Tiger approaches dividend crossroad

The junior copper miner will generate strong cash flows from this year, but pressure to declare a dividend is building.

UPDATE: Tiger Resources (TGS) announced a capital raising the day after the article below was published. The capital injection has lowered my price target to 50 cents from 60 cents a share, but my "buy" recommendation remains. You can see an updated analysis here.

Tiger Resources (TGS) may have bucked the downtrend afflicting the junior resource sector, with the stock doubling in price since I first urged investors to buy the stock in July last year. But Tiger Resources could get a second wind later this year or next.

This will be triggered by a second re-rating of the stock (where the market is willing to pay more for a stock as risks subside) when Tiger Resources undergoes the next transition from being a copper producer to a dividend producer.

The transformation will be significant, because it is rare for junior miners to deliver both earnings growth and dividends. What’s more, the dividend milestone could happen sooner than you think and the potential yield would make bank and Telstra investors green with envy.

The market hasn’t caught on to this catalyst as yet, and the stock’s strong performance reflects Tiger Resources’ initial re-rating when it moved from being an explorer to a profitable producer.

Investors are so far reluctant to count their dividend chickens before they’re hatched. This healthy dose of scepticism is understandable, with the uncertain outlook for the Chinese economy and metal prices.

The junior resource sector has been outperforming recently, but there are still more sceptics than believers out there given the general lack of development capital available to bring new mining projects to life.

The risks of investing in the sector are further heightened, because valuing a junior miner typically requires you to make more assumptions than a small industrial company. And that means calculating a target price is far more of an art than a science.

While I would normally be reluctant to cover the sector for these reasons, it is difficult to ignore Tiger Resources because it does stand out from the pack. As I wrote nearly a year ago, the fledgling miner is well placed to become one of the world’s lowest-cost large-scale copper producers.

Tiger Resources is well on the way to achieving this goal, under the stewardship of managing director Bradley Marwood, who spent 20 years developing and operating mines in Africa, and used to manage projects for Normandy Mining.

Based on my earnings estimates, Tiger Resources has the financial muscle to pay a dividend when it releases its full-year results in February next year, even as capital expenditure for the expansion of its solvent-extraction & electro-winning (SXEW) plant ramps up to more than $US200 million from 2014 to 2016.

In spite of this and its debt repayments, Tiger Resources can support a 20% profit payout for 2014 (its financial year ends in December), which would equate to a 0.6 cent a share dividend. Naturally, this assumes it doesn’t undertake any corporate activity or unexpected expansion programs.

That works out to be a pretty modest yield, but the cash generation from the SXEW plant can quite easily fund a material and steady increase in dividends in the following years, and by 2016 the stock could be delivering a yield of close to 10% if things go according to plan.

The question is whether management will feel brave enough to declare a dividend. Tiger indicated its willingness to pay a dividend in February this year if it can be confident about sustaining the payout for at least five years. On the other hand, it will also consider paying a one-off special dividend.

Many observers believe that management will err on the side of caution and wait until 2016 or beyond to declare a distribution, because that is when capital expenditure drops significantly and operating cash flow accelerates. But paying a dividend earlier, even a very modest one, can go a long way to support the stock and build shareholder value.

I suspect management will feel pressure from shareholders to pay a dividend before 2016 if the SXEW plant performs to expectations, and I am forecasting a first dividend in 2015 of 1.74 cents, which equates to a yield that’s a touch under 5%.

Regardless of when dividends kick in, Tiger Resources is a well-priced stock that’s ideal for most portfolios with a medium- to long-term investment horizon.

The SXEW plant started commercial production two weeks ago, and Tiger Resources’ forecast for the plant at its flagship Kipoi project in the Democratic Republic of Congo (DRC) was upgraded by 41% to 532,000 tonnes of copper cathode at a cash operating cost of $US1.04 a pound earlier this.

The low cost is in part driven by the fact that Tiger Resources doesn’t have to mine for ore to feed its SXEW plant for the next three years. This is because of its large stockpile of ore, which is valued at around $US1 billion at the current copper price.

Moreover, the successful start of the SXEW plant has de-risked the project significantly and there is potential for management to further upgrade Kipoi’s ore reserves from its ongoing exploration program.

Kipoi isn’t the only feather in Tiger Resources’ hat. Management is looking to explore and develop the Lupoto and La Patience projects in the DRC. Tiger owns a 60% equity stake in the Kipoi and 100% of the other two projects.

To be conservative, I have only valued Tiger Resources on the Kipoi project based on management’s current production estimates using a risk weighting of 10%. This gives Tiger Resources a price target of 60 cents a share.

Some might feel that the 10% discount rate is too low given that I usually use 12% to 14% for small cap industrial companies. However, Kipoi stage 2 is fully funded, with a $US50 million debt facility that attracts an interest rate of a little over 4%.

The more relevant question therefore is whether to assign a country risk premium. In general, investors are likely to prefer local mining projects if the project economics are similar. But I think an argument could be made either way. Australia may be a developed and more transparent country, but the Australian government has shown a strong propensity to introduce arbitrary taxes. Also, Australian-based miners appear to have greater difficulty with controlling labour costs.

Given that I am not factoring any upside from exploration successes and the potential for better-than-expected production output (management has a track record of under-promising and over-delivering), ignoring country risk is not inappropriate.

I am also ignoring Tiger Resources’ takeover appeal, even though merger and acquisition activity is likely to pick up further this year.

The target price of 60 cents a share is based on the Australian dollar averaging US93 cents for 2014, and US90 cents and US88 cents for the following two years. Copper is forecast to average $US6,500 a tonne this year, $US7,100 per tonne for 2015, and $US6,650 a tonne thereafter. Copper is currently trading at around $US6,670 a tonne.

I am reiterating my “outperform” call on Tiger Resources with a “high risk” rating to reflect the volatile nature of the industry and to account for the geographical area it operates in.

To see Tiger Resources’ forecasts and financial summary, click here.