Sandfire Pressured To Find New Resources

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This story features SANDFIRE RESOURCES LIMITED.
For more info SHARE ANALYSIS: SFR
The company is included in ASX100, ASX200, ASX300 and ALL-ORDS

Exploration success has become increasingly important to Sandfire Resources and several brokers downgrade the stock in the face of investor caution.

-Even with Monty, mine life at DeGrussa is only around five years
-Approvals process at Black Butte appears bogged down
-Scope for capital return?
 

By Eva Brocklehurst

Exploration success is becoming increasingly important to Sandfire Resources ((SFR)) and several brokers downgrade the stock to neutral territory on the back of the June quarter results, being Morgans, Macquarie and Ord Minnett. Macquarie materially lowers earnings estimates in the wake of the June quarter outcome and believes guidance for FY18 is weak.

The broker is also disappointed with the exploration around Doolgunna and, given limited life at DeGrussa, believes the pressure is on to make a meaningful discovery. In the absence of an acquisition or exploration success the broker believes the stock lacks a positive catalyst.

Ord Minnett suggests Sandfire is a good operator and DeGrussa has proved to be a stable and reliable producer. The Monty development is underway and remains low risk and implementation of the flotation upgrade is expected to improve DeGrussa copper recovery by 1-1.5%.

Nevertheless, even with the Monty deposit, mine life at DeGrussa is about five years. On this basis the broker believes the stock is unlikely to trade at a premium to net present value. Ord Minnett would look to become more positive if there were signs of further growth plans, such as Black Butte, Montana.

Credit Suisse has no qualms about the company's execution at DeGrussa nor the company's strong commitment to exploration and identifying additional reserves. Moreover commitment to the endeavour is well funded and methodical.

Yet, the broker remains sceptical about permits at the Tintina joint venture (Black Butte). The company reports some progress at Black Butte, having submitted a third and final modified application for a mine operating permit. Once the project has achieved a compliant status a draft mine permit will be transmitted and the process moves a further step towards a full environmental impact study.

Morgans suggests investor attention will increasingly rely on exploration success and the progress of approvals at Black Butte. The broker notes the risk around approvals and development is readily observable in Tintina's market capitalisation.

Meanwhile,the company is spending $28m on near-mine and other regional Australian exploration in FY18 in an effort to supplement cash flow beyond the exhaustion of DeGrussa reserves. If this is unsuccessful the broker believes the market will become increasingly nervous about how the company chooses to deploy surplus cash. Morgans maintains a preference for OZ Minerals ((OZL)) as a pure copper exposure.

SFR vs OZL

Deutsche Bank remains more upbeat, believing that at the current share price investors are not paying for any further mine life extensions. The broker considers the stock a simple pure copper exposure that is trading on three times FY18 enterprise value/operating earnings (EBITDA) using spot copper prices, compared to six times for OZ Minerals.

Moreover, while OZ Minerals has a greater pricing leverage because of the long life nature of Carrapateena, this investment comes with technical risk and over $1bn in capital expenditure.

Running spot prices, Deutsche Bank suggests Sandfire can lift earnings by 35% over the next three years while OZ Minerals' earnings are likely to fall from this year. Sandfire's spot free cash flow yields can increase to over 20% in FY20 from 12% currently, while the broker believes OZ Minerals' cash position has now peaked.

Capital Return?

The broker also believes there is scope for Sandfire's dividend to be lifted from FY18 onwards, as the current 30% pay-out ratio implies a dividend yield of 5% over the next three years, being the base case. The broker believes the company could fund Monty out of internal cash flow and continue to progress the Black Butte project towards an investment decision, which may come in FY19/20 if there are no delays to permits.

UBS is confident in the delivery of current mine plans but acknowledges the question of what comes next is starting to dominate investor thinking. The broker believes the company will continue to prefer exploration over capital returns, evidenced by the push into exploration joint ventures.

Credit Suisse's earnings forecasts and valuation remain affected by depressed medium-term copper price assumptions. The broker also notes that depreciation increased materially, to $136m guidance on amortisation of FY17 and FY18 planned strategic capital, which must be recovered over the very limited remaining mine life to the end of 2021.

The company produced 17,100 tonnes of copper and 10,000 ounces of gold in the June quarter and delivered full year production at the top end of guidance. C1 costs were US$0.95/lb. The company entered FY17 with $127m cash in hand and no debt. FY18 guidance suggests 63-66,000 tonnes of copper, 35-38,000 ounces of gold and C1 costs of US$1-1.05/lb.

The consensus target on FNArena's database is $6.28, suggesting 9.8% upside to the last share price. This compares with $6.62 ahead of the June quarter report. Targets range from $4.65 (Credit Suisse) to $8.20 (Deutsche Bank). There is one Buy rating (Deutsche Bank) five Hold and two Sell.
 

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