Australia | Dec 05 2011
– JP Morgan initiates with Overweight rating on Grange Resources
– Value the main attraction
– Upside from new project and increased production, some risks at Southdown
– Grange rated Buy by all five brokers offering coverage
By Chris Shaw
Grange Resources ((GRR)) is Australia's largest producer of magnetite iron ore, this through its wholly-owned Savage River mine in north-west Tasmania. Expansion will come via the Southdown mine in Western Australia, where production is expected to commence by 2015.
Savage River currently produces 2.4-2.5 million tonnes per annum of premium quality iron ore and pellets, with plans in place to lift this to annual output of around 2.7 million tonnes per year. Current mine life at Savage River is around 19 years, with further upside potential from exploration.
JP Morgan has picked up coverage on Grange Resources, initiating coverage with an Overweight rating. The positive view is primarily driven by valuation with JP Morgan's model suggesting a 100% return to valuation from current share price levels.
The other positive in JP Morgan's view is more than 85% of its valuation stems from the Savage River mine, which is already in production. This implies lower risk associated with expectations for Grange Resources, especially relative to peers that are still in the construction or commissioning stages of projects or are still considering whether to proceed with new developments.
A further plus for Grange Resources, according to JP Morgan, is no infrastructure constraints at either Savage River or Southdown, as port facilities relating to both projects are largely to be sole use.
Grange Resources is of course not without risk, JP Morgan identifying the key risk for the company at present being financing for the Southdown project. The project is expected to be partly funded from cash generated by the Savage River operations, with the rest coming from potential sales of joint venture interests in the project and additional equity as required.
JP Morgan expects Grange Resources will raise $500 million in equity in 2013 to partly fund Southdown, likely at an offer price of around $0.50 per share. If the share price was to remain around current levels Grange may consider other options such as partial asset sales notes the stockbroker.
An issue with Southdown is a somewhat marginal valuation, as on JP Morgan's numbers the project is valued at $275 million, with Grange's stake worth around $193 million. Upside is possible, this most likely to come from better than expected capital expenditure and extensions to mine life.
Production at Southdown is expected to reach 10 million tonnes per year of premium magnetite concentrate by early 2015. Production at this rate implies a mine life of 14 years, but known extensions to the magnetite deposit offer the potential to extend the life of the project significantly.
JP Morgan's positive view on Grange Resources brings to a perfect five-for-five the Buy recommendations on the stock among brokers in the FNArena database. As with JP Morgan, the other brokers in the database also see value at current levels.
As an example, Citi's analysis in September suggested Grange Resources was trading on an earnings multiple of around four times post its interim result. While limited liquidity is an issue given a market capitalisation of less than $600 million, Citi sees scope for Grange to become a target of M&A activity, with major Chinese shareholder Shagang regarded as the most likely to make a move.
The consensus price target for Grange Resources according to the FNArena database stands at $0.82, JP Morgan's $0.95 target among the highest , trailing only Macquarie's target of $1.00. RBS Australia has the lowest target at $0.62.
Shares in Grange Resources closed last Friday at $0.485, which compares to a trading range over the past year of $0.37 to $0.915. The last sale price implies upside of around 73% to the consensus target in the FNArena database.
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