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Morningstar | Copper Sell-Off Sees Oz Minerals Now Only Slightly Overvalued

We raise our fair value estimate for no-moat-rated Oz Minerals to AUD 8.30 from AUD 8.00 per share. The increase reflects the time value of money and relatively strong second-quarter 2018 production. Copper output of 32,100 tonnes was 4% ahead of our forecast, and cash costs of USD 0.72 per pound were mildly better than expected. The June quarter was the first following the exhaustion of the open-pit mine and the transition to processing ore from the stockpile.

Trading at AUD 9.20, Oz Minerals is around 11% overvalued. Shares have declined about 14% in five weeks from their June 2018 peak with the recent dip in the copper price, fuelled by fears of a trade war and weakening global economic growth. We think Oz Minerals is less expensive than most of the other mining firms we cover, particularly versus miners with significant exposure to buoyant coal and iron ore prices. We think the moderate overvaluation wholly reflects our expectation for the copper price to fall in future. A partial offset is the valuation uncertainty that comes with the recent acquisition of Avanco Resources in Brazil, the forecast decline in output from Prominent Hill, and major capital expenditure under way at Carrapateena mine.

But the outlook for cash flow is reasonable. From 2020, meaningful production at Carrapateena should offset headwinds from the decline in grades and production at Prominent Hill and a lower long-term forecast copper price of USD 2.30 per pound by 2021. Oz Minerals should generate about AUD 550 million of aftertax operating cash flow per year for the next five years. Coupled with about AUD 450 million net cash, the firm is in strong financial shape and is well placed to fund committed capital expenditure and potential internal growth options. Barring a dramatic copper price sell-off, a large cash return to shareholders, or a significant new acquisition or development, which we think is unlikely, Oz Minerals should retain net cash in the medium term.

We’ve been impressed with management’s efforts to build a series of potential future growth options. It’s still early days in terms of those options bearing fruit, but the pipeline of possible developments has expanded greatly under current management. Most recently, the acquisition of Avanco Resources brings a few new copper and gold deposits to evaluate. Whether shareholder value is ultimately created will depend on production rates, cost estimates, and price forecasts. But in our view, the greater number of investment options increases internal competition for capital and should help management pick the best investments. Oz Minerals paid a fair price for Avanco, and we think the purchase is value-neutral. It's now up to exploration success or development enhancements to drive any potential additions to shareholder value.

While acknowledging the rich set of investment options relative to peers, we think a key question is whether Oz Minerals can deliver projects that generate reasonable returns at commodity prices below current levels. There are three key areas to watch. First is potential for enhancements at Carrapateena. This could come from expansion of the existing planned mine to take the more extensive lower-grade parts of the deposit through a cheaper bulk-mining method, such as block caving. Drilling of the nearby Khamsin deposit has shown renewed promise. Earlier drill intercepts at Khamsin have tended to be inferior to Carrapateena’s, but a new drill result has opened potential for a large, higher-grade discovery. Second is the integration of the Brazilian assets acquired with Avanco. We’re looking for continuity of production and progress to mature the potential growth options there. Third is the Nebo-Babel nickel and copper deposit in Australia, where a prefeasibility study is under way.

If we’re wrong on the copper price, and it’s better than we expect, our bull-case scenario fair value estimate is AUD 11.30 per share. This assumes a nominal price of USD 3.07 per pound by 2021. After adjusting for inflation, this is close to the current copper price.