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Morningstar | Zijin Mining on Acquisition Spree; FVE Unchanged

No-moat-rated Zijin Mining announced in early September that it has proposed a CNY 9.5 billion cash takeover of Canada-listed miner, Nevsun Resources and it will also acquire 63% of RTB Bor Group for USD 350 million. We think the move is in line with management’s guidance, given the budgeted CNY 12 billion spending for investment, merger and acquisition in 2018. These transactions are still subject to regulatory approvals and we do not expect them to significantly change our view on Zijin, given our bearish view on long-term material prices. Our fair value estimate remains intact at HKD 2.96 (CNY 2.56).

If both deals are successful, we estimate it could increase the firm's resources (including inferred resources) for zinc, copper and gold by about 24%, 42%, and 32%, respectively. That said, given that these resources are located overseas, the firm will have higher operating risks going forward. For example, RTB Bor Group controls 4 low grade copper (gold) mines in Serbia, and produced 43,500 tonnes of copper, 700 kg of gold and 5,000 kg of silver in 2017. However, due to low metal prices, insufficient investment and obsolescence of equipment in recent years, RTB has been facing difficulties in its operation and management. As such, RTB will need additional funding for technological reform and expansion in order to turn around.

Meanwhile, Nevsun owns a 60% interest in the Bisha copper-zinc mine project in Eritrea, Africa (currently in production) and the Timok copper-gold mine project in Serbia (100% interest of the Upper Zone and final interest of 46% for the Lower Zone). Zijin’s offer price for Nevsun at CAD 6 per share is not cheap, given the 21% premium over Nevsun’s closing price on Sept. 4 and 26% over the hostile take-over bid for Nevsun made by Lundin Mining on July 26. However, this is compensated by the potential low-cost operation of Timok (estimated to be in the first quartile of copper cost curve).

Timok’s Lower Zone is still under exploration stage while a feasibility study of the Upper Zone will only be completed in 2019, with initial production targeted for 2022. The project sounds promising with expected IRR of 80% under copper price assumption of USD 3.15 per pound. However, we have a different view and we are bearish on long-term copper prices. We continue to forecast 2018 copper prices to average USD 3.00 per pound. Although prices averaged USD 3.14 during the first half of the year, they have fallen to about USD 2.65 as of Sept. 5. As new supply ramps up and demand growth in China continues to slow, we expect prices to fall further and our long-term 2022 copper price forecast is at USD 2.34 per pound (in nominal terms). As such, we think the IRR of the project will be lower than expected.
While we think funding will not be an issue for Zijin, we estimate the transaction will increase the firm’s net gearing ratio to more than 1.1 times from 0.8 times as at end-2017. This is roughly similar to end-2015’s level.