Turquoise Hill Resources Ltd (TSX: TRQ) is a global mining company that primarily mines copper, gold, and coal in the Asia-Pacific region. The company holds a 66% interest in Oyu Tolgoi, one of the world's largest copper-gold-silver mines, which ships concentrate to customers in China. The remaining 34% interest is held by Erdenes Oyu Tolgoi LLC (Erdenes), a Mongolian state-owned entity. It also holds interests in companies that mine molybdenum and rhenium in Australia and gold at the Kyzyl Gold Project in Kazakhstan.

Investment Rationales

• Robust Q2 2021 performance: The company reported decent performance in the Q2 2021, with revenue surged by 14.3% to USD 317.8million, against USD 278.0 million on a YoY basis, gross profit elevated to USD 235.2 million, against USD 96.0 million and net profit rose by 64.2% to USD 118.7 million compared to the previous corresponding period.

• Strong production figures in Q1 2021: On the back of strong gold production, the company clocked a consolidated revenue of USD 317.8 million in Q2 2021, increased by 14.3% against USD 278.0 million in the previous corresponding period, reflecting an increase of USD 74.9 million in revenue from gold, partially offset by a USD 34.3 million decrease 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. When compared to Q2 2020, copper output stood constant at 36,735 tonnes of copper, while gold production jumped 264.5% to 113,054 ounces. Although on sequential basis Copper and gold production was lower than Q1 2021 due to slower mining rates in Phase 4B.

Source: Company

• Industry beating margins: Despite the second wave of the Covid-19 Pandemic, the Company maintained its pace and witnessed spirited performance across its margin matrix. In addition, the management’s solid determination helped them leap the industry median margins on many fronts in Q2 2021, which exhibits the competitive advantage of the company within the industry. The chart below gives a glimpse of this. 

Source: Refinitiv 

• Improving cash flow from operating activities: Cash generated from operating activities was of USD209.3 million in Q2 2021 compared to USD 81.8 million cash used in operating activities in Q2 2020, the improvement was mainly 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 improvement in gross margin as well as favourable movements in deferred revenue. Higher average realized prices of the commodities also played a crucial role in achieving healthy revenues and margin.
• Elevated commodity prices to support future earnings: The recent rally in the commodity prices is moving well for the company, and we can see a significant impact of this movement in the precious and industrial metal mining company’s balance sheet. As the prices go up, it increases averages realization prices for the miners, which lead to a higher margin profile, higher free cash flow generation and deleveraging of the balance sheet. We believe that the company is well placed to capitalize on the increasing prices of the underlying commodity and exit FY2021 on strong financial health.
• Operational outlook for 2021: The company’s mine “Oyu Tolgoi” has updated its operational outlook for 2021 and is now expected to produce 150,000 to 180,000 tonnes of copper and 400,000 to 480,000 ounces of gold. The small drop from earlier guidance reflects both the mine design change in Phase 4B to address geotechnical concerns about a multi-bench failure in Q4 2020, as well as the impact on productivity and greater uncertainty caused by COVID-19-related measures already in place on site. Furthermore, the move downward into the higher-grade sections of Phase 4B will result in an increase in gold output in 2021 compared to 2020. Operating cash costs are estimated to be between USD 800 and USD 850 million in 2021, with capital expenditures between USD 105 and 125 million.
  

• Risks associated with investment: The company's business is significantly exposed to the volatility in gold and copper prices. Further inherent risks associated with mining and mineral processing such as the company's mines may not perform as planned; uncertainty with the company's ability to secure additional capital to execute its business plans; the speculative nature of mineral exploration and development, including the risks of obtaining and maintaining necessary licenses and permits, including the necessary licenses, permits, authorizations and/or approvals from the appropriate regulatory authorities.

Financial overview of Q1 2021

Source: Company

• The company's revenue grew 14.3% to USD 317.8 million in Q2 2021, compared to USD 278.0 million in Q2 2020, owing to a USD 74.9 million rise in gold revenue, partially offset by a USD 34.3 million reduction in copper revenue. The planned transition to the higher-grade gold regions of Phase 4B resulted in a 6.3 percent rise in the average price of gold and a 135.5 percent increase in quantities of gold in concentrates sold, which boosted gold income. The volume of copper in concentrates sold fell 50.6 percent due to force majeure, which was somewhat offset by an increase of 82.5 percent in the average copper price.

• Cost of sales in the reported period stood at USD 82.6 million, decreased 54.6% against USD 182.0 million in the previous corresponding period, The cost of sales decreased mainly due to lower volumes of concentrates sold resulting from the impact of the force majeure during Q2 2021.

• On the back of robust growth in consolidated revenue and a decrease in cost of sales, the group’s gross profit enhanced to USD 235.2 million in Q2 2021, against a gross profit of USD 96.0 million in the previous corresponding period.

• Total operational cash expenses climbed 16.4% to USD 210.5 million in Q2 2021, owing to higher royalty costs generated by greater sales income, as well as extra COVID-19-related expenditures, slightly offset by decreased power study costs.

• Unit cost of sales of USD 1.91 per pound of copper sold in Q2 2021 was down 8.2% from USD 2.08 per pound of copper sold in Q2 2020, owing to a 54.6% drop in cost of sales largely offset by a 52.3% decline in quantities of copper in concentrates sold.

• Income before finance items and taxes in Q2 2021 were reported at USD 138.8 million, against USD 34.8 million in the previous corresponding period. The company witnessed higher operating expenses at USD 73.2 million V/s USD 49.8 million in pcp, other expenses also increased to USD 14.6 million V/s USD 1.4 million in pcp.

• Income from operations before taxes increased to USD 137.8 million compared to USD 36.5 million in Q1 2020. The group witnessed slightly higher finance cost.

• Thanks to robust revenues and gross profit in the reported period the company clocked net income of USD 118.7 million, against USD 72.3 million in the previous corresponding period. Partially offset by Income tax of USD 19.0 million.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which forms around 76.94% of the total shareholding. Rio Tinto PLC and Pentwater Capital Management LP hold the company's maximum interests at 50.79% and 9.48%, respectively. The company's institutional ownership stood at 36.97%, and ownership of the strategic entities stood at 50.81%.

Source: Refinitiv 

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

*1USD=1.27CAD

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

Despite the impact of significant COVID related challenges experienced during the quarter, which included a series of lockdowns and staffing constraints, the company reported another strong performance with production of 36,735 tonnes of copper and 113,054 ounces of gold, generating revenue of USD 317.8 million, a 14 percent increase over the same quarter last year. Furthermore, the group continue to access the higher copper and gold grades from Phase 4B for the remainder of the year and is maintaining the production projection of 150,000–180,000 tonnes of copper and 400,000–480,000 ounces of gold for the second half of 2021, which is significant plus.

The recent rally in the commodity prices is moving well for the company. We believe that the company is well placed to capitalize on the increasing costs of the underlying commodity and exit FY2021 on strong financial health. We predict copper prices to stay constant in the coming months since most governments worldwide have relaxed shutdown restrictions, resulting in more industrial activity resumption.

Moreover, Turquoise Hill Resources Ltd. is expected to achieve healthy revenue growth over the medium term on the back of higher commodity prices and improving business risk profile, higher gold production, and higher gold realization prices. In addition, the management's solid determination helped them leap the industry median margins on many fronts in Q2 2021, which exhibits the competitive advantage of the company within the industry.

Therefore, based on the above rationale and valuation, we recommend a "Buy" rating on the stock at the closing price of CAD 18.73 as on September 30, 2021. In addition, we have considered Endeavour Mining Corp, First Quantum Minerals Ltd, Lundin Mining Corp, etc., as a peer group for the comparison. 

*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:

One-Year Technical Price Chart (as on September 30, 2021) Source: REFINITIV, Analysis by Kalkine Group

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

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