Sandfire’s water woes

While investors should keep an eye out for further developments, Sandfire is well equipped to handle this operational setback.

Water is always a problem for mining companies. Either they haven’t got enough when working in a dry environment, or they have too much, because when you dig a hole it becomes a natural drainage point.

Both problems, too little and too much, can be fixed either by importing water from nearby aquifers, rivers or dams, or by installing de-watering pumps to remove an excess.

Sandfire’s problem is too much and that’s why it has called for extra pumping equipment and scaled back mining operations to deal with the issue.

In response to market speculation, the copper miner announced to the market last week (November 20, 2014) that increased water flows have occurred at its underground drill holes at its conductor 4 and 5 decline.

Development at the decline has been suspended until around the end of the December quarter and the mining activities at the conductor 1 deposit, situated closer to the surface, have been put on hold until early next month as a “precautionary measure” while Sandfire seals the drill holes and increases its pumping capacity.

The market has reacted poorly. The market speculation and update sent Sandfire shares down 9.3% to $4.85 last week – their lowest levels in four and a half years. However, they have since rebounded on Monday to $5.03.

The real question of the water problem is one for management and why the company’s technical teams were not aware of the underground aquifer which appears to have caused the flooding, because evidence of water-soaked rocks should have been revealed during exploration drilling.

While this update highlights the risk of investing in a company with one operating mine, nothing has fundamentally changed for the company at this stage and our investment thesis (see Sandfire’s time to shine remains intact.

Importantly, Sandfire said that it doesn’t expect to change production guidance for between 65,000 and 70,000 tonnes of contained copper. Mining may have stopped for the next 10 or so days, but the company’s concentrator is still processing run-of-mine (ROM) stockpiles.

Further, the conductor 4 and 5 deposits aren’t expected to contribute to production until 2015-16. The development of these deposits is important as multiple ore bodies provide stability and consistency of production, however, they won’t meaningfully add to the ore feed until later in the mine’s life.

We maintain our “buy” recommendation with a price target of $6.27 on the stock. Sandfire is well equipped to handle operational setbacks – which are common with any mining company – having little (and decreasing) debt and sizeable, increasing free cash flows.

Investors should keep an eye out for further developments, as Sandfire is likely to update the market on whether the more intensive water management program is proceeding to schedule.