Copper and nickel producer First Quantum Minerals (LSE: FQM; TSX: FM) is undisputedly one of the best mining companies in the business. It's highly rated bosses and large team of engineers and geologists have a reputation for building mines faster and cheaper than almost any competitor. They've boosted copper production by more than a half in the past two years and plan to more than double it again over the next five.
- Highly rated management
- Low production costs
- Growing fast
- Upside already priced in
- Execution risk
- Stretched balance sheet
- Highly leveraged to copper price
The problem is, shares in the company have run way too far ahead of fundamentals. First Quantum's share price has climbed over 30 per cent in the past 12 months amid a minor recovery in sentiment toward large-cap miners, a rising nickel price and a flat copper price; the rest of the FTSE 350 miners have seen their shares re-rate by just 9 per cent.
True, First Quantum arguably should demand a premium rating over its peers. It has a superior growth profile, costs in the lowest quartile, and is often touted as a potential takeover target. But, based on forecasts, even after factoring in a 10 per cent enterprise-value-to-cash-profits premium against an exclusive peer group, the the shares are only worth 1,044p; more than a quarter less than the current level.
Analysts at HSBC arrive at a more generous sum-of-the-parts valuation of 1,142p, but that's still one fifth below the current price. What's more, that sum-of-the-parts model factors in some contingency for each major project or expansion, as well as a chunky rise in the copper price. Moreover, First Quantum's forecast enterprise-value-to-cash-profits ratio of 11.5 in 2014, 7 in 2015 and 5.6 in 2016, is well above the peer group average ratios of 6.4, 5.7 and 5.1, respectively.
FIRST QUANTUM MINERALS (FQM) | ||||
|---|---|---|---|---|
| ORD PRICE: | 1,409p | MARKET VALUE: | £8.3bn | |
| TOUCH: | 1,397-1,478p | 12-MONTH HIGH: | 1,512p | LOW: 960p |
| FORWARD DIVIDEND YIELD: | 0.4% | FORWARD PE RATIO: | 14 | |
| NET ASSET VALUE: | 1,386¢ | NET DEBT: | 47% | |
| Year to 31 Dec | Turnover ($bn) | Pre-tax profit ($bn) | Earnings per share (¢) | Dividend per share (¢) |
|---|---|---|---|---|
| 2011 | 2.6 | 1.1 | 118 | 18.1 |
| 2012 | 3.0 | 2.2 | 374 | 17.5 |
| 2013 | 3.6 | 0.9 | 82 | 15.1 |
| 2014* | 3.8 | 1.1 | 101 | 11.5 |
| 2015* | 5.4 | 1.9 | 175 | 11.5 |
| % change | +42 | +73 | +73 | - |
Normal market size: 300 Matched bargain trading Beta: 1.56 £1=$1.69 £1=Can$1.84 *HSBC forecasts, diluted EPS figures | ||||
The premium rating leaves little room for disappointment; successful delivery of multiple projects simultaneously is required. Not only will First Quantum have to expand production by a third over the next few years at its flagship Kansanshi mine - already the largest copper mine in Africa - the company will also have to ramp up production at its new Sentinel mine in Zambia, finish building a smelter, and construct a huge new mine in Panama from scratch. It's borrowed heavily to fund that expansion and will be nearly $5bn (£3bn) in debt by the end of next year.
We don't doubt management's execution skills but we have seen countless projects suffer from delays or soaring costs due to circumstances largely beyond control, be they caused by mother nature, greedy governments or other sources. First Quantum is certainly not immune in this regard; an early warning signal flashed in June when the company had to temporarily halt construction for a few weeks at its Cobre Panama project due to an illegal work stoppage. Overall, it's safe to assume risks to forecasts and schedules look skewed to the downside.
