Sherritt looks to past to forge brighter future

Sherritt International (S-T) wants to get back to where it started… or at least where it was eight years ago.

After announcing a net loss of $592.1 million for the fourth quarter and $289.7 million for all of 2008, the company says it plans to right the ship by re-instating itself as one of the world’s lowest cost nickel producers.

With nickel prices hovering around US$4.30 per lb., it has its work cut out for it.

Sherritt’s selling price of US$6.18 per lb. of nickel was higher than prevailing spot prices but that figure was still roughly half of what it was for the fourth quarter of 2007.

Adding to concerns are rising cash costs for the metal’s production as they came in at US$4.59 per lb — much higher than the US$1.27 per lb. it cost for the same period in 2007.

On a Feb. 25 conference call, Sherritt’s chairman and chief executive Ian Delaney said he believes that production costs have now peaked and lower commodity prices will soon translate into lower input costs.

“Costs remained high relative to nickel reference prices since short-term contract prices for critical inputs were above prevailing spot prices and costs in inventory reflected elevated prices from prior periods,” the fourth quarter financial report reads.

Delany, however, says there isn’t much of the higher cost inventory left to work through and he expects it will take only one quarter before the impact of lower costs inputs are felt. Furthermore, he expects input cost to fall even more as the year progresses.

But such a scenario offers a two edged sword: in an environment where input prices are falling, commodity prices are falling too, further jeopardizing Sherritt’s bottom line.

“We know we can match production costs (to falling selling prices) as input prices come down,” Delaney said on the conference call. “We’re not at all bullish on commodity prices — I think there’s still a lot of room for them to go down – but we’re confident that as nickel prices come down we will maintain a position we had in the year 2000 as one of the lowest cost producers. And that knowledge is driving is to stay at Ambatovy which is virtually identical to our project in Cuba.”

The mine in Cuba Delaney refers to is the Moa joint venture — a project that helped to make Sherritt’s name in the nickel industry. As one of the lowest cost producers eight years ago, the project remained economic despite depressed nickel prices.

And despite massive costs overruns at the construction of the company’s next flagship nickel project, Ambatovy in Madagascar, Delaney believes that like Moa, Ambatovy will be a low cost producer built to weather the storm of falling metal prices.

“At the last commodity cycle when nickel price went down to US$2 per lb and cobalt was at US$7 per lb…at that time that we were one of the lowest cost producers in the world, and we’ve done nothing to alter the equation of how we did it in the interim,” he says.

“Everyone gets a little sloppy with high prices and we know the nickel price was up over US$20 per lb. But we know the ore body in Madagascar is virtually identical to the one in Cuba and the process is identical to that in Cuba.”

The surging capital costs at Ambatovy, however, are fostering some scepticism. The latest financial statement upgraded the estimated capital costs by roughly over US$1 billion dollars to US$4.52 billion from the previous estimate of US$3.2 billion.

Sherritt, however, is not alone in dealing with such ballooning figures.

Ambatovy is a joint venture project with Sherritt holding a 40% interest and the rest being divided amongst Sumitomo Corporation, Korea Resources Corporation and SNC-Lavalin.

In situations such as these it’s good to have partners. Sherritt says it is getting support from the group in its efforts to determine the best way to come up with its portion of the capital expenditure.

And while Delaney conceded that the company doesn’t yet have a plan to come up with the funds – it is likely to be worked out in the next two months — he says the key factor the company looks at when raising money is how best to preserve its liquidity.

It is true that despite the gathering clouds the company sits with an enviable cash position and access to capital. Fourth quarter results shows the company to hold cash and equivalents of $500.8 million with another $1.6 billion available to it under its credit facilities.

Further it has no public debt coming due until 2012.
But while its cash position remains strong, its non-cash assets took a beating in the quarter. The company, after all, had to take a $463.3-million goodwill impairment on Ambatovy.

The goodwill impairment has to do with the price that Sherritt paid for the project above what the hard assets were worth at the time. Because part of the buying price was based on discounted cash flows generated from higher anticipated metal prices and lower projected capital costs for building it, the new cost environment required the company to re-assess the project and show a non-cash loss for the difference.

“Goodwill is what it is,” Delaney said. “It’s always a thing on the balance sheet you’d like to get rid of and frankly I’m glad we’re writing it off and getting rid of it.”

Once built Ambatovy does promise to be one of the world’s most impressive nickel and cobalt mines.

The project lies 80 kilometers east of the capital Antananarivo and is being built with the capacity to turn out 60,000 tonnes of nickel and 5,600 tonnes of cobalt a year over a 27 year mine life.

By the end of 2008 Sherritt reported that engineering at the project was 88% complete, construction was 44% complete and procurement commitments were 68% complete.

The fourth-quarter losses for the company worked out to $2.03 per share, compared with year-earlier earnings of $83.5-million or 36¢ per share.

The full-year loss was $1.05 per share was down from 2007 net earnings of $370.4 million or $1.79 per share. Annual revenue came in at $1.6-billion, up from $1.34-billion.

In Toronto on Feb. 25 Sherritt’s shares were trading off roughly 19% or 49¢ to $2.10 on 4.6 million shares traded. Its shares have moved between $17.35 and $1.75 over the last 52-week period and it has 293 million shares outstanding.