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Morningstar | Market Enthuses Over Sandfire Resources’ Strong Fiscal 2018 Result but Shares Are Overvalued

Sandfire Resources delivered strong fiscal 2018 net profit of AUD 123 million, up 59% from fiscal 2017 and soundly beating our AUD 110 million forecast. The better-than-expected profit reflected higher fourth-quarter production and sales volumes, as well as an unexpected AUD 10 million benefit from provisionally priced copper. The latter benefit is just a timing issue and varies with fluctuations in the copper price. The realised copper price is typically finalised three months after sale of the concentrate, and the recent decline in the copper price means a similar-size reduction is likely for fiscal 2019 revenue.

The shares have risen almost 10% on the day. We attribute the market’s positive reaction to the improved profit and bullish management comments on the conference call. Sandfire is particularly optimistic on the potential for exploration success around the DeGrussa copper mine. However, exploration expenditure can also destroy value, and in the company’s recent history, depletion of reserves through mining has outstripped reserve growth from exploration. Management is also confident that the majority-owned Black Butte copper project in Montana will be approved in the next six months. However, it still must traverse public consultation, and there is a significant risk that approval could be hampered by the actions of nongovernmental organisations.

In short, we think nothing material changes with this result, and we maintain our AUD 5.80 per share fair value estimate. The share price credits either significantly higher copper prices or greater exploration success than we can currently justify, or both. We’ve credited Sandfire with extending life by mining an additional 50% beyond current reserves. There is enough prospectivity around DeGrussa to justify an assumption of some success, particularly given the planned expenditure. Still, the market seems overly optimistic on the potential for value-add via the drill bit.

Sandfire is in strong financial shape with net cash nearly doubling to about AUD 240 million. Free cash flow of AUD 146 million was up 9% from a year ago, reflecting the increased profitability, partly offset by a rise in expenditure for exploration, development, and investments. Total dividends of AUD 0.27 per share (fully franked) were a record, up 50% on a year ago. The payout ratio of 35% was similar to last year’s. Earnings increased 58% to AUD 0.78 per share, with shares on issue little changed in fiscal 2018. Given the strong balance sheet and forecast free cash flow, we expect the payout ratio to rise in the absence of a large acquisition or new discovery.

Guidance for fiscal 2019 was slightly weaker than we expected, with Sandfire planning to mine lower-grade parts of the Monty orebody. We had expected the start of mining at Monty to boost overall grades, but that is now likely in fiscal 2020 and fiscal 2021. The reserve at Monty averages 8.7% copper, roughly double DeGrussa’s reserve grade of 4.4%. Monty will contribute approximately 25% of the mill feed when fully ramped up in fiscal 2020. Sandfire’s guidance to produce 63,000-67,000 tonnes of copper and 37,000-40,000 ounces of gold is in line with fiscal 2018 output. Cash costs are expected to be marginally higher at USD 1.00-USD 1.05 per pound of copper, up from USD 0.93 per pound in fiscal 2018.