Cash Outlook Fades For OZ Minerals

This story features OZ MINERALS LIMITED. For more info SHARE ANALYSIS: OZL

-Cash negative in 2015 too?
-Issue of short mine life remains
-Macquarie cuts dividend expectations
 

By Eva Brocklehurst

A significant improvement in OZ Minerals' ((OZL)) grades and operations in the June quarter has not mitigated broker concerns regarding the outlook for the Prominent Hill mine. The copper-gold miner may have upgraded 2014 copper production forecasts by 13% and reduced cost guidance, as it accelerates access to higher grade ore, but this has been counteracted by increased cash burn.

Copper production guidance is upgraded to 85-90,000 tonnes for 2014, from 75-80,000t, while gold production guidance is maintained at 130-140,000 ounces. Some working capital is expected to be released in the second half but increased material movements will result in higher mining expenditure than previously expected. A prior forecast for a cash neutral outcome for 2014 has now been revised away.

Credit Suisse observes the opportunity to undertake corporate actions is further reduced with lower cash. The broker had expected a materially lower cash position but the deterioration was still below its modelling. The company may have pulled off a "beat" on production and costs and upgraded guidance but the cash balance is also the big negative for CIMB. A balance of $155m at the end of June was well below the broker's forecast of $279m. Yet management has suggested this working capital impact will reverse and Morgan Stanley takes heart in this expectation, envisaging the net cash burn will abate in the second half. Morgan Stanley retains an Overweight rating. Moreover, accelerated pit development at Malu adds 8% to the broker's mine discounted cash flow. The Malu underground reserve met expectations and first production of around 4,000t is expected later this year.

BA-Merrill Lynch was encouraged by the improvement in mine performance but cash consumption worries the broker, which estimates the company will not be cash flow positive until the second half of 2015. More cash to become more positive is Merrills' view, and the broker retains a Neutral rating. Deutsche Bank notes, based on the updated open pit schedule, the company will continue mining above milling capacity for the remaining life of the open pit. This offers more processing flexibility but consumes additional cash and a considerable build in ore inventory will drain cash over the next few years, although the broker acknowledges working capital swings can be significant. Deutsche Bank expects the focus to remain on defining and de-risking the Malu underground. 

Credit Suisse found the fall in cash costs the most pleasing aspect of the quarterly report, as contracts appear to have been renegotiated favourably and at faster rate than expected. The company has flagged a strong first half performance, with Credit Suisse observing after a site visit that the pit is in good shape and now very productive. That said, the implied second half mining costs increase alarmingly, in the broker's opinion, attributable, apparently, to the reduced tonnage being mined. Mining congestion and haul distance will increase as the pit gets deeper and achieving material re-negotiation in contractor costs will be challenging because of the short, defined life at Prominent Hill, the company's flagship asset in South Australia. This is the nub of the outlook issue for brokers.

The company's other main potential mine is at the Carrapateena deposit in South Australia, where pre-feasibility work continues but no longer includes an exploration decline. The company does not have balance sheet capacity to develop the project so needs to sell equity to a JV partner. UBS is negative about Carrapateena, because the cost of development is beyond the company's ability. A partner may be found in time but interested parties will probably look to earn in via staged payments, less useful than an up-front cash payment to OZ Minerals. UBS expects the December half to be challenged in terms of cash flow and retains a Sell rating based on valuation. Overall, the broker thinks Prominent Hill's mine life remains a challenge, with the open pit being depleted by 2018 and Malu underground lacking a strong positive investment signal. In fact, UBS thinks the $200m in capital spending on Malu may have been better returned to shareholders.

Macquarie incorporates the changes to production and mining rates and this translates to a material improvement to the broker's forecasts for 2014 but modest reductions to 2015 and beyond. Macquarie retains an Underperform rating, expecting the company to report negative free cash flow in 2014 and 2015, which is likely to put pressure on the dividend. Macquarie reduces its dividend forecast for 2014 by 50%.

On FNArena's database OZ Minerals has two Buy, three Hold and three Sell ratings. The consensus target is $4.28, suggesting 2.0% downside to the last share price. This compares with $4.23 ahead of the production report. The targets range from $3.40 (Deutsche Bank) to $5.50 (CIMB).
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms