Source: Stock Photo
Turquoise Hill (NYSE:TRQ) exceeded expectations in the last quarter, and I believe it's going to continue to do well in 2017 and onward.
On the production side of the business, 2017 isn't going to generate the type of results the company enjoyed in 2016, when it exceeded copper guidance for the year with a total of 200,000 tons, and gold guidance with its final result of 300,000 ounces.
The good short-term news is the company continues to remove costs out of the overall process, setting itself up for a more profitable future as it gradually moves closer to becoming fully operational with its underground portion of the mine over the next several years.
In the short term, meaning the next year or so, low grades will continue to weigh on the performance of the company, the degree of which will be determined by the price of copper and gold. Also a factor will be whether it comes in at the low or high end of production guidance.
How the next year looks
As mentioned above, production guidance for 2017 is far below the 200,000 tons of copper produced last year, and the 300,000 ounces of gold produced in 2016, due to lower ore grades.
In 2017, annual production guidance is for copper in a range of 130,000 to 160,000 tons and gold 100,000 to 140,000 ounces.
The company said in the fourth quarter it stockpiled ore from Phases 1 and 2 in order to "balance" Phase 6 ore. Ore from Phase 6 has to be blended in order to meet shipping specifications. The blending is the result of having some arsenic. So while Phase 6 is its high grade ore at this time, it is limited by the blending process.
Concerning the stockpiles from Phase 1 and 2, the company said investors should think of the lower grade ore as adding about 12,000 tons per month of copper and about 10,000 ounces of gold on average. Again, where production lands for the year will determine the performance of the company.
Last year, total operating cash cost at its flagship Oyu Tolgoi came in at $775 million under guidance. This was driven primarily by lowering costs and increasing production efficiencies. Specifically, it was the result of improved terms of contracts, lower costs of input and "slower use of consumable."
For 2017, the company maintains an operating cash costs outlook of about $720 million.
Improvement in costs and higher-than-expected copper and gold prices should bring positive operating cash flow for full year 2017. As for cash flow, the outlook at best is to be cash neutral.
Long term outlook
About 80 percent of the value of Oyu Tolgoi is locked up in its underground, and that is of course what Turquoise Hill is working on developing over the next eight years.
Through 2025, copper production at the mine is projected to increase by over 320 percent, and gold by over 450 percent. This is a major reason I've been so bullish on the company, beyond its overall resource, which has yet to be fully determined.
If the company is able to continue to improve efficiencies, it has the potential to outperform this year, taking into account the potential to reach the high end of its production guidance.
Further out, lower costs will help the company to widen margins and accelerate profits, assuming some of the extra capital is used to pay down debt and improve the balance sheet of the company.
The trigger point for the share price
What remains to be seen for Turquoise Hill isn't whether or not it's going to enjoy a big spike in its share price over time, it's a matter of when. Investors aren't currently pricing in its long-term potential of the company, but once they do, it's going to move up quickly and steeply.
The question now is how much and for how long investors want to take a position in the company. If they wait too long, they'll miss out on a lot of the upside benefit, and if they get in too early, they have to maintain discipline as they wait for the stock to finally pay off.
Personally, I've been adding to my position off and on over the last three years, lowering my cost basis while boosting the number of shares I own. Eventually, I'll cap it at a certain share level and wait for the stock to soar - which it will.
Based upon commodity price support, I think the share price has a lot of short-term upside potential, but much of upward move will start to happen as the underground portion of the mine starts to produce and the bulk of expenditure winds down. That means in about three years or so the price will surely rise. It's only a matter of when investors start to get nervous about missing out on the move. It'll also be determined by copper and gold market conditions. If the price of both retain support and climb, Turquoise Hill could become a growth stock before the underground portion of the mine is completed.
One other potential trigger is the potential for the company to be acquired. I'm not thinking so much about the rumors there, but for Rio Tinto (NYSE:RIO) itself to buy up the rest of the Turquoise. I've said for some time it wouldn't make a lot of sense for Rio to hold back on getting full benefit of the upcoming production of the company.
Rio faces a similar situation investors do if it has any desire to take full possession of Turquoise. If it waits too long, it'll have to pay a much steeper price as its value increases. I for one, really don't want to see Turquoise taken over. But I have to consider the fact it's going to become very attractive going forward.
Conclusion
It's been a nice surprise to see Turquoise Hill exceed cost expectations, and with the strong probability that copper and gold prices will continue to find support in 2017, it could easily reach the high end of its production levels, which means revenue and earnings could exceed expectations.
That said, it still has to be taken into consideration the company will face low grade conditions this year. The result will be the predictable decline in performance. Why I like that is it sets the company up for a surprise, which I think is coming on the price side of commodities.
Within three years, Turquoise should start producing at its underground portion of the mine, and by 2025, it should be generating a lot of cash flow for company shareholders.
I'm a long-term investor in Turquoise Hill, so I don't worry about timing or short-term challenges. Even so, investors interested in the company need to consider the trigger point where the share price will start to move in a way it'll never return to past levels. That's why I invest over time, rather than thinking in terms of taking a one-time position.
Patient investors are going to enjoy solid returns from Turquoise Hill.