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Morningstar | Lower Copper Price and Higher Exploration Dents Sandfire’s 1H19 Profit. AUD 6.40 FVE Unchanged.

Sandfire Resources' first-half fiscal 2019 net profit after tax fell 19% to AUD 48 million versus AUD 60 million a year ago. The decline was largely driven by lower copper prices and doubling of exploration expenditure. The weaker AUD/USD exchange rate and stronger gold price were partial offsets.

Production from the DeGrussa mine was solid, with copper and gold production growing 10% and 15%, respectively, on last year. We expect further improvement through 2019 as high-grade Monty ore is added to production. Fiscal 2019 guidance is maintained. Production is expected to come in at the upper end of the guidance ranges of 63,000 to 67,000 tonnes of copper and 37,000 to 40,000 ounces of gold for the full year. Cash costs are expected to be at USD 0.90 to USD 0.95 per pound of copper, similar to fiscal 2018.

Reserve life is less than five years and puts pressure on the firm to take risks on exploration and development, and possibly acquisitions. Key for Sandfire will be to grow reserves to extend life, but we think this will be a significant challenge. Incremental exploration success is incorporated into our unchanged AUD 6.40 per share fair value estimate. However, with the recent increase in the share price, we think Sandfire is overvalued. Beyond the challenge from finite reserves, we expect copper prices to soften as China’s investment activity cools.

We see an elevated risk of potential capital destruction in the near to medium term given depleting reserves. The recent approach to ASX-listed Mod Resources supports this view. While the probability of a transaction with Mod Resources looks low, it’s still symptomatic of a heightened appetite for activity; namely exploration, developments or acquisitions. The company is also throwing considerable resources at exploration. Elevated expenditure in the period reflected exploration around Greater Doolgunna, and the feasibility study and environmental impact statement Black Butte Copper in Montana.

The net cash outflow of AUD 35 million for the half was an anomaly and reflected the AUD 73 million acquisition of Talisman’s 30% interest in the Monty project. Despite this, we expect free cash flow to average about AUD 150 million for the five years ended fiscal 2023. The interim fully-franked dividend of AUD 7 cents per share was down 13% from a year ago on a 21% payout ratio. Sandfire tends to bias its dividends to the final and we expect total dividends of AUD 0.32 per share for fiscal 2019, a 51% payout ratio. Sandfire has the financial strength to increase shareholder returns given the buoyant operating cash flow and robust balance sheet with net cash of AUD 178 million. However, the desire to take risk to extend life and grow production is most likely to take priority.