Australia | Feb 23 2007
By Greg Peel
Mineral sands miner Iluka Resources (ILU) has always promised so much. With new management in place, it should have been a case of waiting for the turnaround and a re-rating on longer term value. When the analysts at Smith Barney Citigroup upgraded their recommendation from Hold to Buy at the beginning of the month, they suggested Iluka had “blue sky” target potential up to $12.00 (yesterday’s close $6.49).
But how long can an analyst maintain enthusiasm? Yesterday Iluka disappointed all and sundry when a 2006 profit result that was generally in line with consensus was accompanied by a guidance downgrade for 2007 that was very substantially below. Where is this turnaround? Certainly not on the horizon.
Prior to the result, Iluka boasted a 5/4/1 B/H/S ratio in the FNArena database. After yesterday, that ratio has crashed to 3/4/3, affected by three downgrades of which one – Deutsche Bank – was all the way from Buy to Sell in one fell swoop.
There now remain only three brokers hanging on to the value story – tenuously. This month’s upgrader Citigroup suggests there is “enough attraction in the discount to our NPV of $8.10 to keep our Buy recommendation”.
Merrill Lynch is hanging in there with a “very tired Buy”, despite admitting “there are no near term upside triggers”. Merrills has focused on Eucla capex being down, Murray Basin start-up risks being diminished, water problems beings sorted and new management that “appears to be doing good things”.
Credit Suisse is keeping its Outperform rating as it is hoping management’s disastrous 2007 guidance – 30% below the market – is simply a ploy. As the new team has only just come together the new strategy will take at least six months to implement, says CS, so let’s look really bad now so we can look much better in six months. But the analysts admit “earnings do look ordinary in the near term”.
So much for the faithful. Hardly a rousing recommendation.
Iluka is suffering from higher costs associated with declining grades, higher input costs along with the rest of the industry, and the depreciation effect of spending a lot of capital against short mine life. It was due to depreciation and interest charges largely that 2007 was downgraded so far, but analysts are even concerned with management’s calculations.
In guiding for 2007 earnings of $90-100m, Iluka assumed an Aussie of US$0.75. So not only was the guidance range a shock to begin with, but analysts soon realised earnings would be even lower still on a more realistic Aussie forecast of around US$0.77-0.78.
Macquarie gave new managing director David Robb a bit of a rap just before sticking the knife in. Said the analysts:
“His focus on return on capital and short-term cashflow management has brought a refreshed rigour to Iluka Resources’ investment process. Robb is clear in his vision – a better business without this necessarily meaning a significantly bigger one.”
And then they downgraded to Neutral, because “Iluka’s risk profile has progressively increased without tangible and consummate rise in expected return”.
If analysts agree on one thing, it’s that David Robb is showing a lot of promise and doing good things. But that’s somewhat academic when, as JP Morgan notes, Iluka has effectively reduced its own NPV with all its write downs. JPM is retaining Neutral, along with UBS. UBS believes the issues facing Iluka will take some time to address, and there will be “substantial downward revisions to earnings” across the market.
ABN Amro suggests that neither the new management team, nor the shareholders, had any idea just how bad things were. Management has now set “more realistic goals for the future”, but it’s a five-year business plan and in the meantime Iluka will be “standing still rather than advancing substantially”. ABN downgraded from Hold to Sell.
Deutsche Bank’s double downgrade was accompanied by slashed earnings forecasts and a general ennui. Said Deutsche: “The upside risks are a much weaker A$ and stronger zircon prices plus the potential to harness the northern Murray Basin development to give much higher returns. However, we believe that in the short term, these are unlikely”.
There is no doubting that despite consensus that Iluka is going nowhere in a hurry, value does still exist somewhere over the horizon. Apart from the potential with the Eucla and Murray Basins, Macquarie, and others, make note of “cutting corporate overheads, potential divestment of the coal business, reworking of the South West model, and exploring for uranium in the Eucla” as potential positives.
Even GSJB Were agrees. Weres was the only broker to hold an Underperform rating going into the result. In the longer term, Weres rates Iluka as Hold. Said the analysts:
“We see no reason to be there in the short term – too many negatives exist in our view. However we have refrained from moving to a L/T Sell as we do see some potential for M&A action and believe the new management team may have some success in turning the company around (although this will not happen overnight).”
The average target price in the FNArena database has fallen from $7.44 to $6.84. This doesn’t seem a lot, given the disappointment, but then (a) Buy recommendations were originally made when the stock was trading at previous lows and (b) like many resource stocks, Iluka’s target range in the database is a very wide $5.35-8.50.
The stock had sold off to $6.35 around lunch today. All you need is just a little patience – perhaps.