One the bright side, they see no problems with gade. On the not so bright side, they see a possibility for additional equity being required. And the major risk is as its always been - Mongolian politics!
Turquoise Hill Resources Ltd.Hard to focus on the long term forecast with somany clouds on the horizonOur view: Following the ~40% correction, arguably the worst case is pricedin; however, it could take time to resolve the key overhangs, namely: thedetails on the mine design update, financing requirements, and the reviewof the investment agreement by the Mongolian Government. We maintainour Sector Perform rating and lower our price target to $2.00 from $3.00.
Key points:Following TRQ's project update we have updated our base caseassumptions and considered an upside and downside scenario whichimplies a risk reward range of $0.50-3.00 using a $3.00/lb long termcopper price and 8% discount rate.
NAVPS drops to $2.01: Our base case assumes $1.6B of additional capex(TRQ's range: $1.2-1.9B) and first production in late 2022 (TRQ's range:May 2022-June 2023) which results in a capital shortfall of $2.6B which weassume is funded by $1.6B debt and $1B equity. The equity componentcould be higher if TRQ struggles to raise additional debt. We have loweredour price target to $2.00 from $3.00 and continue to use 0.85x NAVPSwhich is inline with development stage copper peers.
Upside case to $3.00: Looking out to 2025 when the underground minestarts to hit its stride, and using a multiple of 5x EBITDA, we calculate anupside case of $3.00 using $3.00/lb copper. There is also potential upsidefrom a higher copper price and expansion scenarios not included in ourbase case.
Downside case to $0.50: If the capital overruns are $2.5B and the projectis delayed to 2024, we calculate a downside NAVPS of $1.20 and in thatscenario, TRQ would likely continue to trade at the current discount toNAVPS of 0.4x which implies a price of $0.50.
Financing requirements: If TRQ is able to take debt up from $4.2Bcurrently to $6B which is the cap in the current financing arrangement, webelieve there could be a need for an additional $1-1.5B of equity.Geo-technical risks: We knew the orebody was soft within morecompetent host rock which is great for caving but this has presentedchallenges in supporting key underground infrastructure. TRQ believesthis infrastructure can still be built, but the additional ground supportand lower productivity are key reasons for the higher capex and longertimeline. This could remain an overhang until the definitive review iscompleted in H2/2020 and possibly until the block cave is fully rampedup. TRQ does not see any issues with the reserve model or grades. Wecontinue to see Oyu Tolgoi becoming one of the largest, lowest cost coppermines globally, we just need to wait (longer) for it.
Investment summaryWe believe Turquoise Hill offers investors exposure to thedevelopment and growth of what will likely be one of thelargest and lowest cost copper producers in the world overthe next ten years. We expect TRQ’s revenue at flat metalprices to increase 4.0x by 2027 on the back of an increasein mined grades and ore volume. Rio Tinto’s involvement asthe operator minimizes development risk; however, given thescale of the underground block cave we expect there will bechallenges. Finally, investors in Turquoise Hill could benefitfrom a bid for the minority interest by Rio Tinto, though weassign a relatively low probability to this outcome in the near-term.
Risk to our rating and price target include:The key risks to reaching our price target and rating aregeopolitical risk in Mongolia and China, which is currentlythe only market for Oyu Tolgoi concentrate, project executionrisk, the outcome of the ongoing review by the Mongoliangovernment, and Turquoise Hill's ability to manage its cashflow, and financing capacity to meet Oyu Tolgoi’s expenditurerequirements. In addition, as with all mining companies, worldeconomic growth, and currency fluctuations could materiallyaffect TRQ's revenues, while energy prices and environmentalconsiderations could impact operating costs. Variations inthese represent risks to our earnings and equity performance expectations.