OZ Minerals: Reorganising expectations

About the author:

Tom Sartor
Author name:
By Tom Sartor
Job title:
Senior Analyst
Date posted:
04 February 2022, 8:00 AM
Sectors Covered:
Junior (Emerging) Resources, Bulk Materials

  • OZ Minerals' (ASX:OZL) 4Q and updated cost outlook showed a material impact from Covid challenges and industry cost pressures.
  • Rising execution risks (timing, capex escalation) may serve to temper the premium the market had built into OZL’s growth assets (Carra BC, WMP).
  • Our valuation adjusts to (login to view) target maintains a 5% premium for OZL’s quality versus peers.
  • Trading near to NPV we downgrade to Hold but note macro-driven volatility has a history of uncovering short-term buying opportunities in OZL

Event

4Q production: CY21 production and costs met guidance despite another year of Covid-19-related challenges. CY21 revenue of $2.1bn was 3% ahead of Factset consensus, with end-of-year cash of $215m roughly $100m ahead of expectations, helped by higher A$ copper prices.

CY22 cost pressure: At the mid-point, CY22 guidance implies an 8% (~11 USc/lb) escalation in Group AISC, despite a 10% (+12.5kt) lift in guided copper production driven by Carrapateena, implying escalation of variable costs above this rate.

Key takeaways

Costs are what they are: Re-based cost guidance is influenced by: 1) a period (unspecified) managing absenteeism (currently 5-10%) and supply chain disruption; 2) 8% lower gold production (~6 USc/lb); 3) industry inflation (consumables, freight); and 4) price-linked inflation (royalties, TC/RCs). Many of these drivers are beyond OZL’s control and we take comfort from: 1) likely conservatism built into guidance; and 2) a significant A$1.51/lb or 34% uplift in forecast copper prices received versus this time last year.

The near 50% (+30 USc/lb) uplift in Carra AISC guidance over 2022-2025 looked dramatic at first glance. However, OZL’s reallocation of sustaining capex into opex is equivalent to 21 USc/lb of this, with the remainder consistent with CY22 changes. Ultimately, we think OZL’s operating base in SA and management track record can better insulate it from cost pressure than competitors, particularly in Latin America.

Capex and timing risks: OZL has committed ~$1.6bn in growth capex to the Carra Block cave (4 years only) and $600m to Prom Hill (3 years). The 2020 PFS identified pre-production capex of ~$1.1bn at WMP (ex power) and Carajas hub studies are also ongoing. Carra growth capex has crept up with market conditions although OZL isn’t seeing pressure at Prom Hill with prices locked in.

However, the risks to capex escalation and to execution/timing are rising, particularly at WMP where WA labour constraints place uncertainty on its deliverability within OZL tolerances. Capex increases and/or delays on these projects look likely, placing downward pressure on project returns/ valuations.

Forecast and valuation update

We adjust for:

  1. Application of guidance;
  2. Higher costs beyond CY22;
  3. Slightly higher CY22 copper and lower AUD;
  4. Reported end-CY22 cash; and
  5. Model roll-forward.

Our DCF based valuation adjusts to (login to view).

Our target price applies a 5% premium to reflect OZL’s premium status in the sector in our view (Reserves, margins, balance sheet, growth options, management).

Investment view

We’ve previously noted that OZL’s longer dated valuation upside (PHOX ramp-up 2025, Carra block cave ramp-up 2024-29 and WMP) has at times already looked baked in to the share price, leaving OZL vulnerable to disappointment.

The capex and execution risks building across the industry takes some shine off those growth options and we see incremental risk to their valuations in the absence of higher commodities prices. We downgrade to a Hold due to valuation and watch for a potential buying opportunity on macro-inspired weakness.

Price catalysts

  • West Musgrave DFS/ Investment decision, Carajas Hub studies (both 2H22).
  • Evolution of industry constraints, cost pressures through 2022.

Risks

  • Production disruption from two key assets, commodity price and FX volatility.

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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