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 Rationale

• Robust Q1 2021 performance: The company reported decent performance in Q1 2021, with revenue surged by ~303% to USD 526.5 million, against USD 130.6 million in the previous corresponding period. Gross profit elevated to USD 370.9 million, against a loss of USD 15.2 million in pcp and net profit rose by ~1,657% to USD 332.1 compared to the previous corresponding period.

• Improving operating matrix: Despite the turmoiled period in 2020, the Company maintained its pace and witnessed a spirited performance in its margin profile. We believe the momentum to continue in the foreseeable future, as the Company had big capital investment plans to support future growth. Higher average realized prices of the commodities also played a crucial role in achieving healthy revenues and margin.

• Strong production figures in Q1 2021: When compared to Q1 2020, copper output jumped 28.6%, while gold production jumped 461.5%. The rise in output of both commodities was mostly due to the planned transition to the higher-grade gold regions of Phase 4B. On the back of strong production, the company clocked a revenue of USD 526.5 million in Q1 2021, which increased by 302.8% against USD 130.7 million in the previous corresponding period.
  

Source: Company

• Industry beating margins: The management’s solid determination helped the group in leaping the industry median margins on many fronts in Q1 2021, which exhibits the competitive advantage of the company within the industry. The chart below gives a glimpse of this. 

• Improving cash flow from operating activities: On the back of higher quantity sold and higher average realization prices of the commodities, the company generated USD 248.2 million of cash flow from the operation in Q1 2021, increased by 246.8 million, against USD 1.5 million in the previous corresponding period. Notable the increase was on behalf of healthy production and elevated metal realization prices.
  

• Elevated commodity prices to support future earnings: The recent rally in the commodity prices (Copper and Gold) is moving well for the company, and we can see a significant improvement in the company’s financial performance. As the commodity 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 would exit FY2021 with strong financial health.
  

• Decent operational outlook for 2021: The company’s mine “Oyu Tolgoi” is 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 into the higher-grade sections of Phase 4B would result in an increase in the 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.
  

• Stock is trading in a bullish rising channel: On the weekly price chart, TRQ prices are moving in a rising channel formation for the past few months. At present, the prices are sustaining above the lower band of the pattern. The stock prices are forming a series of higher tops and higher bottoms, which indicates bulls are still in action. Moreover, the price is trading above its 21-period simple moving average, which may act as a crucial support zone in the short term. Furthermore, the momentum oscillator RSI (14-day) is trading at ~54.79 levels, supporting the bullish bias in the stock.

Technical price chart, Analysis by Kalkine Group

• Risks associated with investment: The company's business is significantly exposed to volatility in gold and copper prices. Further, the company is exposed to the 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

• In Q1 2021, the company generate revenue of USD 526.5 million, which increased 302.8% against USD 130.7 million in the previous corresponding period. The increase in revenue was primarily due to higher revenues from copper and gold.
• The increase in copper revenue was driven by a 51.6% increase in the average price of copper and a 29.0% increase in copper production. Gold revenue benefitted from a 13.7% increase in the average price of gold and a 461.5% increase in gold production, reflecting the scheduled move to the higher-grade gold areas of Phase 4B.
• The cost of sales in the reported period stood at USD 155.6 million, an increase of 6.6% against USD 145.9 million in the previous corresponding period. The cost of sales increased mainly due to higher volumes of concentrates sold and increased depreciation driven by the significant increase in production in Q1 2021 compared to Q1 2020.
• On the back of robust growth in consolidated revenue, the group’s gross profit enhanced to USD 370.9 million in Q1 2021, against a gross loss of USD 15.2 million in the previous corresponding period.
• In Q1 2021, total operating cash costs stood at USD 201.2 million, an increase of 7.0% compared to USD 188.1 million in the previous corresponding period. Principally it increased due to higher royalty costs driven by higher sales revenue as well as additional COVID-19 related costs in response to positive COVID-19 cases that arose in Q1 2021. These increases were partly offset by lower power study costs.
• The unit cost of sales of USD 1.81 per pound of copper sold in Q1 2021 decreased 29.6% from USD 2.57 per pound of copper sold in Q1 2020, reflecting a 51.2% increase in the volumes of copper in concentrates sold during the reported period.
• Income before finance items and taxes in Q1 2021 was reported at USD 288.1 million against a loss of USD 61.6 million in the previous corresponding period. The company witnessed higher operating expenses at USD 56.4 million V/s USD 44.9 million in pcp, and corporate admin expenses also increased to USD 13.0 million V/s USD 4.7 million in pcp.
• Income from operations before taxes increased to USD 287.8 million compared to negative income of USD 52.0 million in Q1 2020. The group witnessed a slight decrease in its finance cost at USD 1.6 million V/s USD 1.8 million.
• Thanks to robust revenues and gross profit in the reported period, the company clocked net income of USD 332.1 million, against USD 18.9 million in the previous corresponding period.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which forms around 76.42% of the total shareholding. Rio Tinto PLC and Pentwater Capital Management LP hold the company's maximum interests at 50.79% and 9.27%, respectively. The company's institutional ownership stood at 37.17%, and ownership of the strategic entities stood at 50.81%.

Valuation Methodology (Illustrative): EV to Sales 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 company had a solid start to the year with substantial first-quarter numbers and a production of 45,449 tonnes of copper and 145,656 ounces of gold. Strong operational performance combined with rising copper and gold prices generated revenue of USD 526.5 million, a 303% increase over the same quarter last year.

On a consolidated basis, the company may witness higher gold production compared to FY2020 in FY 2021. The recent rally in the commodity prices is moving well for the company, and we believe that the company is well placed to capitalize on the increasing costs of the underlying commodity and exit FY2021 on a strong note. Copper prices are likely to remain elevated in the coming months since most governments worldwide have relaxed shutdown restrictions, resulting in more industrial activity resumption.

The company ships its concentrates to China, which were halted due to the covid pandemic conditions. Recently, it stated that the concentrate shipments to Chinese customers have recommenced and have begun to ramp up from April 15, 2021, which is a key positive.

The group 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.

Therefore, based on the above rationale and valuation, we recommend a "Buy" rating on the stock at the closing price of CAD 20.90 as of June 03, 2021. We have considered Endeavour Mining Corp, First Quantum Minerals Ltd, Lundin Mining Corp, etc., as a peer group for the comparison.

One-Year Technical Price Chart (as on June 03, 2021). Analysis by Kalkine Group

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

*Recommendation is valid at June 4, 2021 price as well.

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Disclaimer

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