Turquoise Hill Resources Ltd. (TSX: TRQ) is an international mining company. The company focuses on the operation and further development of the Oyu Tolgoi copper-gold mine in Southern Mongolia, which is the company's principal material mineral resource property. The Company's Oyu Tolgoi mine is held through approximately 65% interest in Oyu Tolgoi LLC (Oyu Tolgoi), and the remaining approximately 35% interest is held by Erdenes Oyu Tolgoi LLC (Erdenes). Rio Tinto plc is the ultimate parent company and indirectly owned a 50.8% majority interest in Turquoise Hill as of June 30, 2021.

Investment Rationale

• Higher copper prices would continue to drive topline: Around 56% of the group's total revenue comes from the Copper segment. On a YTD basis, Copper prices are up approximately 25%, and the uptrend in copper prices is expected to continue for a longer term on the back of fiscal stimulus programmes announced by the Biden administration and talks of a future structural deficit in the market as the transition to a greener economy calls for more copper units.

• Higher copper production is likely in H2FY21: In Q2FY21, the company's operations were significantly impacted at the Oyu Tolgoi location, as COVID-19 cases increased significantly in Mongolia during Q2 2021 causing a series of lockdowns in the country and South Gobi. This resulted in personnel numbers below 25% of planned requirements at certain points during the quarter. However, As of July 9, 2021, the Oyu Tolgoi workforce is 93% fully vaccinated, and it is expected that the company would recover its copper pace in the second half of 2021, and a higher production amid high copper prices would significantly boost financials in the second half of 2021.

• Solid Liquidity Profile: As of June 30, 2021, the company had USD 0.7 billion of available liquidity, consisting of consolidated cash and cash equivalents. The company's current assets exceeded current liabilities by USD 0.5 billion on June 30, 2021. The company expects to fund its current liabilities and current commitments through its liquidity position and from cash flow generated at its existing open pit operations. The company continues to review its near-term operating plans and continues to take steps to achieve operating cost efficiencies in order to maximize cash generated from its existing open pit operations.

• Significant Margin Expansion: On the back of a strong surge in the underlying commodity prices, TRQ's margin profile has bolstered significantly. Further, economies of scale would help the group to sustain it throughout the strong commodity cycle. Also, the company commands a strong competitive advantage against its peers in terms of margin profile.

• Reaffirmed production guidance: The company is maintaining its production guidance of 150,000 – 180,000 tonnes of copper and 400,000 – 480,000 ounces of gold as it continues to access the higher copper and gold grades from Phase through the remainder of the year. The increase in gold production in 2021 compared with 2020 is the result of transitioning lower into the higher grade areas of Phase 4B.

• Prices are sustaining above the rising trend line: On the weekly chart, TRQ prices have been under pressure from the high of CAD 26.45 and made a recent low of CAD 16.06 level on 20 July 2021. After this massive sell-off, prices are continuously sustaining above the rising trend line and taking support of the same. Moreover, the prices are trading above the trend-following indicator 50-period SMA. The leading indicator RSI (14-period) is trading at ~49.80 level, indicating a possibility of a rebound in the stock.

Source: REFINITIV, Analysis by Kalkine Group

• Risks Associated with Investment: The company’s business is primarily exposed to volatility in Copper and Gold prices. Further, higher input costs such as power, oil, and others may also weigh on the group’s performance. TRQ is exposed to currency translation risks; other risks factors are resurgence in COVID-19 cases, which could hamper production.

Financial Highlights: Q2FY21

Source: Company Filing

• Revenue of USD 317.8 million in Q2'21 increased 14.3% from USD 278.0 million in Q2'20, reflecting an increase of USD 74.9 million in revenue from gold partly offset by a decrease of USD 34.3 million in revenue from copper.
• Gold revenue benefitted from a 6.3% increase in the average price of gold and a 135.5% increase in volumes of gold in concentrates sold.
• Copper revenue was impacted by a 50.6% decrease in volumes of copper in concentrates sold, partly offset by an 82.5% increase in the average price of copper.
• During Q2 2021 Oyu Tolgoi produced over 36,000 tonnes of copper and then 113 ounces of gold with a C1 cash cost of USD 0.83 per pound. Production was lower than in Q2 2021 from Q1 2021 due to slower mining rate and the higher-grade Phase 4B this resulted in an increase in lower grade stockpile material being processed through the mill.
• Income for the period was USD 118.8 million compared with USD 72.3 million in Q2'20, primarily reflecting the impact of a USD 139.2 million increase in gross margin driven by both increased revenue and a decrease in cost of sales.
• Cost of sales was USD 1.91 per pound of copper sold and C1 cash costs were USD 0.83 per pound of copper produced. All-in sustaining costs were USD 1.48 per pound of copper produced.
• Total operating cash costs1 of USD 210.5 million in Q2'21 increased 16.4% from USD 180.8 million in Q2'20, due principally to higher royalty costs driven by higher sales revenue as well as additional COVID-19 related costs, partially offset by lower power study costs.
• Cash generated from operating activities was USD 209.3 million in Q2'21, compared to USD 81.8 million cash used in operating activities in Q2'20. The difference was due to the impact of a USD 261.0 million improvement in cash from operating activities before interest and tax, which was primarily due to a USD 139.2 million higher gross margin as well as more favourable movements in deferred revenue in Q2'21 compared to Q2'20 driven by the timing of ramp-up in concentrate shipments during Q2'21 following the declaration of force majeure as well as related contingency measures to improve Oyu Tolgoi's short-term liquidity.
• All-in sustaining costs of USD 1.48 per pound of copper produced in Q2'21 decreased 32.1% from USD 2.18 per pound of copper produced in Q2'20. Similar to the decrease in C1 cash costs, the decrease primarily reflects the impact of the higher gold revenues but, unlike C1 cash costs, was partly offset by the impact of increased royalty costs due to the increased revenue.
• Capital expenditure on a cash basis was USD 230.3 million in Q2'21 compared to USD 261.9 million in Q2'20, comprised of USD 211.4 million (Q2'20 - USD 250.0 million) in underground capital spend, including USD 49.9 million in underground sustaining capital (Q2'20 - USD 11.0 million), and USD 18.9 million (Q2'20 - USD 11.9 million) in open pit sustaining capital expenditure.

Top-10 Shareholders

Top-10 shareholders together holds 76.03% stake in the company, with Rio Tinto PLC and Pentwater Capital Management LP [Activist] are the major shareholders with an outstanding holding of 50.79% and 9.27% respectively.

Valuation Methodology (Illustrative): EV to EBITDA based Valuation Metrics

Note: Premium (discount) is based on our assessment of the company’s growth drivers, economic moat, competitive advantage, stock’s current and historical multiple against peer group average/median and investment risks.

Stock Recommendation: The Oyu Tolgoi team turned in another strong performance with the production of 36,735 tonnes of copper and 113,054 ounces of gold, generating revenue of $317.8 million, a 14% increase over the same quarter last year despite the impact of significant COVID related challenges experienced during the quarter.

Operating cash costs for 2021 are expected to be USD 800 million to USD 850 million. Capital expenditure for 2021 on a cash basis is still expected to be USD 105 million to USD 125 million for the open-pit and at the low end of the USD 0.9 billion to USD 1.0 billion range previously disclosed for the underground, including underground sustaining capital expenditure.

Also, from the long-term perspective, Copper miners are well placed to capitalize on fiscal stimulus programmes announced by the Biden administration and talks of a future structural deficit in the market as the transition to a greener economy calls for more copper units.

Hence, based on the rationale discussed above and valuation, we recommend a “Buy” rating on the stock at the closing price of CAD 19.30 on August 05, 2021.

*Depending upon the risk tolerance, investors may consider unwinding their positions in a respective stock once the estimated target price is reached.

Technical Analysis Summary

Source: Refinitiv, Analysis by Kalkine Group

*Recommendation is valid on August 6, 2021 price as well.

*The reference data in this report has been partly sourced from REFINITIV.

Disclaimer

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