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KAZ Minerals: remember last time?

This highly leveraged copper play looks precariously poised, but a low-cost profile has worked wonders before
July 26, 2018

What is the current state of global economic growth? Yes, the shadow of a trade war looms large and the International Monetary Fund (IMF) sees rising protectionism as the “greatest near-term threat” to its outlook. China, many argue, must put a pin in its credit balloon. Both issues should give mining investors pause for thought, but neither factor need obscure a reliable trend: economic expansion. Copper, through its use in everything from electronics to power, transportation and construction, is hard-wired into IMF expectations of 3.9 per cent global GDP growth in 2018 and 2019, during which time demand for the metal is widely forecast to outstrip supply. On most projections, that deficit is expected to persist beyond 2020. Yet the price of the red metal has just hit a one-year low, knocking the likes of KAZ Minerals (KAZ) with it. We feel the situation is unsustainable, and for those with the stomach, a buying opportunity.

IC TIP: Buy at 785p
Tip style
Speculative
Risk rating
High
Timescale
Long Term
Bull points

Looming copper deficit

Share price dip

Growth-oriented

Operational track record

Bear points

Trade war fears

High leverage

Might this also be a 'falling knife' scenario? The possibility makes a stock like KAZ a high-risk bet, but the central Asian miner’s production ramp-up couldn’t have been better executed in recent years and KAZ shows few signs of slowing down. For resource stocks, prices tend to have an exaggerated effect on the cash flow statement, and in KAZ’s case, the ability to grow while keeping a lid on $3.9bn (£3bn) of debt as of the end of 2017 ($2.1bn less its cash).

For a company with net assets of $1bn, those are considerable liabilities. But it’s worth noting that the strain has been greater in the recent past. At the end of 2015, KAZ’s borrowings less cash deposits were $2.25bn, seven times total net assets. Copper was selling for $2 a pound, or around the gross cash cost of ageing operations at Bozymchak and in the east of Kazakhstan. So while lower cost output from Bozshakol and Aktogay couldn’t come through fast enough, the newly built plants were set to underwhelm cash-generative expectations. The share price hovered at 100p.

What followed was a steady rise in copper prices, production, cash generation and cash balances, propelled by the cost-reduction benefits from the devaluation of the Kazakh tenge. By June 2018, the shares had risen 11-fold to 1,103p.

In 2019, production is projected to flatline after three years of 50 per cent compound annual growth. If it wanted, KAZ could focus only on debt reduction and dividends. But the group has already green-lit the $1.2bn Aktogay II expansion project, which starts producing in 2021 and adds some 80,000 tonnes of annual copper (tpa) output from 2022. Koksay, an early-stage, 100,000tpa development that recently attracted a $70m investment from Chinese group NFC, looks to be next in line.

While the balance sheet remains a tightrope, KAZ has an excellent cost profile, aided in part by strong gold, silver and zinc by-products. So with all of its mines in the lowest quarter net cash cost producers, the group has breathing room if prices deteriorate further. If needed, the company could delay dividends and certain payments to Aktogay II contractors to extend an aggressive three-year $1.5bn debt repayment schedule.

Despite recent copper price weakness, market fundamentals should provide longer-term assistance. BMO Capital Markets recently estimated that the price of copper has fallen below the ninetieth percentile of the cost curve. In other words, a tenth of global production is lossmaking. The longer this situation persists, the more likely that low-margin private miners in China and Chile will be forced to slash output, further straining supply.

Then again, there’s no escaping the shake-out in the spot market; at $2.71 a pound, copper is now 18 per cent off its June high. That would represent a stunning collapse even if market fundamentals were weak. Some participants have suggested the fall might be down to the unwinding of a massive bull position by Chinese futures broker Gelin Dahua, which a recent Reuters report cited as the source of a crash in the Shanghai copper price.

Could that be shrewd timing by a Chinese party with their ear close to the buying ground? No one’s quite sure, but whatever the reason, deficits tend to effect prices eventually, particularly if the costliest production is leaving the food chain. And short of a massive demand shock, BMO calculates that by 2025, small mine elasticity, new mega-projects and scrap growth will still fall 5Mtpa short of global copper consumption, buoyed by growth in renewables and electric vehicles.

KAZ MINERALS (KAZ)   
ORD PRICE:785pMARKET VALUE:£3.51bn
TOUCH:784.6-785.2p12-MONTH HIGH:1,103pLOW: 630p
FORWARD DIVIDEND YIELD:1.6%FORWARD PE RATIO:6
NET ASSET VALUE:223¢NET DEBT:206%
Year to 31 DecTurnover ($bn)Pre-tax profit ($m)*Earnings per share (¢)*Dividend per share (¢)
20150.6712-2.2nil
20160.7722040.3nil
20171.66580104nil
2018*2.2780514415.9
2019*2.4393316716.7
% change+7+16+16+5
NMS:2,000   
Matched Bargain Trading    
Beta:1.63   
£1=$1.31. *Peel Hunt forecasts, adjusted PTP and EPS figures