Treasure Chest: Re-Rating For Sandfire?

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

By Greg Peel

In the December quarter, copper/gold miner Sandfire Resources ((SFR)) was hamstrung by water problems at its flagship DeGrussa mine in Western Australia, but brokers were pleased to see that these issues had been addressed to the point the mine performed ahead of expectations in the March quarter. Costs were also lower than forecast.

The other good news in the quarterly report was the company’s completed debt restructure, which lowered interest costs and extended the repayment profile to provide Sandfire with more immediate access to cash. Solid cash flow from DeGrussa already allows dividends to be paid to shareholders on a payout ratio of around 20%, thus the restructure at the least underpins dividends, if not provides for an increased payout.

But while brokers have been net positive on the stock, as evidenced by six Buy or equivalent and two Hold ratings in the FNArena database, the market has been sceptical, as evidenced by the consensus price target among those brokers suggesting 22% upside from the current (today’s) trading price.

The market has had two issues.

The first had been two large stakes in Sandfire held respectively by OZ Minerals ((OZL)) and Korea’s POSCO. One such stake can be good but two can be problematic, as it implies a blocking stake against any takeover attempt from the other. The two stakes also reduced the level of free float of Sandfire shares, and institutional investors prefer liquidity.

The other is the fact that while DeGrussa is a high grade, low cost resource, its mine life is, to date, limited to only six years. Sandfire is continuing to explore the area, but until any further significant strikes occur, the company is faced with the prospect having to acquire for growth, and that threatens dividends.

So the market has given Sandfire a bit of a wide berth. But on the first issue, there have been some developments.

On March 13, OZ Minerals sold out of its 19.1% stake at $4.20 per share. This allowed in some light, but the clincher occurred last week when POSCO sold out of its 15.2% stake at $5.43. Suddenly Sandfire’s free float has been increased by a net 35%.

With liquidity now opened up, will the market rethink its valuation of Sandfire? UBS believes it should.

Yet still there remains the issue of DeGrussa’s short mine life. To that end, UBS notes DeGrussa already boasts an additional inferred resource, known as the C5 conductor, but under international mining disclosure laws an inferred resource cannot be included as a reserve. Sandfire’s drilling program should nevertheless see C5 converted to a reserve over the next 12 months, UBS believes.

Hence, to UBS, Sandfire “ticks all the right boxes”. Cash flow from DeGrussa is supporting an active regional exploration program, the balance sheet is de-leveraged, the company pays dividends and there is also potential for a second mine to be added to the portfolio via Sandfire’s stake in Tintina Resources.

UBS values Sandfire at $7.80, some 53% above today’s trading price.

Yet as the broker tries to convince its clients of Sandfire’s value, it is still met with concerns over DeGrussa’s limited mine life. In UBS’ view, the geological understanding of the DeGrussa region has progressed significantly over the last two to three years and recent drilling on the Talisman joint venture has “validated strong conceptual targets”.

Ongoing testing may yet find another orebody, UBS contends.

For stockbroker Morgans, mine life is the biggest restriction for a mining stock otherwise offering only “modest” upside. Morgans still rates Sandfire a Buy (Add), but has set a low-end target in the FNArena database of $5.12. The bottom of the range target is that of Morgan Stanley at $5.00. Morgan Stanley believes the market is pricing in too much of a premium over spot copper/gold prices, and retains Hold.

Macquarie (Outperform) is looking for increased dividends following the debt restructure while Citi (Buy) makes the point that with PanAust ((PNA)) about to depart the ASX post takeover, there are only two major copper pure-plays (gold is a ubiquitous but welcomed by product of copper mining) left on the Australian market in the form of Oz Minerals and Sandfire.

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