Turquoise Hill: Mr. Market Should Not Run Down The Long Investor

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

TRQ has delivered a strong Q1 in terms of production.

Depressed copper prices and delay in completion of Shaft-2 act as headwinds.

Sailingstone Capital has raised concerns about TRQ’s management.

The stock appears risky in the short term.

Nevertheless, the fundamental strength indicates that TRQ would be very promising for the long investor.

Turquoise Hill Resources (TRQ) has recently reported the results for Q1 2019. The company saw a massive improvement in Y/Y copper and gold production and remains on track to achieve full-year production guidance. The declining copper prices limit the potential for growth in TRQ’s revenues, and the delays in completion of Shaft-2 slows the outlook for production growth. Moreover, grievances raised by a major shareholder against TRQ’s parent company Rio Tinto (RIO) could further deteriorate the situation. All these factors continue to weigh down heavily on the share price and the stock appears risky in the short-to-medium term despite its attractive technicals. Nevertheless, for the patient and long investor, TRQ is a promising investment. Let’s get into the details.

Figure-1 (Source: Mining.com)

During Q1, TRQ’s copper and gold production stood at 45,800 tons and 120,000 ounces respectively. These metals saw a respective 18.2% and 187.6% Y/Y increase in production. For the remainder of FY 2019, TRQ’s production is likely to decline due to expected declining head grades, as the company plans to derive a large proportion of its production from its relatively low-grade deposits at Oyu Tolgoi Phase-6. Nevertheless, the full-year production is expected to lie within the guidance range of ~125,000-155,000 tons of copper and ~180,000-220,000 ounces of gold. Since copper is the main product of TRQ’s OT (read: Oyu Tolgoi) mine, the persistent decline in copper prices (Figure-2) will negatively impact the company’s revenues, although these will be supported to some extent by the recent improvement in gold prices (Figure-3).

Figure-2 (Source: Infomine)

Figure-3 (Source: Infomine)

TRQ has announced that Shaft-2 of the OT mine will be completed with further delays (that is, in October 2019), and I believe this would push the expected ‘expansion of OT’s production potential’ further into the future. As if these issues were not enough to indicate that prices would remain flat throughout the year; a recent grudge between the two giant investors of TRQ has further deteriorated the situation. Sailingstone Capital (which owns more than 10% of TRQ’s shares) announced its decision to vote against the independent directors nominated on TRQ’s board by RIO, alleging issues of ill corporate governance exercised in managing TRQ’s business. Sailingstone’s Managing Partner commented:

We have long been troubled by corporate governance practices at TRQ, and have worked diligently with the Board to attempt to address these issues. Unfortunately, the Board has refused to engage in productive dialogue, and we are left with no choice but to vote AGAINST the independent directors. This is not a decision which we have entered into lightly, given our significant investment and our long-term commitment to the Company. But, the fact remains that this is a world class asset that deserves world class corporate governance practices so that all stakeholders - Rio Tinto, the minority shareholders and the people and government of Mongolia - are aligned to achieve success at both the project and the corporate level.

While RIO seems to have turned a blind eye to the concerns raised by Sailingstone, I believe this situation may create more pressure on TRQ’s prices. Due to a prolonged series of negative news that thrashed TRQ’s stock time after time, the investors have become quite sensitive, especially those who bought at or above $3/share and are holding shares at ~$1.30 hoping for a rebound. Sailingstone believes in the long-term growth opportunity in TRQ’s stock (discussed later) and it’s very unlikely that this grudge would lead them to initiate a sell-off. Nevertheless, if Sailingstone decides otherwise, then the stock may well slip at or near the ~$1/share mark.

Even though the company’s technical price chart (Figure-4) indicates that TRQ is currently trading at the 52-week lows and technically fit for a rebound, the red flags analyzed above indicate that it would be unwise to invest in the company purely for short- to medium-term gains.

Figure-4 (Source: Finviz)

Considering the situation as a whole, the risk of further downside is low. Nevertheless, the likelihood of any significant upside stretches only into the long term due to the fact that TRQ’s strong fundamentals may take some time to realize (say, the next 3-5 years). As shown in Figure-5, TRQ’s copper and gold production will witness significant upside over the next decade. Similarly, the cost metrics will also witness significant improvement over the next 10 years (Figure-6) and would enhance TRQ’s operating margins in future. Additionally, if the increased production could gain support from metal prices, then it’s easy to visualize how TRQ’s long-term outlook would brighten up.

Figure-5 (Source: Presentation)

Figure-6 (Source: Conference Call)

In short, despite delivering a strong first quarter, TRQ’s FY 2019 outlook is troubled on account of reduced production guidance for the forthcoming quarters, and copper prices. Moreover, the management concerns raised by Sailingstone Capital might trigger sell-off activity (though not very likely), and that could bring down the share prices further. But given TRQ’s situation, one thing is for sure. The stock may not promise a significant upside in the short-to-medium term (say, 12-24 months), but the long-term operational outlook is strong enough to make TRQ an attractive long investment.

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.