Sandfire Needs Options Beyond DeGrussa

This story features SANDFIRE RESOURCES LIMITED. For more info SHARE ANALYSIS: SFR

A short life at the DeGrussa mine constrains the upside for Sandfire Resources, unless there is material success on the exploration front and the company progresses with Black Butte in a timely manner.

-Additional ore at DeGrussa adds to mine life but lowers overall grade
-Medium term risks remain attached to depletion of DeGrussa
-Public consultation phase remains a heightened risk at Black Butte
 

By Eva Brocklehurst

Sandfire Resources ((SFR)) has confirmed extended mine life for DeGrussa while recording strong gold production in the March quarter amid well-controlled costs. Still, in the absence of M&A or material exploration success brokers suggest the short mine life at DeGrussa constrains the upside for the stock.

Copper recovery of 91% disappointed brokers, as it reflected lower grades as well as plant maintenance. Nevertheless, FY18 marks a turning point for the company as the construction of Monty advances and progress is made on Black Butte.

Gold production was very strong in the March quarter as grade recovered. FY18 guidance has been lifted by around 7% for gold and cost guidance has been lowered. Deutsche Bank acknowledges Sandfire Resources is generating significant cash, noting a 16% FY19 free cash flow yield, but downgrades to Hold from Buy on valuation.

The company has added 1.3mt at 3.5% copper for 46,000t of contained copper to the DeGrussa reserves. This is lower than the overall grade of the reserve but the increased tonnage adds around nine months of mining and takes the mine life to 2022.

Canaccord Genuity considers this a positive development, as the additional ore should enhance the options in relation to exploration and development and provide a buffer for likely slippages in the timetable at Black Butte.

Still, the broker flags the fact the quality of the ore reserve, overall, may have deteriorated. To gain traction, in the broker's opinion, Sandfire requires a discovery and permits at Black Butte.

Canaccord Genuity, not one of the eight monitored daily on the FNArena database, maintains a Hold rating and $7.50 target. Valuation is supported by production assets, and nominal exploration and development value.

UBS suggests the stock is yet to reflect the shorter mine life, and increasing risk that the company will embark on M&A to fill the void once DeGrussa fades. Instead, the broker believes the market is looking at the strong free cash flow, strengthened balance sheet and near-term production growth.

The latter is benefiting from a reduction in mine development and the start up at Monty. While the broker does not believe the premium will unwind in the short term those that are looking for long-term copper exposure are expected to look elsewhere.

UBS maintains a Sell rating, noting the company has not missed on production forecasts and starting in 2012 but exploration has not met expectations as Monty only adds incremental mine life.

DeGrussa

Exploration success which extends the life of DeGrussa, Western Australia, remains the near-term catalyst, in Macquarie's opinion,. An acquisition would also be a positive catalyst. The broker considers Sandfire well funded to pursue a material acquisition, noting cash of $188m and cash flow from DeGrussa will exceed $1.0bn over the remaining four years.

Macquarie increases earnings estimates to account for the extension of the mine life to 2022, having previously assumed no production in FY22. As a result the broker's target rises to $8.30. Morgans, which had incorporated FY22 production into forecasts, downgrades to Reduce from Hold because the recent strength in the share price discounts the emerging risks.

While acknowledging the upgrade to reserves buys some time, the broker suggests the short-term appeal of free cash flow overshadows the risks surrounding both the possible cessation of DeGrussa cash flow and the likely step up in the risk profile as Black Butte enters development from early 2019, if approved on schedule.

Black Butte

Credit Suisse also highlights that Black Butte, Montana, remains a risk, given the public consultation phase is yet to be circumnavigated. There is no certainty that Black Butte will pass the public consultation phase of the environmental impact statement, or be in production before the depletion of current copper reserves at DeGrussa.

If the process completes within the statutory 12-month timeframe the company may be in a position to commit to a new mine by the end of 2018. Credit Suisse notes Black Butte is not blessed with either the grade or scale of the combined DeGrussa and Monty mines but has significant operating cost advantages.

While there is reason to be optimistic that the development could be permitted, the broker is cautious, noting OceanaGold's ((OGC)) experience at Haile in South Carolina. That company, subsequent to taking control at Haile, found shortcomings in the project design with a need for capital upgrade.

UBS also has reduced confidence in the Black Butte project given the sensitivity regarding permits. An updated feasibility study is expected later this year.

The database shows three Hold ratings and four Sell. The consensus target is $7.38, signalling -7.1% downside to the last share price. Targets range from $6.10 (Credit Suisse) to $8.40 (Deutsche Bank, Ord Minnett).

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