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Morningstar | Raising our Oz Minerals FVE to AUD 11 per Share, Shares Now Undervalued

Shares in no-moat-rated Oz Minerals have sold off recently, declining to AUD 9.50 per share from highs around AUD 11 in April 2019. The sell-off probably reflects weakness in base metals prices and concerns around global trade. While iron ore has been shielded from the economic concerns due to tight supply, the prices of copper, nickel, and zinc have all sold off by about 10% in the past few months. Oz Minerals shares fell in sympathy and that provides an opportunity.

We make no change to our near-term copper price forecast and continue to expect the price to average USD 2.80 per pound in 2019. This is in accord with the year to date average of USD 2.82 per pound. We raise our fair value estimate to AUD 11 per share from AUD 10.30 previously. The uptick reflects the lower Australian dollar--now below 0.70--the time value of money and the strong start to the year on production. With the increased fair value estimate and the decline in the share price, Oz Minerals now screens relatively undervalued. The shares trade at an approximate 14% discount to our fair value estimate.

Qualitatively, we think Oz Minerals business has improved in recent years. Management has done a good job of strategy and execution. The focus has been to lower costs, improve production reliability, extend life at Prominent Hill, develop Carrapateena efficiently and generate growth options. On those measures, the business is performing well. Carrapateena importantly adds low-cost copper gold production from a deposit with relatively long life. There may be some concerns in the market around the acquisition of Avanco Resources, which brought exposure to several development options in Brazil, and a small scale, operating copper-gold mine. It’s early days on the integration front, and too soon in our view to make a call on the success of the acquisition. However, Oz Minerals paid a good price, it brings useful growth options and we’re confident in management’s ability to execute.

Development of Carrapateena is the major change on the horizon for Oz Minerals. The start of production there should improve the overall quality of the business by adding a second mine with a much longer life of 20 years. Initial annual production of 65,000 tonnes of copper is smaller than Prominent Hill at around 100,000 tonnes, but a planned block cave expansion should almost double volumes by 2026 to around 115,000 tonnes a year. This would make Carrapateena the key production asset for Oz Minerals, particularly as output from Prominent Hill declines. Once stockpiled open pit ore depletes, Prominent Hill is likely to produce around 40,000 to 50,000 tonnes of copper a year from the underground.

The expanded Carrapateena should see cash costs of USD 0.50 to USD 0.55 per pound, placing the mine well inside the lowest quartile of the copper cost curve. We like that OZ Minerals has developed the mine with a smaller, lower capital footprint to start, and will then scale up. Production is set to begin at Carrapateena in late 2019. Brownfields expansions are generally lower-risk and starting smaller also reduced the potential financial risk.

From a financial perspective, Oz Minerals is very well placed to fund the preproduction capital of AUD 1.0 to 1.3 billion for the block cave option. Net cash at end 2018 was AUD 505 million, or AUD 1.55 per share. This year represents the peak expenditure for Carrapateena’s development, and we forecast a net cash outflow of about AUD 230 million. However, the start of meaningful cash flow from Carrapateena will see the strong financial position improve again from 2020 onwards. We forecast average annual free cash flow of about AUD 400 million or AUD 1.23 per share from 2021 through 2023. Development expenditure for the Carrapateena expansion should start around 2022 and extend to 2026. The approximate AUD 250 million annual cash outflow is well covered by cash and cash flow and the firm still has firepower to pursue further growth options.

On growth; in Brazil, we’re expecting the Pedra Branca deposit to move towards development and for a positive prefeasibility study outcome at CentroGold this year. A positive prefeasibility study at the 70%-owned West Musgrave project in Western Australia could bring upside to our fair value estimate, depending on the materiality. We’re yet to include it in our fair value estimate given the nickel and copper grades are relatively low.