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TABLE OF CONTENTS Aug 13 - 19, 2012 Volume 98 Number 26 - 0 comments

Sherritt copes with falling prices, permit delays

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By: Matthew Keevil
VANCOUVER 2012-08-13

Toronto-based Sherritt International (S-T) is suffering from symptoms of the global economic slowdown, including rising cash costs and lower realized prices on production.

Sherritt has tried shielding itself with its diverse portfolio — including plays in the nickel and coal sectors, as well as oil and gas industries — but second-quarter profits still fell. Sherritt is also facing permit delays at its US$5.5-billion Ambatovy nickel-cobalt project in Madagascar.

The company’s second-quarter profits fell 32% to US$40 million, or 14¢ per share — down from US$60 million, or 20¢ per share year-on-year. According to data from Thomas Reuters the results beat average analyst estimates of 13¢ per share, though Sherritt missed the mark on revenues, which fell short at US$488 million for the quarter.

Higher-than-expected nickel and cobalt production at the company’s Moa nickel-cobalt joint venture in Cuba — owned with 50% domestic partner General Nickel Company — totalling 4,500 tonnes nickel and 500 tonnes cobalt, helped offset underperformance at Sherritt’s Canadian coal projects in Alberta and Saskatchewan.

But realized nickel prices were on the decline, falling from $10.56 per lb. in second-quarter 2011 to $7.88 per lb. in second-quarter 2012.

The company also benefitted from an unexpected boom in fertilizer sales, fuelled by seasonal demand. Sherritt enjoyed higher by-product credits from its fertilizer output that dropped nickel cash costs down to $4.16 per lb. at Moa — forecasts had cash costs at around $4.92 per lb. nickel.

“Costs on the input side have been a big story over the past few quarters,” president and CEO David Pathe said during the company’s second-quarter conference call. “Input commodity prices have been maintaining themselves at a stubbornly high level recently relative to the prices for output commodities. We did see prices come off a bit on the input side for things like sulphur and sulphuric acid, and saw quite significant improvement in our net direct cash costs for nickel.”

Sherritt’s operational performance fell in-line with expectations, though markets remain more interested in the company’s massive build-out at its world-class Ambatovy nickel-cobalt project located 80 km east of Madagascar’s capital city of Antananarivo. Sherritt owns 40% of the project alongside joint-venture partners Sumitomo and Korea Resources, which each hold a 27.5% stake. Engineering contractor SNC-Lavalin accounts for the remaining 5% interest.

According to Pathe the project is on budget, with the company having committed US$5.3 billion in capital to date. Sherritt is commissioning its processing facility and the company is capitalizing operating costs until Ambatovy reaches commercial production, which will occur when the operation reaches 70% capacity.

“When that happens and what the total costs will be is largely a function of the ramp-up schedule, what sort of realized nickel prices we have for our production, as well as foreign exchange rates and those sorts of considerations,” Pathe predicted. “But it will likely happen sometime early next year.”

Sherritt will apply its operational experience with nickel-cobalt deposits to its Malagasy venture, as the mine is using a hydrometallurgical process the company developed that ensures nickel-cobalt recovery in excess of 90%. Ambatovy’s slurried lateritic ore will be transported to the processing plant near the port of Toamasina using a 220 km long pipeline. Once the operation reaches full capacity it is projected to produce 60,000 tonnes of refined nickel and 5,600 tonnes of refined cobalt annually.

Sherritt’s commercial deadline at Ambatovy has been pushed back. The company originally expected to complete its ramp-up and commissioning activities by year-end, but recent releases indicate the date has shifted closer to March 2013.

The company revealed on July 25 that it had received notice from Madagascar’s transitional government indicating there would be a review of Ambatovy’s operational permit. Sherritt has the government approvals to proceed through ramp-up, but as Pathe pointed out, the company cannot export any of its products until it achieves a final permit milestone.

“You can’t apply for that permit until you’ve demonstrated your plant is up and operational,” Pathe commented. “We’ve been working with the Malagasy government and we’ve had success on the commissioning side. We think we’ve satisfied all the requirements. There have been a number of on-site reviews and meetings, but we’ve had some recent communications from the government indicating they’d like to do further review, and we don’t have much detail yet as to what that is going to look like.”

CIBC World Markets analyst Alec Kodatsky dropped Sherritt’s 12- to 18-month price target from $7.70 to $6.50 following the news.

Kodatsky noted lower-than-expected coal production at Sherritt’s Prairie and Mountain coal operations in Alberta and Saskatchewan, as well as a lower valuation for “the company’s non-core assets, which include the technology division and other unconventional coal-based businesses, in light of weaker market conditions and the contraction of market multiples observed over the course of 2012.”

Sherritt’s shares remained flat following the second-quarter results, with a marginal price decrease of 1.4%, or 6¢ during the July 25 and July 26 trading sessions, on average 480,000-share volumes.

“Key risks to Sherritt’s earnings and share price are commodity price changes, notably for nickel, cobalt, coal, oil and gas,” Kodatsky writes in a July 25 report. “We believe that the key catalyst for Sherritt remains the ability to deliver the Ambatovy nickel project on time and on budget. In the meantime, the shares will likely be kept in check until metal production start-up approaches in the coming months.”

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