Power Supply A Key Risk For OZ Minerals

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OZ Minerals offers leverage to copper prices with substantial reserves at Prominent Hill and Carrapateena. The main issue for brokers is the uncertainty of the power supply to Prominent Hill.

-Near-term catalysts are exploration updates from regional drilling programs
-Alternative power sources and infrastructure required at Prominent Hill by 2020
-Technical challenges at Carrapateena may become more visible through 2018
 

By Eva Brocklehurst

OZ Minerals ((OZL)) produced a solid September quarter, sustaining significant cash flow and enabling it to pursue opportunities, whether via exploration or small acquisitions.

Canaccord Genuity considers a scalable production profile and large reserve enable exposure to a buoyant copper price. UBS agrees that, as the near-term outlook for the producing assets is well communicated, the stock offers increasing leverage to copper.

Near-term risks include a slowdown in the development rate at Carrapateena and ongoing power uncertainty beyond 2020 at Prominent Hill, both in central South Australia. Yet UBS suggests an underweight position in the stock could mean risking leverage to potentially higher copper prices and expansion options at West Musgrave (Western Australia).

Credit Suisse elects to retain an Underperform rating and believes the greatest near-term opportunity is from the re-optimisation of Prominent Hill underground, to progressively include additional resources that have long been defined but offer an in-situ value that is too low relative to the extraction cost.

The opportunity is yet to be examined in detail, the broker acknowledges, in order to determine if a lower-cost mining method can be applied without the need for material establishment capital.

Near-term catalysts in Macquarie's opinion are exploration updates from the regional and joint venture drilling programs,combined with the scoping study for the West Musgrave project.

Macquarie notes material movements were 25% higher in the quarter from Prominent Hill's open pit, a driver of higher costs along with power. The increased movement of material stemmed from the company accelerating the closure of the open pit to the first quarter of 2018, six months earlier than the broker had previously forecast.

Power Supply

One of the major risks for the stock is the need for a power strategy at Prominent Hill, adjacent to the Olympic Dam complex in South Australia. BHP Billiton ((BHP)) has decided to terminate an existing connection and power access agreement. Under the existing agreement, Prominent Hill shares BHP's power line from Davenport to Olympic Dam while OZ Minerals owns the infrastructure from Olympic Dam to Prominent Hill.

This highlights the competition and scarcity of infrastructure in the region. Alternative power sources and associated infrastructure at Prominent Hill are required before 2020. Power costs at Prominent Hill are expected to rise 60% this year and higher power costs are assumed in guidance.

UBS interprets the company's revelation that discussions with BHP regarding joint power transmission are ongoing as a sign there is potential for a shorter-term access arrangement and/or at a higher price. The company is also looking at building its own infrastructure which could, in the broker's opinion, involve part duplication of power lines to Mount Gunson, or on-site power.

Morgans expects resolution of power security for Prominent Hill is some months away and this contributes to the concerns for marginal investors. The broker agrees that power certainty will only improve from current levels and backs the company's ability to manage both the long-term transmission and pricing risk.

The broker had hoped for more detail regarding solutions to the power issue, including a stand-alone infrastructure corridor and possible integration of on-site generation/renewables. Still, given commercially sensitive negotiations are ongoing, Morgans is prepared to be patient and suggests a self-funded power corridor is the worst-case scenario. Conceptually, if $100m in capital expenditure is required in FY20 this equates to a $0.34 reduction to the broker's valuation.

Government intervention in the market could support more palatable alternatives, although Morgans believes the summer months and potential load shedding have the potential to knock the stock around. Hence, buyers should watch the dips closely. The broker retains an Add rating.

Carrapateena

Canaccord Genuity accepts that assuming there is no significant cost blow-out at Carrapateena, the company's existing balance sheet and strong cash being generated from Prominent Hill mitigate the financial risks associated with the additional expenditure required for the new power strategy.

Carrapateena is not affected by the discussions with BHP as the proposed power supply is from Mount Gunson. Nevertheless, while Carrapateena is not directly affected, as first concentrate is expected in the fourth quarter of 2019, this coincides with implementing an alternative power strategy at Prominent Hill and provides added complexity and risk, Canaccord Genuity contends.

The broker expects the logistical and technical challenges associated with Carrapateena will become more visible from 2018 onwards and, not being one of the eight stockbrokers monitored daily on the FNArena database, retains a Sell rating and $7.30 target.

Even after including Carrapateena in valuation on an unrisked basis, the stock is trading close to valuation and Ord Minnett maintains a Hold rating. FNArena's database shows four Buy ratings, two Hold and two Sell. The consensus target is $8.33, suggesting -0.8% downside to the last share price.

This stock is not covered in-house by Ord Minnett. Instead, the broker whitelabels research by JP Morgan.
 

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