Australia | Nov 12 2020
This story features DETERRA ROYALTIES LIMITED, and other companies. For more info SHARE ANALYSIS: DRR
What are Deterra Royalties? Well, the recently-listed stock offers a unique ASX exposure to iron ore, taking a royalty stream from BHP Group's Mining Area C.
-Deterra Royalties intends to grow through acquisitions
-Low volatility exposure to iron ore, with strong production outlook
-May be an easy bolt-on for larger market participants
By Eva Brocklehurst
Deterra Royalties ((DRR)) is a pure iron ore stock that offers a unique ASX exposure to the bulk commodity with minimal operating and capital costs. It has several royalty streams, only one being currently active.
There is minimal net debt and a dividend pay-out policy of 100% of net profit is on offer, fully franked. While the primary source of revenue is the Mining Area C (MAC) royalties, Deterra Royalties has indicated that it will also look to grow through acquisitions.
The company was de-merged in October from Iluka Resources ((ILU)), which retains a 20% stake, and owns a 1.232% royalty over BHP Group's ((BHP)) MAC, a long-life iron ore hub in the Pilbara, Western Australia. Deterra Royalties aims to build a portfolio with multiple sources of earnings growth, providing greater resilience for cash flow and less risk.
Macquarie assesses the stock offers a low volatility exposure to iron ore amid a strong production growth outlook. The broker's positive view is supported by the dividend policy, with returns expected to translate to yields of 5-6% once BHP Group's South Flank enters full production.
Goldman Sachs believes it is best to focus on the potential production of bulk and base metal royalties, given an inability to leverage scrip to pay for precious metal royalties compared with North American peers that are trading much higher multiples.
In 2019 Deterra received $600,000 in revenue from the Yoongarillup mineral sands operation. Citi does not forecast any revenue from other royalties in the existing portfolio that includes Eneabba, Wonnerup and the St Ives gold project.
UBS uses a discounted cash flow approach to value Deterra and, based on a US$60/dmt long-term iron ore price with weighted average cost of capital of 5%, estimates a net present value of $4.81 a share.
Several brokers have initiated coverage of the newly-listed stock, resulting in two Buy, one Hold (Credit Suisse) and one Sell (Citi) on FNArena's database, with a consensus target of $4.40 that signals 4.5% upside to the last share price.
Goldman Sachs, not one of the seven stockbrokers monitored daily on the database, in its initiation has a Neutral rating and $4.10 target. The broker finds the earnings growth attractive but the stock fully valued versus a broader peer group. Moreover, the dividend yield for iron ore miners on an average 2021-22 forecasts is 6%, which compares with Deterra on a 4% yield.
There are no direct peers listed in Australia, with Goldman Sachs noting the closest is the Labrador Iron Ore Royalty company in Canada which has a stake in Rio Tinto's ((RIO)) mine as well as revenue royalty.
The broker believes the superior quality of MAC and with BHP Group as operator warrants a premium for Deterra, assessing BHP will have the highest rates and margins in the Pilbara by 2022.
Iron ore production from the MAC hub is set to increase to 145mtpa by FY23, from the current 60mtpa. Goldman Sachs suspects the stock will trade like in iron ore ETF (exchange traded fund), tracking net asset value, until it expands and diversifies.
Credit Suisse expects the stock will garner interest from the market across both resources and yield-focused investors. The main risks stem from the concentration on a single commodity revenue stream from a single region of just one country.
Any adverse moves in the Australian dollar iron ore prices or changes to operating activity within the MAC area present the highest risk for shareholders, in the broker's view.
Credit Suisse also questions whether the company's strategy to de-merge is actually about building a business that will attract corporate interest, as it is an easy bolt-on for larger existing market participants, many of which may trade on higher multiples.
Citi anticipates peak earnings for Deterra of $164m in FY23 and, despite expecting continued production growth at MAC out to FY25, believes this does not offset forecasts for declines in the iron ore price.
The broker expects dividends will peak in FY23 at $0.22, representing a dividend yield of 5.2% at the current share price. That said, the broker accepts operations at MAC would still be profitable even in a very much lower iron ore price environment.
Citi now forecasts benchmark iron ore prices in a range of US$100-120/t for the balance of 2020 as ongoing strength in China now drives a more broadly balanced seaborne market. The broker expects iron prices to average US$90/t in 2021, easing to US$75/t in 2023 as rising output couples with declining Chinese steel demand.
UBS assesses the iron ore market will remain tight in 2021 and accrue a slight surplus by the end of the year. Chinese imports are expected to remain strong but this will be offset by higher production from the three main producers.
Goldman Sachs expects iron ore will drop to US$105/t by the end of the year as shipments from Australia and Brazil rise and Chinese steel production moderates.
Mining Area C
BHP is currently expanding the hub through the development of South Flank that will start producing in mid 2021 and ramp up over 18 months. South Flank has a life of around 25 years from 2021.
UBS believes BHP has managed the issues well and its operations have largely been without disruption. South Flank is expected to be in the first quartile of the global iron ore cash cost curve.
MAC produces iron ore fines of around 61% iron as well as lump iron ore. The royalty is paid to Deterra as Australian denominated revenue and one-off capacity payments of $1m are made per one tonne increase in annual capacity.
Capacity payments will be received in July alongside the June quarter royalty. Goldman Sachs notes, since inception to June 2020, $52m in capacity payments have been made. BHP has identified two future operations, Tandanya and Mudlark, which are likely to be at least partially within the royalty area.
Goldman Sachs also points out the Western Australian reforms to the Heritage Act and potential renegotiation or amendment of land-use agreements with the Banjima, the traditional owners of the land on which the royalty is located. This could result in some delays to permits, revaluation of heritage sites and exclusive zones.
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