Rio Tinto could be ready for a Turquoise Hill takeover, analysts say

VANCOUVER — It’s not a secret that many in the mining community are pretty bullish on copper’s long-term prospects. There’s some disagreement over the timeline for recovery, but typical analyst models assume a supply deficit for the red metal within the next decade. Copper supply stocks at the London Metal Exchange (LME) hit a two-year low in late March, while China continues to buy up material quantities of the metal for its warehouse stocks in Shanghai.

A second not-so-well-kept secret is that mega miner Rio Tinto (NYSE: RIO; LON: RIO) is on the look-out for long-life copper assets to add to its production portfolio. Rio added a little fuel to the fires of speculation on March 17, when it announced CEO Sam Walsh would be retiring and that copper and coal chief Jean-Sébastien Jacques would be stepping up to lead the company. Interestingly, Rio has a history of appointing chief executives from its high-priority segments. Walsh took the job in 2013, after running the company’s iron ore and aluminum businesses.

In addition, Jacques earned the top job at Rio largely due to his success in navigating the sociopolitical quandary in Mongolia, where Rio runs the Oyu Tolgoi copper mine through its 51% interest in Turquoise Hill Resources (TSX: TRQ; NYSE: TRQ). The companies made big strides in 2015, via a landmark, US$4.4 billion finance and development agreement that resolves outstanding issues with the Mongolian government and sets the stage for a large-scale underground expansion at the mine.

Oyu Tolgoi open-pit operation. Credit: Oyu Tolgoi LLC.

“In terms of the history of Turquoise Hill, I think 2015 will be seen as one of the most pivotal years for [us],” elaborated CEO Jeff Tygesen on a March 18 conference call. “I’m proud of what we achieved and I believe we are well positioned to restart underground development mid-2016. In my opinion it’s the best copper opportunity in development today, and 80% of Oyu Tolgoi’s value resides in our underground reserves.”

Turquoise Hill reported production results for the year totaling 202,000 tonnes copper, 653,000 oz. gold and 1.2 million oz. silver. The company generated approximately US$477 million in free cash flow and increased its cash balance to US$1.34 billion. Oyu Tolgoi reported 2015 all-in sustaining costs of US$1.37 per lb. copper

So it seems obvious that taking out Turquoise Hill — and by extension grabbing the remaining stake in Oyu Tolgoi — would be a pretty enticing situation for Rio. The project is essentially already in-house and now that the political situation has been de-risked it looks like one of the better long-life copper assets in the world.

Scotiabank analyst Orest Wowkodaw pegs Turquoise Hill’s net asset value (NAV) at around US$7.8 billion, assuming a 10% discount rate. Scotiabank notes that Rio owning Oyu Tolgoi would be “the obvious natural fit,” and that the “key prize” is the underground, which it calls “one of the best copper assets in the world.”

Meanwhile, Canaccord Genuity adds that the management change at Rio could lead to “increased appetite for opportunistic acquisitions.” Canaccord also notes a recent revision in a metal purchase agreement between Sandstorm Gold (TSX: SSL; NYSE-MKT: SAND) and junior Entrée Gold (TSX: ETG; NYSE-MKT: EGI) involving the Hugo North Extension and Heruga expansion opportunities at Oyu Tolgoi.

Oyu Tolgoi Location Map. Credit: Turquoise Hill Resources.

Former Rio executive Stephen Scott was appointed as the interim CEO of Entrée in late 2015, and Canaccord speculates that “sorting out of the Sandstorm agreement would have been a high priority, as it would be a prerequisite for development.” The thesis is basically that the agreement revision could be setting the stage for the consolidation of Turquoise Hill.

Canaccord went one step further in a March 17 note from its trading desk when it speculated that Rio might also have interest in Reservoir Minerals‘ (TSXV: RMC) Timok copper properties in Serbia.

The project is currently under joint venture with Freeport-McMoRan (NYSE: FCX), but Lundin Mining (TSX: LUN; US-OTC: LUNMF) is attempting to buy the rights to develop a high-grade mine at Timok’s Upper zone. Reservoir maintains a right of first offer, however, and Rio could disrupt the Lundin bid through an agreement with the project generator.

Rio has traded within a 52-week window of US$21.89 and US$47.37, and closed at US$29.13 per share at the time of writing. The major maintains 1.37 billion shares outstanding for a $99.53 billion press-time market capitalization.