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Morningstar | Oz Minerals on Track to Meet 2018 Guidance, AUD 8.30 FVE Retained

No-moat-rated Oz Minerals' first-half 2018 net profit after tax of AUD 128 million was slightly better than our AUD 120 million. The stronger-than-expected result reflected lower than forecast smelter treatment and refining charges. Compared with last year, the 59% rise in net profit was principally due to the 18% higher copper price. We marginally increase our 2018 earnings forecast as a result to AUD 0.86 per share from AUD 0.83 previously. Our AUD 8.30 per share fair value estimate is retained with our key assumptions and outlook for the firm essentially unchanged. Guidance remains to produce 100,000 to 110,000 tonnes of copper at a cash cost of USD 0.75 to USD 0.85 per pound in 2018.

The recent sell-off in base metals prices sees Oz Minerals now trading within 10% of our fair value estimate. While still slightly overvalued, based on our expectations for the copper price, the shares appear less overvalued than most of the miners under our coverage. We think this likely reflects the high level of capital expenditure and development activity currently under way. Mining companies sometimes make capital allocation mis-steps or are subject to risks outside management's control. However, we think current management is doing a creditable job and don't see any specific reason to be concerned by the elevated level of expenditure and activity. Treatment of lower-grade stockpiles at Prominent Hill will also see net profit decline, however, we expect net operating cash flow to be relatively consistent and to average AUD 530 million a year between 2018 and 2020.

Development of Carrapateena remains on schedule and budget. In parallel with construction of the mine, Oz Minerals is evaluating potential to expand with higher volume, lower-cost mining methods. It is early days, but these initiatives could bring longer-term upside. At Prominent Hill, the company is exploring the potential to increase underground ore mining rates, which could incrementally improve production volumes and/or mine life. Management continues to review the recently acquired Avanco assets in Brazil with a view to improving the value of development options.

The balance sheet remains very strong with AUD 493 million net cash, though down 21% from a year ago reflecting the heavy capital expenditure for Carrapateena and the 50% of Avanco purchased with cash. Based on our expectation for the copper price to average USD 2.70 per pound between 2018 and 2020 inclusive, the company is well placed to fund Carrapateena plus the Pedra Branca and CentroGold developments in Brazil. Oz Minerals should be able to comfortably fund those developments from existing cash and cash flow from operations without taking on debt. However, if the firm undertakes meaningful additional acquisitions or developments, we could see a modest level of borrowings.
Oz Minerals new CFO has now specified a maximum net debt/total assets of 20% and net debt/EBITDA of 1.0. We think it's sensible for management to retain relatively conservative balance sheet given the sensitivity of cash flows to the cyclical copper price. Excess cash will be returned to shareholders, most likely through special dividends, but the company also retains the option for buybacks based on value. It's mildly encouraging that management has not undertaken buybacks in the last year, counter to many peers, given the shares have generally traded at an elevated level.

The first-half dividend of AUD 0.08 per share fully franked was up 33% from a year ago but reflected payout ratio of less than 20%, due to the upcoming period of heavy capital investment. We've retained our AUD 0.20 per share full-year dividend forecast. It is likely dividends will remain modest for the next couple of years given the expenditure on Carrapateena and the Brazilian assets, and the potential for more to follow once those mines are fully developed.