Via SeekingAlpha.com

Thesis

In a previous article, I discussed how declining copper prices could pose a threat to the near-term outlook of Turquoise Hill Resources (TRQ). The prevailing uncertainty amid the pandemic-triggered lock downs also elevated the troubles. However, with easing lockdowns and recovering oil prices, copper’s price outlook has witnessed a turnaround particularly due to the gradual reopening of the Chinese economy. This is good news for TRQ, whose share prices have been depressed for long and whose copper and gold concentrates are shipped to Chinese smelters.

More importantly, the GoM (read: Government of Mongolia) has recently revealed its plan to construct and self-fund the 450 Megawatt TTPP (read: Tavan Tolgoi Power Plant) instead of RIO Tinto (RIO). This reduces the total underground project development CAPEX by $924 BB, and brightens Oyu Tolgoi’s outlook. In this article, we will discuss the implications of these two positive catalysts on TRQ.

Figure-1 (Source: Energy Central)

Spotlight on copper prices

Copper prices are staging a slow but steady recovery (Figure-2) after having tanked from over $2.8/lb (toward the beginning of FY 2020). At the time of writing, the industrial metal’s prices have already climbed by more than 25% from their mid-March lows; and post-lockdown, step-by-step resumption of economic activity in China (the biggest consumer of copper) is helping stabilize copper prices.

Figure-2 (Source: Finviz)

China’s GDP dropped by 6.8% during Q1 2020 but the country has managed to emerge from the economic ramifications of the pandemic. This is quite relevant for TRQ since all concentrate produced at its OT mine is shipped to Chinese smelters. TRQ’s Q1 2020 revenues of $130.7 MM saw a whopping 63% YoY decline owing to significantly lower copper and gold production (~23% and 78%, respectively), YoY. However, since FY 2020 copper production is expected to ramp up from last year, improving copper prices would reflect positively on the company’s revenues. Gold prices are already trading near their 12-month highs (at ~$1,735/oz at the time of writing), and therefore we can expect TRQ’s share price to continue to get support from metal prices. However, for TRQ to fully benefit from this bullish momentum in metal prices, it’s imperative that the trajectory in copper should continue even if at a slow pace. Any reversal in copper prices could hurt those gains recently posted by the stock.

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The TRQ story takes another twist

Another, more interesting, and more significant twist to the TRQ story comes from the GoM’s recently announced plan to provide and construct a reliable power source for the OT mine. Before we analyze this new development in detail, let’s have a quick look at the bare facts of this issue:

  1. In February 2020, TRQ submitted feasibility study to construct the TTPP with a rated capacity of 300 MW. Back in 2018, TRQ had announced that an amount of ~$250 MM will be set aside during FY 2019 and 2020 each, for construction of the power plant.
  2. In April 2020, the Mongolian Cabinet (on behalf of the GoM) decided to construct the power plant and to arrange the project funding itself rather than relying on foreign direct investment to develop the power source. The government’s decision also included increasing the PP’s rated capacity from 300 MW to 450 MW with a planned CAPEX investment between $560-600 MM. The cabinet’s decision also termed RIO’s dedicated power plant CAPEX estimate of $924 MM as being excessively costly.
  3. In May 2020, GoM notified RIO of its final decision to develop the state-owned coal-fired power plant at Tavan Tolgoi. Whatever the confusions (if any) regarding acceptance of this proposal by RIO, the same have largely been eliminated with this latest update. The positive thing is, RIO has welcomed the proposal and stated that the TTPP project advancement was subject to certain important considerations including commercial terms of power supply, development process, proposed sources of financing and expected timing of completion.

Interpretation

Now let’s briefly discuss the key takeaways from this update on the horizon of OT mine’s underground development. First, TRQ will save an estimated $250 MM in annual development costs, and the company’s liquidity profile is put out of harm’s way with this proposal from GoM. Moreover, there’s an aggregate saving of ~$1 BB in TRQ’s planned project CAPEX.

[Author’s Note: Prior to this proposal, TRQ stated that it had sufficient liquidity to meet its liquidity needs until Q2 2021. With additional $250 MM in CAPEX savings, I expect enough liquidity to be available to meet needs until at least the end of FY 2021.]

Second, the reduced CAPEX adds more certainty to project development since the main concern for TRQ had been the painful fact that OT underground development was lagging behind schedule (by approx. 16-30 months) and was expected to cost another ~$4.5 BB to finish completion. The Definitive Estimate of project CAPEX would shed more light on the expected project completion cost. Nevertheless, I believe that GoM’s proposal to take responsibility of constructing the TTPP would reduce some of the pressure on those project development timelines, announced earlier.

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Third, the proposal shows that GoM is eager to get the OT underground development up and running. Mongolia’s Energy Minister informed while addressing the press (after the Cabinet meeting relating to TTPP development )[emphasis added],

The government is responsible for funding the TTPP project, which will be made available from every possible financial source, including foreign loans.

The GoM expects to complete TTPP between 2020-24 and to recover its investment over the next 5 years. There’s a risk that if GoM fails to gather adequate funds for TTPP, the power plant development could be delayed. The GoM’s proposal highlights that cost of power production at TTPP would be 50% cheaper to RIO’s proposed investment. However, there’s a mild risk that GoM’s power tariff might be a bit on the higher side (to serve their aim of recovering the project’s initial outlay over the first 5 years of operations). Nevertheless, it would need to be more economical than the existing power tariff, or OT LLC could seek other power supply options including purchasing from the existing suppliers. Of course, this whole situation will remain subject to the terms and conditions of power supply, negotiated between GoM and OT LLC, and would certainly go a long way to improve administrative relationship between the two stakeholders.

Investor Takeaway

GoM’s proposal to build the TTPP has removed one layer of uncertainty over the timely completion of the OT underground project. The Mongolian Government has shifted responsibility for construction/ development of the TTPP from Oyu Tolgoi LLC to GoM, and seems determined to complete the project within the next 3-4 years. This has triggered modest gains in TRQ’s share price (~30% upside during the past 30-days). Luckily for TRQ, copper and gold prices are edging higher. The stock is a rising bet on copper, and chances are; copper would stretch its upward trajectory to $2.8/lb ($3/lb is less likely, in my view) amid recovery in Chinese demand and the gradual restoration of global economic activities. TRQ’s technical chart (Figure-3) reveals that the share is now trading at the 6-month support after the most recent selloff, and the current price provides an entry point for suitable near-term gains within the target price range of ~$0.90-1.00.

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Figure-3 (Source: Finviz)

However, the Definitive Estimate is expected to be out soon (scheduled for release during H2 2020), and will account for the reduction in project CAPEX arising from the GoM’s proposal to build the TTPP. Once we have the Definitive Estimate, we can analyze the market’s reaction to the catalyst. So far we have seen that the market has welcomed GoM’s final decision of taking responsibility for construction of the power plant through self-funding, and the Definitive Estimate of project CAPEX would help set the share price direction in the medium term.

The GoM is determined to see completion of the OT underground mine together with all related projects (including TTPP); and while copper prices are recovering, we need to see more sincerity from RIO to expedite project development and protect the minority shareholders’ interest. This could significantly alleviate the negativity and uncertainty revolving around an otherwise promising long investment in the copper and gold mining space.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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