Mineral Resources Setback At Christmas Creek

This story features MINERAL RESOURCES LIMITED, and other companies. For more info SHARE ANALYSIS: MIN

-Financial, production impact minimal
-Mineral Resources reputation dented
-UBS sees good leverage to iron ore
 

By Eva Brocklehurst

Mineral Resources ((MIN)) subsidiary, Crushing Services International, has been removed as operator of the Christmas Creek plant in Western Australia, with mine owner Fortescue Metals ((FMG)) stepping in to temporarily manage and supervise the site. Fortescue has acted to take over the management of two ore processing facilities following the death of an electrician who was carrying out maintenance work at the plant. The death is being investigated by the Department of Mines and Petroleum.

Mineral Resources does not anticipate a material earnings or cash flow impact, as Fortescue will continue to pay for the tonnage produced, less any direct and reasonable costs incurred in taking over management. CSI delivers 25mtpa output from the facilities on a build-own-operate basis. CSI employees will be retained on site but work under the supervision of Fortescue. Fortescue has said both plants would be ramped down during the change over but 2014 production targets are unlikely to be affected.

Brokers suspect the move will have more of an impact on Mineral Resources' reputation than its financial performance. CSI has had a good operating record to date, JP Morgan observes, but safety is a major criterion across the Western Australian iron ore sector and issues arising from the investigation of the fatality will need to be addressed promptly. The risk of terminating the contract is small but, if it occurred, Fortescue would likely have to acquire the facilities from Mineral Resources.

Outside of this issue, JP Morgan considers the risks to executing on plans for both minerals processing and mining means the stock is trading at a premium to valuation and an Underweight rating is deserved. Investors are not seen compensated adequately for such risks, such as the move into Engineering, Procurement and Construction. The company is yet to secure and deliver on EPC contracts for new ore processing facilities in Western Australia as well as gain more volume for crushing operations. Then there's negotiations for port capacity at Port Hedland and Port Fremantle.

Macquarie believes, while the news Fortescue is stepping in may shake confidence a little, the company has plenty of options for growth and leverage to commodity prices. Should Fortescue choose to bring the operations in house then it must buy out Mineral Resources position. This would turn the company's net debt position of $347m into a net cash position and Macquarie's price target could be 5% lower under such a scenario. Nevertheless, at this stage it is just that, a scenario. Macquarie notes these plants were the largest in the company's crushing portfolio and the most central to a single client. The balance of Mineral Resources' contracts are more like satellite facilities and Macquarie does not think there's a "takeover" trend happening.

UBS thinks Mineral Resources is a good way to leverage exposure to iron ore, because it has has a greater leverage to volumes versus price with an annuity style offering that benefits from the down cycle. Moreover, the company's own iron ore operations provide a flexible way to leverage sustained changes in the iron ore price. Still, that's all factored in to the current share price. The broker surmises that Mineral Resources is currently processing around 50mtpa at Christmas Creek 1 and 2 and this could represent $200m in annual revenue. The first contract for a 19mtpa plant at Christmas Creek was announced back in 2010 for a term of 10 years but no monetary value was disclosed. The second plant contract was announced in 2011. This was a 25mtpa plant with a contract expected to generate revenue in excess of $1bn over 10 years.

UBS' analysis suggests a 50mtpa crushing contract represents approximately $60m in earnings annually for Mineral Resources. A loss of 50mtpa of crushing would reduce FY14 earnings estimates by 17.5% but this does not account for any payments for termination. The contract is likely to include a payment for the processing plant and loss of potential earnings. UBS estimates a termination payment for the Christmas Creek contracts in the order of $1bn.

On the FNArena database there are three covering Mineral Resources and three different recommendations. Macquarie's Outperform, UBS' Neutral and JP Morgan's Underweight. The consensus price target is $10.97, suggesting 0.2% upside to the last share price. The dividend yield on FY14 forecast earnings is 5.8% and for FY15 it's 5.6%.
 

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