More Copper, Less Gold For OZ Minerals

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More copper and less gold production is expected from OZ Minerals in coming years and Carrapateena's imminent feasibility study could be a catalyst for the stock.

-Main risks in the trajectory of the copper price and AUD
-Production outlook materially improved at Prominent Hill
-Is the market overlooking the risks with Carrapateena?
 

By Eva Brocklehurst

Copper-gold miner, OZ Minerals ((OZL)), has revised its medium-term guidance for Prominent Hill, with more copper and less gold expected over the next three years. The Carrapateena feasibility study is expected early in the June quarter, and brokers expect this could be a catalyst for the stock.

The company's 2016 copper production of 116,900 tonnes beat guidance of 105-115,000 tonnes and gold production of 118,300 ounces was within the guidance range of 115-125,000 ounces. 2016 C1 cash costs of US 74.1c/lb were in line with expectations, despite the 15 days of power black-outs in South Australia. Management has confirmed the share buy-back will continue.

Citi forecasts higher milling and underground mining rates and raises its expectations for copper and gold grades in FY17-19. Accordingly, earnings per share estimates are increased for those years. Citi expects the news flow will now focus on Carrapateena, one of the world's largest undeveloped copper resources, and possibly include M&A, as the company seeks to acquire base metal and gold assets which can diversify its production footprint.

The main risks for the stock are in the copper price and the Australian dollar. Citi notes copper is highly geared to economic recovery and any change in economic activity has the potential to alter earnings assumptions and valuations for OZ Minerals.

Clearer Path For Prominent Hill

A revision to the mine plan at Prominent Hill has materially improved the production outlook for copper in 2018 and 2019, and Macquarie believes the focus on copper ore in changes to the open pit plan should mean a production rate close to 100,000 tonnes per annum is maintained through to 2019. The broker lifts copper production forecasts at Prominent Hill by 4% for 2017, 13% for 2018 and 53% for 2019 to match guidance.

The drive to produce more copper means the broker's gold production forecasts fall -10-20% over the next three years, while cost assumptions (AISC) rise 32% and 10% for 2017 and 2018 respectively. Factoring in the longer mine life at Prominent Hill means the broker's price target is raised 11% to $9.30.

Other brokers agree a clearer plan for Prominent Hill has now been established and the market's focus should shift back to Carrapateena, but both Morgans and Credit Suisse highlight the current share price appears to ignore the risks from the undeveloped project.

Morgans upgrades forecasts for earnings per share in line with higher copper price assumptions and the benefits to medium-term operating assumptions at Prominent Hill. The broker notes a significant portion of the upgrade to the Prominent Hill reserve in November was driven by reduction in the mining reserve cut-off grade, which the company believes to be sustainable.

Credit Suisse believes the greatest near-term opportunity is from the re-optimisation of the Prominent Hill underground mine, to progressively include additional resources which, while already defined, have an in-situ value that is too low relative to the cost base. Ultimately, the broker believes exploration success underground will need to be balanced by a cost structure that is more appropriate to the re-configured, lower underground-only milling rate.

The broker believes power availability in South Australia has impacted the company's decision on the configuration of the mill, with a steady power draw possibly more readily accommodated if supply is fragile in coming years.

Carrapateena The Catalyst

Morgans notes Carrapateena remains a technically complex project, where relatively small changes in key inputs can have large detrimental effects on value. The broker also lauds the company's agility during the October power outage in South Australia, as it mined more underground ore, maintaining its 2016 copper guidance. The company displaced lower-margin gold-only ore with higher-value copper ore.

Morgans suspects the recent rating upgrade of the stock has been driven by general demand for large, liquid and high-margin copper exposures amid rising copper prices. Such stocks are scarce on the ASX and this helps to explain the stock's premium. Still, with prices now well ahead of fundamentals the broker believes the market is overlooking inherent risks and downgrades to Reduce from Hold. Morgans retains a preference for Sandfire Resources ((SFR)) in copper.

Ord Minnett believes the risks to the share price are evenly skewed. The broker remains bearish about the near-term copper outlook, expecting prices will retrace towards US$2/lb in 2018. Ord Minnett maintains a Hold rating. The stock remains the key pick in the copper space for UBS, supported by its two long-life assets and a positive outlook towards copper. UBS has a Buy rating.

The broker notes investors are somewhat cautious regarding Carrapateena, with a view that the asset is marginal and the risk profile elevated. The broker expects the full feasibility study due by the end of the March quarter to deliver the details necessary to de-risk the asset further.

On FNArena's database there are two Buy ratings, three Hold and three Sell. The consensus target is $8.01, suggesting -10.4% downside to the last share price. Targets range from $5.80 (Morgan Stanley) to $10.50 (Citi).
 

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