The challenges for OZ Minerals

I have been investing in OZ Minerals (OZL) for a long time. From 2004 to 2007 Zinifex was one of my best performing investments, rising from $2 to $20. In 2008, Zinifex merged with Oxiana to form OZ Minerals, which at the time was a copper and zinc miner with multiple mines.

It was not long after the merger that OZ Minerals ran into serious financial difficulty, and most of the existing OZ Minerals mines were sold to China Minmetals.

But one significant asset was not sold to China Minmetals. Prominent Hill is a copper and gold mine located in the Woomera Prohibited Area in South Australia, and the sale was blocked by the then Federal Treasurer on national security grounds.

Since that time Prominent Hill has been the only operating mine for OZ Minerals. It performed well for a number of years and it has now reached the point where production from the open pit is declining, while at the same time costs are rising.

I shorted OZ Minerals in mid-2012 based on my view that the market was underestimating the problems facing OZ Minerals at Prominent Hill, and still hold the short position.

Prominent Hill is still in a difficult situation with OZ Minerals expected to report a loss for the full year to December 2013. Based on my model the company will continue to make a loss in future years unless the copper price increases or the Australian dollar falls. The remaining mine life is only five or six years, unless new nearby deposits can be successfully added to the mine.

On the positive side, OZ Minerals’ net tangible assets per share were $6.87 at June 30, 2013, which is significantly above the current share price of $3.67. These assets were written down by $331 million ($1.09 per share) in the half year to June 2013. Included in the $6.87 of net tangible assets is $1.43 of cash, $0.55 of listed investments, and $0.87 for the Carrapateena exploration project (based on the $US250 million purchase price in 2011). The remaining $4 of net tangible assets per share relates primarily to the loss making Prominent Hill mine.

In my view investors focus more on profitability than net assets. I have seen numerous examples of large write-downs impacting the book value of listed companies, including by OZ Minerals itself as mentioned above. On this basis OZ Minerals is not a popular investment at the moment, and the shares have been in a strong downtrend for three years. It appeared that the shares had found some support at $4, but a poor quarterly report recently along with another downgrade in production guidance at Prominent Hill saw the shares fall below $4.

OZ Minerals faces significant challenges in the years ahead, potentially facing continuing losses in the short to medium term. The challenge will be for the company to rectify the profit and loss situation, without overspending on acquisitions and impacting on the net asset value.

(We reported in Collected Wisdom on October 16, 2013 OZ Minerals as a neutral).

Chris Garrard is Investment Manager at Cadence Asset Management.