Nyrstar : Our first take on the reportedly difficult negotiations between smelters and miners

An article published by Metal Bulletin mentioned the ongoing difficult negotiations between smelters and miners on treatment charges and free metal; i.e. the main components of Nyrstar Metal Processing’s division gross result (resp. 44% and 31% of the division’s gross profit in 2016). Miners are reportedly asking for: i/ higher payable metals, ii/ zinc benchmark treatment charge (TC) of USD 100 per ton (vs USD 203m previously), and iii/ no “escalator” linked to the increase of spot zinc price (vs up to 9% of the price increase previously). - However, note that these figures were put on table by miners at the start of the talk) and this will of course be subject to negotiations. Besides, it is mentioned that the smelters and miners have come closer to each other on nominal TC (the smelters targeted nominal TC of USD 200 per ton). - Following a quick talk yesterday evening with Nyrstar’s IR, we understand that: - such difficult negotiations also happened in previous years. Last year, the benchmark TC was down by -17%. It is absolutely usual for miners to start negotiations with very aggressive proposals; - it is very unlikely that the three items (free metal, benchmark TC and escalator) will be revised downwards in the same time. Besides, decreasing the free metal and removing the escalator have never been seen in the industry in the recent past. A more likely scenario would be standard downward revision of benchmark TC, as seen in early 2016; - the negotiations depend very much of the supply situation on the zinc concentrate market and it is possible that Glencore, which has taken out a significant portion of zinc in concentrate production last year, decides to increase its production this year, which will be favourable for smelters; - one should also not forget the sensitivities of Nyrstar’s Ebitda to other parameters, such as: i/ EUR:USD: currently at 1.06 vs 1.11 on average in FY-16; and ii/ zinc spot price (through free metal and escalator in realized TC): currently at USD 2,841 per ton vs USD 2,095 on average in FY-16. The positive impact of these two items will yet be mitigated by the strategic hedges implemented by the group last year; - lastly, in case of negative outcome of the negotiations, according to Nyrstar’s IR, some smelters would be closed, zinc metal would become very tight and the zinc price would rally very hard. At the same time, the zinc miners would have limited place to have their concentrate processed and, as such, the treatment charges would increase again. This is a somehow cyclical equation: miners need smelters and the smelters need miners. - We always highlighted that Nyrstar’s investment-case was not a simple « future » on zinc price (see our Credit Focus published on 14 October 2016: “The recent increase in zinc price is no cure-all for the credit”). We notably highlighted the risk of further downward pressure on treatment charges. We definitely believe that these headlines could put negative pressure on Nyrstar bonds prices (it started yesterday). This is all the truer as Nyrstar 2019 bond, for example, was particularly expensive. The worst-case scenario would indeed put into question the sustainability and survival of the company (leading a materially negative group Ebitda – see our three different scenario in the report). Note yet that such a scenario seems unlikely to us and a more moderate agreement should be reached between smelters and miners. We therefore maintain our Neutral recommendation on Nyrstar bonds at this stage. - Concerning Trafigura, recall that its balance-sheet exposure to Nyrstar is very limited (USD 162m related to its 25% equity stake + maximum USD 250m of granted working capital facility + prepay/offtake agreements…, to be compared with Trafigura’s total assets of USD 41.2bn as at end-September 2016 and total equity of USD 5.85bn). - >