Metal Prices The Issue For Oz Minerals

This story features OZ MINERALS LIMITED. For more info SHARE ANALYSIS: OZL

By Chris Shaw

Since its merger with zinc producer Zinifex the re-named Oz Minerals ((OZL)) has seen its share price slashed given the combination of increasing zinc exposure at a time when that metal is out of favour and more recently from falling commodity prices generally.

The group’s quarterly production report shows production itself is not the issue, as output in the September quarter largely met market expectations and, as Credit Suisse notes, also showed some signs of a fall in the cost pressures that have plagued not only Oz Minerals, but most of the resources sector in recent quarters.

So why hasn’t the share price recovered?

The problem remains metal prices, which are continuing to slide and so are putting earnings at risk not only this year but in coming years as well. While most in the market were happy enough with production in the quarter, and as UBS notes copper production was actually around 9% more than it had forecast for the period, downgrades to earnings forecasts continue to flow through.

The broker has been one to adjust its numbers, cutting its earnings per share (EPS) estimate for the current year by a whopping 82% and its 2009 number by 9%, putting its forecasts at 1c and 13cc respectively. The 13c in 2009 represents a net profit estimate of $619 million, but as the broker points out, if current spot metal prices and foreign exchange rates were extended through next year, this number would fall to around $170 million, highlighting just how exposed the group’s earnings are at present.

Other brokers have made similar adjustments. JP Morgan lowered its EPS estimates in 2008 to 4.6c from 6.9c previously and in 2009 to 15.1c from 22.2c, while Credit Suisse is forecasting EPS of 1.6c and 12c respectively. Overall, the FNArena database shows consensus EPS forecasts of 4.2c and 14.8c.

This has of course flowed through into valuations and price targets, with JP Morgan’s valuation on the stock falling to $2.23 from $2.68 and Credit Suisse lowering its valuation to $1.20 from $1.50. Given the wide disparity between the two brokers it comes as no surprise they have different views on the stock. Credit Suisse rates it as an Underperform given the expectation the volatility in metal prices at present will flow through into a volatile earnings outlook, which suggests investors will have little confidence in the company’s numbers.

JP Morgan, in contrast, prefers to adopt a longer-term approach and as a result sees more value, pointing out the company’s exploration potential and range of new projects such as Prominent Hill should see additional value created over time. As well, it suggests the share price fall of close to 40% since late last month has been excessive and so the valuation equation has improved for investors.

Deutsche Bank has taken the middle ground and rates the company as a Hold, as while not particularly in favour of a capital expenditure program approaching $1 billion at a time of falling metal demand and falling prices, it sees this not threatening the company’s future given the $900 million the company has as cash in the bank.

Where it differs from others in the market is the broker sees no dividends in coming years, which is well below consensus expectations for payouts of around 8c in both 2008 and 2009. If the broker is correct and others in the market scrap or significantly lower their payout assumptions, it would be reasonable to expect additional share price pressure, as this would impact on the attractiveness of the stock for investors.

Macquarie was the most voluble in voicing its dismay with the direction both the stock and base metals prices have taken. Again, while it was ok with the levels of production and costs recorded over the quarter, it said it could no longer hide from the fact that copper and zinc prices are currently 30% and 50% respectively below its 2009 forecasts. It also noted that the company’s flagship Century zinc project has become unprofitable at current zinc prices.

On the broker’s new base metal price forecasts, it has cut its FY08 earnings forecasts by 30% and 2009 by a massive 85%, saying it had “wrongly” maintained a Buy for far too long in hopes the share price might track back to somewhere near pre-merger levels. Its recommendation is lowered to Neutral in the absence of any clear near term catalyst.

The cuts to earnings estimates have seen price targets reduced. ABN Amro has lowered its target from $2.64 to $2.21 on lower earnings expectations and JP Morgan and Credit Suisse have both cut their valuation-based targets to $1.90 from $2.32 and to $1.20 from $1.50 respectively after factoring in the quarterly numbers. Unsurprisingly, Macquarie hacked off the biggest chunk, cutting from $2.20 to $1.20.

This brings the average price target on the stock, according to the FNArena database, down to $1.81 from $2.31, though a further fall is possible given Merrill Lynch currently has the highest target at $2.90 and is yet to update post the release of the group’s quarterly figures. These changes have not resulted in big changes to ratings, as the FNArena database now shows the stock is rated as Buy five times, Hold twice and Sell once, with just Macquarie downgrading.

Having rallied yesterday in a stronger market, shares in Oz Minerals today are down in line with the broader market and as at 11.25am the stock was 4.5c or 3.9% lower at $1.115. The stock has a trading range over the past 12 months of $0.955 to $2.17.

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