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Morningstar | Vale Supply Issues and a Dovish Fed Sees Optimism Return to the Miners and Overvaluation Grow. See Updated Analyst Note from 06 Feb 2019

The meaningful fall in resources stocks saw pockets of value emerging among the Australian miners in November. The S&P/ASX 200 Resources index fell 15% in less than two months. But since the end of November, shares have rallied on iron ore supply concerns and the apparent easing in the U.S. Federal Reserve’s tightening bias. The resources index is back at five-year highs.

We see the greatest overvaluation among the bulk producers, particularly iron ore, which is benefiting from Vale’s disruption. The miners generally still face longer-term demand challenges. Buoyant commodity and share prices do not reflect the inevitable shift in China’s economic growth towards less commodity consuming activities. Iluka is about 13% undervalued, recovering with a strong fourth quarter and continued price momentum. Newcrest is trading broadly in line with our fair value estimate.

We’ve updated our fair value estimates post the December 2018 quarter production actuals and prices. The largest valuation change is for Whitehaven Coal, up 9% to AUD 3.80, reflecting strong final quarter coking coal prices, the lower AUD/USD exchange rate and higher near-term production volumes with the strong recovery in output. Our fair value estimates for Oz Minerals and Regis Resources also rise by about 6% to AUD 8.80 and 3.20, respectively. Oz Minerals had a strong fourth quarter, performed well against 2018 guidance and increased 2019 guidance. Robust production and recent incremental exploration success at Regis Resources drive its fair value uplift.

Our fair value estimate for Sandfire Resources also increases by 5% to AUD 6.40. Production is tracking ahead of guidance and we’ve raised our full-year forecasts above the top of Sandfire’s guidance ranges. Sandfire also lowered its unit operating cost forecasts to USD 0.90 to 0.95 per pound of copper. Our fair value estimates for Newcrest Mining, South32, and New Hope Corporation have been retained at AUD 23, AUD 2.80 and AUD 3.50 respectively.

Aside from iron ore where supply has been impacted by the disruptions at Vale, prices for the mined commodities were generally in line with our expectations for the fourth quarter of 2018. We’ve made no major changes to our commodity estimates for 2019 and beyond.
Production at Whitehaven Coal also recovered strongly in the December quarter. The company’s share of salable coal production increased 33% to 4.3 million tonnes. Fiscal 2019 guidance for managed coal production of 22 to 23 million tonnes looked optimistic after a soft first quarter, but the improved second quarter now looks more realistic and we’ve raised our near-term volume forecast accordingly. This, along with the lower AUD/USD exchange rate, strong recent coking coal prices, and the time value of money, drive a 9% increase in our fair value estimate.

Output at South32 is tracking in line with our expectations for fiscal 2019, with the exception of Illawarra coking coal. The Illawarra operations are recovering faster than expected, but this follows earlier downgrades. The higher expected coal output for fiscal 2019 by itself is not sufficient to shift our fair value estimate for South32, which remains AUD 2.80 per share.

At Regis Resources, the market continues to credit the firm with considerable exploration success. The recent results incrementally extend life, as recognised with our latest AUD 3.20 per share fair value estimate. However, we think the relatively short reserve life at the company’s Western Australian operations is a challenge being underestimated by the market. We retain our preference for Newcrest, which has a much longer life reserve and resource base and is wringing efficiencies to better exploit it. Our fair value estimate credits Regis with a 100% chance of the McPhillamys development going ahead. We think the project should be developed but it still needs to secure water and environmental approvals.

Oz Minerals continues to perform strongly and reliably with copper production coming in at the top of its full-year guidance for 2018. Cash costs of USD 0.73 per pound at Prominent Hill bettered the bottom of the guidance range. The company has also boosted guidance for 2019 with incremental improvements to mill throughput and underground mining rates. This will see more gold produced, which also benefits the cash costs by increasing the byproduct credit. Oz Minerals is only slightly overvalued now, and screens as better value on a relative basis than most of our Australian mining coverage. Copper trades at a smaller premium to our nominal USD 2.30 per pound long-term assumption, from 2021, compared with coking coal and iron ore in particular. There may also be some concern over the potential development risk with Carrapateena, which is so far on track and on budget. First production is set for 2019, with Oz Minerals expecting to produce a modest 2,000 to 4,000 tonnes.

Newcrest’s December quarter was strong with gold production increasing 20% sequentially to 655,000 ounces. Improvement at Lihir was particularly pleasing with output rising 38% to 251,000 ounces and the cash cost falling to USD 663 per ounce from USD 979 per ounce in the prior quarter. Improvement came from better processing plant performance, lower unit mining costs and higher grades. The improvement in Lihir is attractive as lowering the unit mining and processing costs improves profit margins across a very long-life orebody. In addition, lowering unit costs also brings the opportunity to convert more of the lower grade resources to reserves.

Cadia has also performed well with record plant throughput. The mine has now recovered from the disruption from seismic issues and is performing as expected. Improvement at Lihir and Cadia was the key driver of our view that Newcrest was undervalued. A normalisation of production at those two key mines has now occurred, and the share price has reacted accordingly. Newcrest’s shares are now close to fairly valued. The company’s competitive position is improving with the better volumes lowering the firm’s position on the cost curve. Overall though, we make no change to our fair value estimate for Newcrest as the firm is just tracking to our full year expectations following a soft September quarter.