We continue our Talking Top Twenty series with an update on three more companies, the first two of which have been rather pleasant experiences for the investor. Conversely, the third has been rather messy. For the impatient, lets begin with the conclusion. We feel that all three could present as great risk reward propositions.
Talking Top Twenty: Commonwealth Bank (CBA.ASX) & Westpac (WBC.ASX)
Talking Top Twenty: National Australia Bank (NAB.ASX) & ANZ (ANZ.ASX)
Talking Top Twenty: BHP (BHP.ASX) & Fortescue (FMG.ASX)
A note before proceeding further, our expectations are predicated on the price targets for commodities stated in last weeks article.
Rio Tinto (RIO.ASX)
Stellar results from Rio. Sales revenue was up +42% while underlying earnings were up +72% to $21.4bn. The all important dividend came in at AU $10.20 per share, a more than pleasing result for shareholders. Much like peer BHP, the business has seen significant tailwinds from the Russian invasion of Ukraine and the resulting upward price action in both iron ore and copper, both commodities seemingly relentless in their upward momentum. When we last wrote about the company our thesis was centred around supply bottlenecks and global inflationary pressures as a result of re-opening. With the exception of concerns about China, our thesis remains intact and we feel that Rio offers an even better risk reward proposition now.
The most recent strategic decision taken by the business has been the all cash offer to acquire the remaining 49% of shares of the TSX and NYSE listed Turquoise Hill, the JV partner in the Oyu Togoi project (a copper-gold mine) in Mongolia. Not only does this represent a stellar move that simplifies the ownership structure of what is undoubtedly the next key driver of cash flow for the business going forward but we feel the offer represents a commercially viable price. With the conclusion of this deal, Rio will now own 66% of the project outright (currently 33%), with the remaining 34% owned by the Mongolian government. Copper is one metal that we believe will be a cornerstone of global growth and the transition to electric vehicles over the coming decade. This is not to mention the substantial rebuild of aging transmission grids required across most of the developed world.
To give some idea of the magnitude of the Oyu Togoi project, here are some numbers. $6.5bn (Capex required, including the debt waiver for Mongolian government), low 1st Quartile (the cost of production), +40 years (life of mine), 500Kt p.a. (copper production), 400 Koz p.a. (gold production), US $26bn (our valuation of the project to the company), <2 months (FCF required to buy Turqouise Hill). This, in our view, will add to the business substantially. Upon reaching full production run rate, the project could represent close to 30% of the RIO’s annual revenue (assuming that our target for copper spot prices holds).
Aside from the above, management remains on track to deliver according to expectations in the Pilbara. Yes, we are aware that labour and equipment shortages have created issues but we think that it will return to production growth. With continued upward pressure for Aluminium and the commissioning and ramp up of brownfield mines Rio is on track to deliver continued cashflow growth.
Red Flags & Risks: The elephant in the room will always be iron ore price weakness. While our long-term view remains bullish, there will be continued volatility. Capex could also be an issue in an inflationary environment while geopolitical and regulatory risks such as the Heritage Act revision in WA along with continued issues with Mongolian stakeholders, the most recent of which have been herders.
Dividend Yield: This is a dividend growth story; we believe that it remains a better substitute for the big banks in this respect (assuming a consistent payout ratio). The dividend yield stands at an exceptional ~10% assuming current share prices hold.
Woodside Petroleum (WPL.ASX)
Many will be aware of our bullishness with regards to oil and natural gas. Our target for Brent remains to the upside, to give a little context adjusting for inflation from the last peak in the late 2000s preceding the GFC, the target for Brent is a price of about US $130 per barrel while we feel that natural gas could head beyond the US$8 target posited in a previous article perhaps even to double digits.
With that context let’s get to Woodside. NPAT at US $1.983bn (up +149%), production for the year coming in at 91.1 MMboe (millions of barrels of oil equivalent), up +9%, with operating cashflow of US $3.792bn. These numbers showcase the sheer scale at which the company has been a beneficiary of a resurgent energy market. What has been disappointing, however, was the lower than expected production volumes. We expect these to be shorter term operational disruptions though. The merger with BHP’s oil and gas portfolio comes at an opportune time; not only can the business now significantly reduce operational capex (synergies), reduce farm-outs but it also puts the business in a significantly better negotiating position when it comes to off-takes.
WPL remains a company at the forefront of the Federal Government’s ambitions when it comes to LNG production and domestic gas supply. Numbers-wise, production came in at 23.7 MMboe, a 5% decline but still in line with expectations. Also disappointing was the realised sales price, with nearly half the delta coming from sales volume timing (i.e. the hedge book). The company has, in our opinion, been rather conservative in its approach. Nevertheless, revenues were up +22% QoQ to US $1.2bn. What has been pleasing is the LNG side. Although the company has indicated a blow-out in capex relating to the North West Shelf JV and low-pitched legacy contracts (pertaining to the same), they have been taking advantage of higher prices across Asian markets. Importantly, Pluto T2 and the works across the KGP Interconnector seem to be progressing as they should with a final investment decision to come shortly in 2H21.
Woodside also updated on Sangomar capex which was increased to US $4.6bn (an increase of $40m), reflecting increased costs in the current operating environment. Our view is that the original guidance was on the optimistic side, especially for a company known for its conservatism. Nevertheless, this is where the next set of growth is likely to come from for this company and we still remain of the conviction that management showed some substance in its acquisition from FAR (FAR.ASX) and its pushing out of Lukoil. WPL maintains a strong balance sheet with net debt remaining at $2.5bn, likely to decrease substantially in the event of a sell-down of Pluto over the coming 24-months. WPL’s exit of the Kitimat LNG project in Canada is also likely to add another US $40-50m profit to the balance sheet, though they have indicated that this will be excluded that in the dividend calculation. Prudent but disappointing for the short-term investor.
The company now has the right energy mix to benefit significantly from what we think should be significant upside; 78% currently comes from natural gas especially given a significant amount remains uncontracted. The company has stated that it expects close to 20-25% of the LNG production to be sold on the basis of Energy Hub Indexes. Another great move.
Red Flags & Risks: The company remains well-capitalised. But the biggest risk remains the elevated inflationary pressures and implications for OPEX. Any delays in pipeline, the most of important of which are Sangomar and Scarborough projects, are potential left-field issues that have to be on the radar for any investor.
Expectations: At the time of our previous writing, the business was trading at about AU $24 per share; our longer term price target was $45 per share assuming US $80/barrel. Assuming our newer targets, this now goes up significantly to $60 per share.
Dividend Yield: The yield is a solid 7%, assuming a share price of $33.39 AUD.
Newcrest Mining (NCM.ASX)
The yellow metal is one that continues to baffle. Not only has it not been functioning particularly well in its historic role as a hedge against uncertainty but the price action is simply unattractive given the sheer scale of geopolitical tensions globally. That said, as an investor, one can only rely on past performance to make reasonable judgements as to what the future may hold. Inflation continues to ramp up and if we are right in our view around commodities it will continue to remain elevated while at the same time central banks remain hamstrung. Despite the headlines, we don’t see the Fed turning hawkish but rather taking a cautionary approach in normalisation (if at all). Assuming that real yields continue to be negative then the thesis around where bullion markets should be priced remains intact.
With the above in mind, onto Newcrest. On track to achieve 2022 guidance with first half net profit of $298m and an AISC margin of $502/oz (this is the more interesting in our view given that it is significantly below the $842/oz previously reported). Cashflows of $423m and, importantly, dividends of US 40c per share. This showcases that management, who some may remember were specifically appointed to implement cost cutting measures in 2014, is on track. What has been interesting is the recent acquisition of TSX listed Pretium (PVG) and its Tier 1 deposit in British Columbia (Brucejack Mine). This sits in British Columbia's highly prospective Golden Triangle which could potentially significantly increase the business’ reserves going forward (significant newsflow this year). For now, shareholders have to be content with $15-20m in cost synergies given its 70% ownership of Red Chris Mine some 140km away (i.e. logistics and procurement), and an immediate increase of approximately 100,000 ounces p.a. in production with some.
Red Flags & Risks: We remain of the view that NCM offers a better risk-return proposition than most among gold majors given the reserve life of 21 years, a number significantly higher (by about 50%) than their nearest competitors in Barrick (ABX.TSX) and Newmont (NEM.NYSE). Previous concerns included cost management and operational leverage but management has been showing decent momentum in its discipline. The biggest risk going forward is macro rather than company specific. That is, the short-term volatility in both gold and copper markets.
Expectations: Lihir continues to be a disappointment but with our base case being substantial upside to bullion markets and, given our views on copper, we feel the company offers a reasonable diversifier. Assuming a gold price of US $1,950 per Oz our price target is AU $35 per share.
Dividend Yield: Assuming a share price of $27.83, then the current yield stands at about 2.12%.
Disclaimer: RIO and WPL are both currently held in TAMIM individually managed account portfolios.
At TAMIM we are committed to educating investors on how best to manage their retirement futures.
Sign up to receive our weekly newsletter:
TAMIM Asset Management provides general information to help you understand our investment approach. Any financial information we provide is not advice, has not considered your personal circumstances and may not be suitable for you.