Turquoise Hill Finally Seems To Have Found Some Ground

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About: Turquoise Hill Resources Ltd. (TRQ)
by: Aitezaz Khan
Summary

TRQ has entered into an agreement with the Mongolian government for the construction of a power plant to provide power for OT mine.

This news has boosted investors' confidence in the stock, and share price support is expected to continue amid recovery in gold prices.

However, a prolonged depression in copper prices have limited the potential for share price growth.

If we could see a rebound in copper prices, then TRQ's prices could explore new levels.

The technical price chart indicates that TRQ is a buy at current prices.

Thesis

In October 2017, I wrote on Turquoise Hill (TRQ) for the first time. In that article, I covered the 5-year outlook of the company and suggested that the company would witness significant growth in the next five years. The main reason was TRQ's strong intrinsic value based on the significant copper and sizable gold resources present in its OT mine (in Mongolia).

Turquoise Hill has finally found some ground. Figure-1 (Source: CTVnews)

However, TRQ has had a rough time lately, and its growth outlook has been blurred by a series of problems caused by the GoM (read: Government of Mongolia), and weak commodity prices (i.e copper/gold). Despite the difficulties faced by the company, I have remained optimistic about its growth potential. More recently, TRQ's share prices were troubled by a rift between the company's management and GoM over a power source for the OT mine. To investors' delight, the ice has started to melt between both parties and they have finally reached an agreement for the purpose.

In this article, I will evaluate TRQ's current situation following the agreement with the GoM. The major resource underlying in the OT mine is copper, and unfortunately for the TRQ investor, copper has witnessed a prolonged depression in prices that limit the prospects of share price appreciation. Nevertheless, a recent recovery in gold prices and the technical analysis indicates that TRQ is a buy at current prices.

Details of the agreement and its implications

The issue at hand: TRQ currently obtains power for its OT operations from China at an annual cost of ~$100 MM. As the company moves closer towards the underground expansion of the OT mine (expected 2022), it would need a lot more power. If TRQ continues to buy power from China, the OT underground expansion phase would spike the cost of power for the expanded operations. Therefore, it's crucial for TRQ to find a domestic power source that is cheaper and could provide an uninterrupted power supply for the mine's operations.

Details of the agreement: TRQ has announced that is has signed a PSFA (read: Power Source Framework Agreement) with the GoM. Under the agreement, the power plant will be constructed near the TT (read: Tavan Tolgoi) coal mine, whose coal will be used to provide fuel for the 300 MW power plant. TRQ expects to commence construction of the power plant in FY 2020, while the plant is expected to be commissioned in FY 2023.

The implications for both stakeholders: In my view, this agreement will have far-reaching implications for both stakeholders (i.e TRQ and GoM). For the government, this would mean generation of more employment in addition to the ~17,000 workers employed in the OT mine. Additionally, the commissioning of the power plant would kickstart regular supplies from the TT project (that is expected to contain ~6 billion tonnes of coal) and would provide a regular stream of revenues and taxes for the GoM.

For TRQ: Besides providing a domestic power source for the expanded operations, the agreement will also pave way for harmonized relations with the GoM. It's appropriate to quote TRQ's CEO Ulf Quellmann on the subject:

We are encouraged by the pivotal decision to proceed with the power project at Tavan Tolgoi. Resolving Oyu Tolgoi’s long-term power requirements is critically important to the mine’s long-term development and today’s signing of the PSFA is a positive milestone toward that goal. We will continue to work closely and collaboratively with our partners to finalize the details of the power project, which will allow this truly great world-class asset to achieve its full potential for the benefit of all stakeholders.

It's worth noting that despite the strong resource profile projected by the OT mine (discussed in the following section), investors' confidence had previously been shattered by the role played by the GoM during the mine's development. In the past, the Mongolian tax authorities had imposed a $155 MM tax demand on the company, out of which TRQ paid $5 MM and disputed the remaining $150 MM. TRQ has the option to refer the dispute to international arbitration (if needed). Nevertheless, the recent agreement would help melt the ice between the two stakeholders and we can expect TRQ to expedite the mine development with increased focus.

An improvement in copper prices is all we need

TRQ's strong copper production profile: During fiscal years 2018-2020, TRQ expects to produce between ~140 and 150 kT of copper per annum (on average). The copper production outlook is expected to increase to ~175 kT in 2021, and then significantly increase to ~265 kT in 2022. Since TRQ expects to start its full-scale underground operations in FY 2022, we can see the significant production potential unlocked by the underground mine expansion. In FY 2023 and beyond, the copper production outlook is expected to increase by leaps and bounds. It's expected to be ~450 kT in 2023, ~583 kT in 2024, and ~622 kT in 2025. Briefly put, TRQ's growth profile in terms of copper production is too tempting to ignore (Figure-2).

Figure-2 (Source: Previous article on Seeking Alpha)

However, during the past 6 months, copper prices have shred by more than 12%, from ~$3/lb to ~$2.63/lb (as shown in Figure-3 below).

Figure-3 (Source: Infomine)

Following the news of the agreement, TRQ's shares went up 1.92% pre-market and jumped another 5.77% post-market (Figure-4). In my view, if only we could see support from the copper prices, TRQ would witness even stronger price gains.

Figure-4 (Source: SA dated 31st December 2018)

As mentioned earlier, the production from the underground expansion phase is expected in FY 2022. By that time, we could see an altogether different picture for the global copper prices. A rebound in copper prices would certainly boost TRQ's revenues and share price.

Nevertheless, TRQ's share price is currently supported by an uptrend in gold prices. As noted in Figure-2, OT mine also contains significant reserves of gold. At present, gold prices have gained strong momentum after having suffered from a prolonged depression since July 2018 (Figure-5). I believe that the recent gold price rally would reasonably continue, and we may see gold prices to touch the ~$1,300 mark. I have briefly discussed the reasons thereof in a recent article.

Figure-5 (Source: Infomine)

Technical price chart

TRQ's 52-week price range lies between $1.43 and $3.59. The stock is currently trading near the 52-week lows. Given the significant production growth profile, I believe the stock is trading at cheap prices. Moreover, based on the technical price chart (Figure-6), if we extend the trend line connecting the resistance levels, we may figure out the short-to-medium price target to lie between $1.80 and $2.

Figure-6 (Source: Finviz)

Investor takeaway

The agreement signed between OT and GoM has finally provided some support for TRQ's share prices. The depression in copper prices is withholding the real growth potential and if we could see a rebound in copper prices, then that would certainly help boost TRQ's share price.

Nevertheless, TRQ has significant potential for copper and gold production and the current upside is also supported by a rally in gold prices. Considering the technical price chart, we may expect TRQ to reach the price target of ~$1.80-2 in the short-to-medium term, while more upside would follow as the company advances on the development of the mine.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.