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.
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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.
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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.
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Source: Turquoise Hill Investor Relations
For those that don’t know, Oyu Tolgoi is a mine with a huge expansion plan in Mongolia.
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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.
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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.
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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.
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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.
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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 reportsImage may be NSFW.
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. 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.
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Source: TRQ 2019 Q1 Results
This is something you never know how it will end up. The management is already talking to financing parties which means the costs will be much higher.
One thing that Wall Street hates is uncertainty, I can’t put the managements’ “I don’t know and can’t talk about it” or “we are working on it” in any kind of model and thus valuation is practically impossible.
Financial situation
The finances look good, the company is cash flow positive and has enough cash to finish the project.
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Source: TRQ 2019 Q1 Results
Or at least that should be the case but we don’t know what will the mine update say later in 2019.
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Source: TRQ 2019 Q1 Results
Valuation of TRQ stock
Let’s make a valuation to see what would TRQ be worth if things end up ok.
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Source: Oyu Tolgoi 2016 Technical Report
I have used the above cash flows to see what is their present value. The table goes forward to 2046 but as you can see above, the cash flows aren’t that positive after year 20, so those are not material when discounted.
When using the expected after tax cash flows, the present value with at 10% discount rate comes to $7.5 billion which is in line with the net present value the company reported.
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Let’s now assume that the new mine plan increases the capital required for $2 billion while the future cash flows remain the same.
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The present value drops to $6 billion. That is still ok. However, there are things we have to consider like TRQ’s ownership and debt. Also, the above calculations are made at gold prices of $1,300 and copper at $3. Copper prices just 20 cents lower, take off another $1.5 billion from the net present value.
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Source: Oyu Tolgoi 2016 Technical Report
So, let’s say that the net present value of the future cash flows is $5 billion. If copper prices reach $3.5, something highly possible, the present value is suddenly much higher and closer to $10 billion. Additionally, there is also the gold hedge where $100 higher gold prices add another half a billion in value.
But now we have to first deduct the debt from the above calculations as the debt is not included in the technical reports. The company already has $4 billion in debt.
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Source: TRQ Q1
The cash will be spent on capex and they will take another $1.5 billion in debt. Thus the total debt before the project is launched should be at least $6 billion if not higher given the power plant and new mine plan that might require more spending.
Given the current 6% interest TRQ is paying on the debt, one can assume that TRQ’s payments on that should be around $360 million per year. Plus, in order to advance on the other projects, they will need to lower the debt. I’ll deduct the interest payments and pay off the debt slowly over 10 years and this will show us TRQ’s real value.
This lowers the present value to $2.8 billion.
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When we deduct the 34% owned by the Mongolian government, the value of TRQ’s ownership of Oyu Tolgoi falls to $1.8 billion. The current market cap of $2.4 million still implies a speculative bet on higher copper and gold, thus it is not an investment.
Copper conclusion – Many copper miners are in the same situation
Even with a 70% drop, TRQ is still not a good long-term investment as of now. However, given copper prices should go up and that the ore body is remarkable, I think over the next 100 years investors should do well if the Mongolian government doesn’t make too much trouble.
This shows how hard it is to invest in miners, there are many promises, false assumptions and a lot of lying so be careful when investing. I looked at most copper miners and only a few pass the integrity test and offer a good return on investment. (colours are just an indication for my personal research so don’t get confused by them.
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Source: Stock Market Research Platform
As a bet on copper and gold, I think TRQ at these prices should be ok as a long-term investment but please expect a lot of volatility. The fact that it is not yet a copper investment, creates investment risks and doesn’t provide a margin of safety yet.
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