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Date : 17/02/2023

Deterra Royalties

ASX :

DRR

Market Cap : $2.57 Billion

Dividend Per Share : $0.336

Dividend Yield : 6.10 %

Buy

52 Week Range : $3.91 - $4.99

Share Price : $4.79

The company has a very simple and reliable revenue stream with lucrative dividend payouts, so we recommended a "buy".

Company Analysis

Deterra Royalties (ASX: DRR) is one of the best dividend stocks on the ASX with a very simple and low-cost business model that wisely pays out 100% of its entire profits after tax in dividends, which are always fully franked. The company simply receives a small percentage of revenue generated from a few Australian mining operations as royalties and, therefore, has very low operating costs and risks. DRR’s producing royalty assets are the followings:

Mining Area C (MAC): DRR holds contractual rights over the Mining Area C (MAC) royalty area. The area is currently used by BHP for iron ore production. DRR receives revenue payments via two separate mechanisms from this cornerstone royalty contract:

  1. A 1.232% royalty from the materials produced at MAC, payable quarterly; and
  2. A one-off capacity payment of $1m per million dry metric tonnes (mdmt) for any increase in annual mine production capacity, currently at 105 mdmt.

Production from MAC in 1HY23 was 62.6 million wet metric tonnes, a 27% increase year-over-year. BHP has indicated that the ramp-up to the full production capacity of 145 million wmtpa at the South Flank zone by the end of FY24 remains on schedule. DRR’s royalty revenue in 1HY23 from the area was $96m.

Yalyalup Mineral Sands Mine: DRR holds a 2% royalty on revenue from the sale of minerals by mineral sands producer Doral Mineral Sands Ltd. The recently approved Yalyalup mine commenced production in 2Q22 and has an expected production capacity of 100ktpa of heavy mineral concentrate over a four-year mine life.

Wonnerup North Mineral Sands Mine: DRR holds a $0.7 per tonne royalty on all valuable heavy minerals produced by mineral sands producer Tronox. Mining at Wonnerup North using the existing facilities has now commenced after successfully receiving all environmental and regulatory approvals required for an additional five years. 1HY23 revenue from Wonnerup was $0.03 million.

DRR also owns two non-producing royalty assets, and no significant progress in those projects was made during the period.

DRR’s earnings are entirely tied to iron ore production at its MAC asset

$96m of DRR’s $96.4m revenue in the period was from the revenue from MAC, which was 4% higher than the prior comparable period (PCP). This was driven by a 27% increase in iron ore production volume for the period as the production in the area ramps up, offset by a 19% lower realised sales price. DRR had operating costs of $4.1m and finance costs of $0.05m in the period, giving a net profit after tax of $63.4, an increase of 3% on PCP.

Mining Area C or MAC is a part of BHP’s iron ore operations in Western Australia. The asset life is longer than 30 years and is operated by the largest diversified mining company in the world. The high-grade iron ore that is found there is thus a low-cost asset that has the potential to expand with more debt investment in the future. Deterra does not have to contribute towards the operational or capital costs of the project. The 30+ year mine life at a huge full production capacity of 145 million wmtpa will generate sustainable and long-term free cash flow for Deterra. Mining Area C also covers additional high-prospect zones besides South Flank, which provide further resource extension potential in a low-risk jurisdiction.

Source: Company

Investment thesis

As DRR’s revenue almost entirely comes from its MAC asset, the company’s future earnings will depend on future iron ore prices and iron ore production from the area. BHP expects natural variability in ore grade as the mine progresses through the close-to-surface material. However, it expects this to stabilise as the mine moves deeper into the ore body and achieves full ramp-up, expected by the end of FY24.

Iron ore prices rallied from US$80 per tonne in November 2022 to a seven-month high of US$130 per tonne on 30 January 2023 after China eased its COVID restrictions in November and then dumped its COVID-zero policy altogether in December. So China’s manufacturing is rebounding and the government is stimulating construction activity through liquidity injections and new credit lines for developers, but experts believe the recent rally in iron ore prices is unsustainable. Pundits point to the remaining risk of a property market downturn in China, plus the country’s program to lower emission levels to curb its steel and iron ore consumption. On the supply side, Australia and Brazil, two major iron ore producers, are increasing their production capacity. The result is a bearish outlook for iron ore prices over the next few years. But how much should this worry us about DRR?

DRR’s stock is covered by 10 analysts, and based on their consensus estimate, DRR’s earnings are expected to drop by 11% in FY23, with further two digits declines in the years after that. Using the consensus estimates, and the company’s policy of paying out 100% of its profits, DRR is expected to offer fully franked dividend yields of 6.1%, 5.8%, 4.7% and 4.35% in FY23, FY24, FY25 and FY26, respectively. We think these forward fully franked dividend yields remain lucrative as the expectations are for the interest rate to peak by early 2024 at levels slightly higher than 4%. Besides, these declining earnings expectations limit the downside risk to DRR’s share price and provide upside potential in case the current outlook for iron ore prices proves too bearish.

How to play DRR’s stock?

DRR’s share price has spent most of its time since the stock’s IPO in October 2020 in a range of 4 to 5 dollars (the blue lines on the chart). As such, we see prices below the top of the range at $5.00 as buy opportunities for long-term investors who are looking for attractive dividend yields. We think the ramp-up production of iron ore at MAC, in addition to increasing production from DRR’s other royalty assets, will help to at least partially offset the anticipated decline in iron ore prices, while any stronger than expected iron ore prices would be a catalyst for a share price appreciation, So a “BUY” recommendation from us under $5.

Deterra Royalties, Weekly Chart in Semi-log Scale (Source: Metastock)

 

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