Why I'm Increasing My Position In Turquoise Hill Resources

| About: Turquoise Hill (TRQ)

Summary

Turquoise Hill Resources is a bargain at under $2 per share.

The miner could do well in the short and long term.

Gold could drive the stock up in 2016.

What is attractive beyond the fundamentals.

Sitting on one of the largest copper and gold mines in the world, Turquoise Hill Resources (NYSE:TRQ), after plummeting from the economic slowdown in China and resultant drop in demand for copper, has had its share price fall to under $1.60 per share recently, positioning it in my opinion, to bring nice returns to investors getting in at under $2 per share.

It's now trading at $1.92 per share as I write, and has made the type of bounce I look for when evaluating whether a stock has found a bottom and support. That doesn't mean there won't be a further downturn in the share price, but it's trading at levels I'm comfortable with, even if it temporarily reversed direction.

As a reminder, its flagship property Oyo Tolgoi, as of 2014, had an estimated "24.9 billion pounds of copper, 11.9 million gold ounces and 78 million ounces of silver," according to Mineweb.com.

Financial Times added once the mine is fully operational, it would produce about 450,000 tons of copper and 330,000 of gold on an annual basis.

It'll take in a range of 5 to 7 years before it is producing at that level. Official approval should come in the second quarter of 2016. It has already secured about $4.4 billion in financing or that purpose.

Turquoise Hills owns a 66 percent stake in Oyo Tolgoi, with the Mongolian government owning the remaining 34 percent. Rio Tinto (NYSE:RIO) owns just under 51 percent of Turquoise Hill.

(click to enlarge) source: StockCharts.com Click to enlarge

How to look at TRQ at this time

There are two ways I'm looking at TRQ. In the short term it appears gold could be a positive catalyst for the company, based upon a strong probability the price will rise consistently under the current global economic scenario, which is weakening.

Turquoise Hill Resources has said annual gold production should be close to its guidance of 653,000 ounces, with Oyu Tolgoi producing from 210,000 to 260,000 ounces of gold in concentrates in 2016. Over the short term I see this has having the most potential to move the share price.

Further out, by which I mean during the period the underground construction is going on, the share price of TRQ should at minimum, move up incrementally in value. Beyond gold, copper should, over time, move up in price, which even at the current production levels, will boost the share price and market cap of the company.

As it gets closer to the underground phase being finished, I see it jumping in price in anticipation of a significant increase in copper, gold and silver production. Only a complete and prolonged crumbling of the commodity market could keep that from being how it plays out.

At the current price I like Turquoise Hill, and see the risk worth being taken for the potential reward.

When it could really take off

As the company stands I like it, and when considering it has the deep pockets of Rio Tinto backing it, the narrative is even more compelling.

Even so, it would be surprising to me for Rio Tinto to maintain its current position in Turquoise Hill once it starts producing at the underground facility. It wouldn't make any sense to be for Rio to leave that level of revenue and earnings on the table, after investing so much in the project and company.

For that reason, I believe Rio will eventually acquire the remaining shares and take full ownership. If that's how it plays out, the timing of that acquisition is important to consider.

Since it will cost a lot more to acquire the remaining share if they start to jump in anticipation of increased production, or even shortly after production climbs, I believe Rio Tinto would have to make a decision to buy it before the market starts bidding the share price of the company up. It wouldn't make sense to wait too long before taking the step.

While I like Turquoise Hill where it is now, this is the long-term play that would bring the highest returns to investors, assuming this is how it plays out.

The fundamentals are important of course, but I'm looking beyond the fundamentals to the high probability of Rio Tinto acquiring the company.

Considering copper and gold

One way to look at the impact of the price of copper and gold on TRQ is in regard to copper being considered the core metal of the mine.

What I mean by that is a company that has gold as the core holding, would be weighed down with weak copper prices as a byproduct, more than a firm like Turquoise Hill will be with gold as the byproduct.

If gold is the primary metal being produced, weak copper prices would put a ceiling on the share price of the company more than if copper, as in the case of Turquoise Hill, is the primary metal.

Part of the reason is psychological, because copper, in the case of gold miners, would be considered a negative, while gold, in the case of TRQ, would be considered a positive.

It is also based in reality, where the byproduct of copper, in the case of gold, would support the share price of a company, while in the case of gold, it would not do so because of the added costs and loss of overall margin and earnings.

Also important for consideration is the amount of gold or copper being produced as a byproduct.

For Turquoise Hill investor, I see this as important in the short term, because of the low-price conditions associated with copper, and the strong probability gold prices could strengthen further in 2016.

How I'm investing in TRQ

I've had a position in Turquoise Hill for years, and I've continued to buy shares even as its share price kept falling. I'm not trying to buy the dip or time the market, but rather am looking at the overall future of the company, which is highly undervalued when you consider the resources under its management.

What I'm doing now is taking a larger position as measured by share in order to drop the average price I'm paying per share. This gives me more flexibility to sell at a profit once the share price rebounds.

Even though the outlook for construction of the underground phase of the mine is for up to seven years, for the reasons mentioned earlier, I don't see it taking that long to boost the share price of the company.

To get the full benefit of the profit potential, It'll probably take until the mid-point of construction before the share price starts to make a big move based upon that criteria. If demand for copper jumps before then, it would arrive earlier, but would then be leveraged by the growing belief the company will be bought out by Rio Tinto. It's a win either way.

As for the movement of the share price, historically, I've seen bounces similar to the one shown in the chart above as conducive to being a sustainable upward move, and not just a temporary boost. That of course doesn't mean it's a certainty, but it does increase the percentages of it being the case.

Conclusion

Based upon the size of the resources under Turquoise Hill's control, and the strong probability it'll be fully acquired by Rio Tinto, I see the potential reward easily outstripping the risk for those with a longer term investing horizon.

While it's waiting for the go ahead to start construction on the underground portion of the mine, gold, if it continues to steadily strengthen, should be the key positive catalyst over the short term.

With the underground mine expected to take 5 to 7 years to complete, the commodity outlook will certainly change, although it's impossible to project out any semblance of what that may be.

By that time China should have a clearer picture of its economic growth, and we will probably have went through and come out of the other side of a recession, which should be good timing for the company.

Taking it all together, Turquoise Hill should do better over the next several years, although under the visible conditions we now see, it's likely to do so incrementally unless the price of gold starts to soar, which would result in a positive surprise to the upside.

Barring that, once investors see the underground portion of the mine reaching the halfway point or a little further along, I think they will start to consider that Rio Tinto could acquire the remaining shares of the company before the price takes off and makes it much more expensive to do so.

Disclosure: I am/we are long TRQ.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.