Contents
- TRQ stock down 70% – a bargain?
- TRQ company overview
- The current issues – 4 big unknowns
- Financial situation
- Valuation
- Copper conclusion – Many copper miners are in the same situation
- TRQ stock down 70% – a bargain?
TRQ Stock and huge 100 year asset down 70%
Turquoise Hill owns an amazing asset, the Oyu Tolgoi mine in Mongolia that is expected to produce copper, gold and silver for the next 100 years. Thus, we have a very important metal for the future, copper, a hedge for inflation, gold and low-cost production. But the stock price is down 70%, so let’s see what is going on and whether this is an investment, speculation and what are the risks and rewards.
The last time I made a proper analysis of Turquoise hill was in 2016 and my conclusion wasn’t positive.
Source: Seeking Alpha
At 2016 copper prices there was too much uncertainty which made the whole project extremely risky as the investment wasn’t justified by the future expected cash flows. Since then the stock did well for a while as copper prices rebounded, but now it is more than 50% below the 2016 price and more than 70% below the 5-year high of $4.4. Plus, copper prices are 30% higher that should have been a huge positive.
However, when you have an asset like TRQ has, namely the Oyu Tolgoi mine in Mongolia, expected to produce copper and gold for the next century and to be one of the top 3 copper mines in the world, it is always good to check whether temporary issues have made the stock a bargain. Let’s first describe TRQ to show what it is and then compare the estimated value of the assets to the current market capitalization.
TRQ company overview
By 2025 Oyu Tolgoi should be the 3rd largest copper mine in the world with extremely low cash costs of around $0.5 per pound. If in 2025 copper prices end up above $3, the yearly production of 1.3 billion equivalent pounds of copper should result in EBTIDA of $3 billion. Not bad when compared to the current market cap of $2.5 billion. Even if we take only 66% of the EBITDA, it is still a great number as Oyu Tolgoi is jointly owned by the Government of Mongolia (34 per cent) and Turquoise Hill Resources (66 per cent, of which Rio Tinto owns 51 per cent). Since 2010, Rio Tinto has also been the manager of the Oyu Tolgoi project.
Source: Turquoise Hill Investor Relations
For those that don’t know, Oyu Tolgoi is a mine with a huge expansion plan in Mongolia.
Source: Turquoise Hill Investor Relations
Plus, given the electrical future that awaits us where copper is an essential metal for such infrastructure, the long-term economics of Oyu Tolgoi might be even better.
Source: Turquoise Hill Investor Relations
On top of everything, the mine offers the potential for increased mining over the next 100 years which is a remarkable feature.
Source: TRQ Presentation 2018
The growth options require huge capital investments of $8 to even $15 billion but those might be considered in 10 or even 20 years. If copper prices go higher, it might be a good idea and it might largely increast TRQ’s value, but for now let’s stick to the current plan.
The 2016 reserve case forecasts an expansion investment of $4.6 billion, that will be increased as there is a new mine plan in the making and they need to build a power plant, and a net present value of $6.9 billion with a discount rate of 8% that should be lowered due to issues just mentioned. Nevertheless, the copper, gold and silver are still there and let’s see what is the mining plan.
Source: Oyu Tolgoi 2016 Technical Report
Something to note from above is that big mining companies usually have an IRR after tax threshold of 20%. Not surprising, the technical report comes out at 21%. I am always suspicious of such results as it is always in the interest of those who make the technical report that the mine is actually build. The company making the report gets much more work and you can make yourself a good career just on a mine like Oyu Tolgoi.
The latest developments showed how the technical report was a bit too optimistic and how the forecasts have been delayed and costs increased. However, even if they hit the expected cash flows a year or two later, it should still be the same story.
Source: TRQ 2018 Presentation
Let’s see what are the issues that are plaguing the business and consequently the stock.
The current issues – 4 big unknowns
A big issue for TRQ is the power supply. The government decided that TRQ shouldn’t import energy from China but that it should source it domestically. This is called extortion, after a big company already invests a lot of money and can’t back out anymore, then you change the rules of the game.
Some analysts assume the government of Mongolia will try to change the current agreement it has with TRQ as the government owns 34% of Oyu Tolgoi. The uncertainty for investors is that we don’t know the price of the power plant that TRQ has agreed to build in Mongolia. A 300 megawatt plant should cost about $300 million from my experience with the energy industry.
Plus, there is a tax issues where the government now wants $155 million for the period between 2012 and 2015. So, a lot of fun there and this is price uncertainty number two.
As investors, we know that when such things emerge, there will probably be more. Mongolia created a parliamentary working group to review the shareholder agreement. They simply want more and are in a position to get more now. The management got the first draft of the report but didn’t want to comment on it during the last conference call. So, that is price uncertainty three.
On top of the power supply issue and agreement review issue, they will also make a review of the mine design which usually means bad things. Stay away from the 21% IRR technical reports😊. The issue is rock stability so they need to remake the mine design and re-estimate the construction costs, mining costs etc. Big cost uncertainty number four.