: New estimates, Kallpa SAB % % % % % % % % 1.6% 5.6% 25.5% 6.2% 5.2% 6.0% 101.2% 39.1% 19.3% 0.9% 3.5% 1, % % % % 1, % % % % 1, % % % % 1, % % % % 5

6 Sensitivity analysis Table N 4: FV's sensitivity to WACC and to long term growth rate (g) WACC \ g 0.00% 1.00% 1.50% 2.00% 2.50% 3.00% 4.00% 8.24% % % % % Source: Kallpa SAB Table N 5: FV's sensitivity to long term silver price (USD/Oz.) and to long term zinc price (USD/Lb.) Silver Spot / Zinc Spot $0.75 $0.80 $0.85 $0.90 $0.95 $1.00 $1.05 $ $ $ $ $ Source: Kallpa SAB 6

7 Multiple analysis Company Boliden AB Sweden 4, Compañía Minera MILPO SA Peru 1, Nyrstar Belgium 667 n.d. n.d. Sociedad Minera El Brocal Peru 618 n.d Minmetals Land Ltd Hong Kong Cia Minera Atacocha SA Peru 103 n.d. n.d. n.d. Average 21, Source: Bloomberg, Kallpa SAB Country Market Cap. (USD MM) Volcan Cia Minera SAA Peru 1,966 P/E 12M P/E 2014 Teck Resources Ltd Canada 13, EV/EBITDA 12M BHP Billiton Ltd Australia 184, Assore Ltd South Afr. 4, n.d. EV/EBITDA 2014 P/BV ROE ROA Dividend Yield % 3.1% 2.1% % 9.6% 4.9% % 1.8% 3.6% % 29.0% 2.3% % 3.2% 1.6% % 6.7% 1.3% % 5.8% n.d % 2.6% n.d % 2.0% 1.5% % 12.9% n.d % 3.9% 2.5% Chart N 8: P/E 2014 vs. EV/EBITDA 2014 EV/EBITDA Assore Market Cap. Chart N 9: ROE vs. ROA ROA 35% 30% 25% 20% Assore Market Cap (5) Minmetals Boliden El Brocal Milpo Volcan P/E % 10% Milpo Volcan 5% El Brocal 0% Minmetals Boliden 5% 10% 0% 10% 20% 30% 40% ROE Source: Bloomberg, Kallpa SAB Source: Bloomberg, Kallpa SAB 7

8 Appendix Disclaimer Analyst certification The analyst that prepared this report hereby certifies that: i) the opinions and views expressed in this valuation report, in regard with the issuer and with the company s overview, reflected his/her personal opinion and ii) No part of his/her salary compensation was, is or will be related directly or indirectly to the recommendations expressed in this report. The economic compensation of the analyst that prepared this report is based in several factors, including but not limited to Kallpa Securities SAB s profitability and the profits generated by its different areas, including investment banking. In addition, the analyst does not receive any kind of economic compensation from the companies he/she covers. This valuation report was prepared by Kallpa Securities SAB s employees that maintain the position of Analyst. Persons involved in the elaboration of this report are authorized to maintain shares. Share prices in this report are based on market prices as of closing of the day prior to the publication of this report, unless it is strictly stated. General statement This document is for informative purposes only. Under no circumstances it should be used / be considered as an offer of sale or an application of purchase of shares or any other securities mentioned in this document. The information herein has been obtained from sources which are believed to be reliable, but Kallpa Securities SAB does not guarantee the trustfulness or accuracy of the content of this report, or the future market values of shares or other securities mentioned in this document. The views and opinions expressed in this document constitute our opinion at the time of this report and are subject to change without any notice. Kallpa Securities SAB does not guarantee analysis updates before any change in the circumstances of the market. The products referred in this document may not be available for purchase in some countries. Kallpa Securities SAB has reasonably designed policies to prevent or to control the exchange of nonpublic information used by areas such Research and Investment, Capital Markets, among others. Definition of qualification ranges Kallpa Securities SAB has 5 qualification ranges: Buy +, Buy, Hold, Sell and Sell. The analyst will assign the coverage one of these ranges. Sell < 30% > + 30% Buy + Sell 30% to 15% + 15% to + 30% Buy Hold 15% to 0% 0% to + 15% Hold The range assigned to each company covered by the analyst in these reports is based on the analysis/monitoring Kallpa Securities SAB has been developing for the company. In some cases, the analyst can express his/her shortterm points of view to traders, vendors and some Kallpa Securities SAB s clients but this point of view may differ in time by market volatility and other factors. The fair value calculated by Kallpa SAB is based in one or more valuation methodologies commonly used by financial analysts, including but not limited to discounted cash flows, In Situ valuations or any other applicable methodology. It should be noted that the publication of a fair value does not imply any guarantee that the value will be achieved. 8

9 KALLPA SECURITIES SOCIEDAD AGENTE DE BOLSA MANAGEMENT Alberto Arispe CEO (511) COMMERCIAL CORPORATE FINANCE Enrique Hernández Ricardo Carrión Manager Manager (51 1) (51 1) EQUITY RESEARCH Marco Contreras Edder Castro Humberto León Sebastián Cruz Fiorella Torres Senior Analyst Analyst Analyst Analyst Assistant (51 1) (51 1) (51 1) (51 1) (51 1) TRADING Eduardo Fernandini Javier Frisancho Jorge Rodríguez Head Trader Trader Trader (51 1) (51 1) (51 1) SALES CHACARILLA OFFICE SALES MIRAFLORES OFFICE Hernando Pastor Daniel Berger Gilberto Mora Walter León Representative Representative Representative Representative (51 1) (51 1) (51 1) (51 1) SALES AREQUIPA OFFICE Jesús Molina Ricky García Representative Representative (51 54) (51 54) ASSET MANAGEMENT Javier Frisancho Rafael SánchezAizcorbe Portfolio Manager Commercial Manager (51 1) (51 1) OPERATIONS IT Alan Noa Mariano Bazán Ramiro Misari Head of Operations Analyst Treasury Head of IT (51 1) (51 1) (51 1) INTERNAL CONTROL ACCOUNTING Elizabeth Cueva Mireya Montero Controller Chief Accountant (51 1) (51 1)