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Morningstar | Carrapateena Expansion a Valuable Option for Oz Minerals, Raising our FVE to AUD 10 per share

Oz Minerals is looking to expand its Carrapateena mine. The expansion would see the planned mining rate to nearly triple to 10 to 12 million tonnes a year from 2026 versus the base case 4.25 million tonnes. The bulk underground mining method of block caving, as used at Newcrest’s Cadia East mine, would increase ore volumes, lower unit costs and exploit a larger portion of the resource. Copper sales would almost double to 105,000 to 125,000 tonnes a year, from the base case of about 65,000 tonnes a year. Cash costs should decline modestly to USD 0.50 to USD 0.55 per pound from USD 0.62 per pound previously. The 20-year mine life is preserved with more of the resource to be mined, but at a lower average grade.

Despite a high up-front capital cost of AUD 1.0 to 1.3 billion, block caving at Carrapateena looks valuable. The capital blow is lessened by the development and infrastructure in place for the smaller scale mine, which starts production this year. Management may also expand the footprint of the planned block cave mine in future to extend the life of the mine.

After factoring in the block cave option, and the potential life extension from expanding the mining footprint, we raise our fair value estimate for Oz Minerals by 14% to AUD 10 per share, from AUD 8.80 per share previously. Increased near-term expenditure on drilling and further studies is a partial offset. The block cave option still has a way to go and needs to progress through the prefeasibility and feasibility study hurdles. But it appears highly likely to proceed so we’ve factored it into our forecasts and valuation. The initial block cave option accounts for AUD 0.90 per share of our increased fair value estimate. The remaining AUD 0.30 per share is attributed to the potential for mine life to be further extended by expansion of the block cave footprint.

Despite our below-consensus midcycle copper price of USD 2.30 per pound from 2021, we think the shares are fairly valued. Oz Minerals is doing a good job of developing valuable investment options. The firm is differentiating itself from its midtier, base metals mining peers by lengthening mine life and progressing several projects through their respective development stages. The pipeline is relatively rich and diverse while the expanded Carrapateena block cave should give the firm a relatively solid base of cash flows for the next two decades. Provided the capital can be allocated effectively, Oz Minerals will have the financial firepower to advance its projects. Efficient capital allocation is not a given in mining, but the current management team has done well to date.

From a financial perspective, Oz Minerals is very well placed to fund the block cave option. After factoring in the planned AUD 1.0 billion plus of capital expenditure, we still expect the company to generate an average AUD 220 million of free cash flow a year from 2020 to 2026. This primarily reflects cash flow from Prominent Hill and Carrapateena. The recently acquired Brazilian assets only modestly contribute. We do expect a free cash outflow of about AUD 300 million in 2019. About AUD 550 million is to be invested to complete the first stage of Carrapateena. Despite this, the financial position overall is strong. Oz Minerals ended 2018 with AUD 500 million net cash. We forecast the company to retain net cash in 2019 and for the balance to grow again from 2020 onwards.

The block cave life extension option is at an early stage. Implementation would be almost 20 years away and the various feasibility study hurdles still need to be cleared. It also likely comes with lower grades and commensurately higher operating costs. Despite these drawbacks, we’ve factored in a 50% chance the life extension project goes ahead. It’s likely to be more capital-efficient than the initial block cave as it leverages off the crushing, hauling and processing assets and infrastructure already in place.

Management is also exploring the potential for other resources to be brought into the life of mine plan. These studies are at an early stage and require further exploration, technical work and optimisation. They’re early stage and likely to be very long dated options though. The higher grade of the Carrapateena block cave ore, relative to surrounding resources, and the ability of the Carrapateena block cave to leverage off the existing mine development, means any development of the regional prospects will be at least 20 years away.

Block caving is a mining method with very low operating costs. It’s essentially a rock factory where ore is drawn from by loaders from fixed points underground, dumped into a central crushed and moved using efficient conveyors to the surface. The orebody self-mines from the bottom up with gravity, assisted by rock fracturing prior to mining. Low operating costs allow lower grade ore to be mined economically. The downside of block caving is the large, upfront capital expenditure.