Stanmore Resources: Dramatic over-reaction

About the author:

Tom Sartor
Author name:
By Tom Sartor
Job title:
Senior Analyst
Date posted:
22 June 2022, 8:30 AM
Sectors Covered:
Junior (Emerging) Resources, Bulk Materials

  • We adjust our modelling inputs around prices and costs (both slightly higher) and for the new QLD royalty regime to apply from July 1.
  • These combined changes lower our valuation by 20cps (5.4%) to (login to view), equating to our revised target price. SMR’s 96cps fall from its recent high therefore looks like a dramatic over-reaction, seeing SMR trade on a P/NPV of only 0.53x.
  • We recognise steel market risks but think confusion around royalty impacts and profit-taking from the March entitlement offer ($1.10ps issue price) is exacerbating weakness. This looks like a unique opportunity.

Recent initiation of coverage at ADD

We recently initiated coverage of Stanmore Resources (ASX:SMR) via Transformational met coal leverage, May 18. We noted the US$1.35bn acquisition of BMC transforms SMR’s operating scale, improves its risk profile and dramatically improves its equity appeal.

Fortunate timing into unprecedented coal price strength supports a ~12-month payback, rapid de-leveraging and clear dividend upside.

We retain our ADD and remain attracted to SMR’s:

  1. Materially higher capital upside versus peers
  2. Superior upside valuation leverage to higher prices
  3. M&A optionality
  4. Ability to frank dividends for Australian investors.

QLD coal royalties and other adjustments

Recent moves look dislocated from fundamentals: SMR has fallen 35% (96cps) in a fortnight and at one stage was down 27% (71cps) today alone. Fears around global steel activity are valid, but today’s move looked like a panic, given we calculate changes to our Base case valuation of only 26cps, inclusive of new QLD royalties.

Why the modest NPV impact? Windfall royalties only get incurred as a function of windfall revenues. Our Base case price forecasts (falling below US$190/t by 2024) sees SMR only incurring additional State royalties in the new A$ pricing brackets in CY22 and CY23, with no cash impact thereafter. This is a function of our conservative Base case price forecasts. See p4 for more detail.

Cashflow impact: NPV impacts are modest, but SMR does pay an additional US$146m in royalties over CY22-23, slowing its de-gearing and ability to release capital. However, this absolute impact (6.5% of CY22-23 EBITDA) is modest.

Leverage impact: SMR’s upside leverage to bullish price scenarios is crimped by the new royalties regime, but not dramatically so. NPV uplift to our “Bull case” coal price scenario reduces to +34% (from +37%).

Forecast and valuation update

Today we also apply slightly higher CY22-23 HCC prices, offset by moderately higher cost assumptions linked to labour challenges in the Bowen Basin. Our Base case DCF-based valuation adjusts to (login to view).

We now set our target price at our NPV using our Base case price forecasts (previously blended Base-Bull case) as upside risk to HCC pricing appears to be abating with steel sector sentiment.

Investment view

New QLD royalties serve to trim some cream from SMR’s earnings in strong years, reducing windfall cashflows/ dividends and NPV leverage to upside pricing scenarios. However, this impact is modest versus recent weakness.

The vast majority of SMR’s ~24% free-float comprise of 187m shares issued at $1.10ps as per the March acquisition equity raising. It’s easy to see how turnover of this stock on recent uncertainty can contribute to artificial price weakness.

Price catalysts

Directional HCC moves, market familiarisation, cashflow and de-gearing.

Risks

Weaker than expected HCC prices (global GDP risks), production disruption risk (labour access, maintenance) and cost inflation (margins) are key risks to watch in coming months.

We think concerns in these areas have fed into recent weakness, but that SMR is navigating them well to date.

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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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