Australia | Oct 20 2016
Western Areas has worked hard to maintain profitability in the face of sluggish nickel prices. The recent rally in nickel has brokers assessing the outlook for the miner.
-Tight control on costs acknowledged but a bearish outlook for nickel prices may provide only modest earnings support
-Conversely, Credit Suisse believes the nickel price outlook is improving amid stainless steel and ore restrictions
-Brokers agree Philippines and Indonesian supply remain the key drivers of the nickel price going forward
By Eva Brocklehurst
Brokers acknowledge Western Areas ((WSA)) has worked hard to maintain its profitability after a long period of sluggish nickel prices and, with the recent rally in prices on the back of the Philippines policy announcements, wonder just what lies in store for the producer. The company advised back in August that mine grades for both Flying Fox and Spotted Quoll (Forrestania) would trend lower to reserve higher grade material pending price improvement and this was evident in the September quarter production numbers.
Head grades fell 9% quarter on quarter, to 4.1%, and this may have been flagged but the decline was more than Ord Minnett expected. The broker is bearish about the outlook for nickel prices and expects this will result in only modest earnings and cash-flow support over the next three years, despite the company being well positioned on the cost curve. In the absence of other material levers for valuation Ord Minnett retains a Lighten rating.
Credit Suisse, on the other hand, observes the company's focus on cash is paying off. Cash at the end of September was $81m versus $76m at the end of June. The realised nickel price was $6.54/lb, up 20% on the June quarter. Credit Suisse is of the view the nickel price outlook is improving amid stainless steel and ore supply restrictions and sticks with its Outperform rating.
China's nickel shortfall is expected to be over 500,000t in 2016 and over 600,000t in 2017. The broker now assumes no dividend is paid in FY17 and forecasts a cash balance at the end of that year of $102m.
Balance sheet concerns may have been alleviated but UBS retains a Sell rating as its forecasts already include a lift in nickel prices to US$5.50/lb in 2017 and US$6.25/lb in 2018, which compares with spot prices of US$4.70/lb. Recent policy changes in the Philippines are supporting the nickel price and should the focus on environmental protection lead to significant mine closures, the price could rise further and take Western Areas along for the ride. All brokers acknowledge the ore production outlook in the Philippines is the wild card.
In Citi's view the company has done everything possible to maintain profitability by increasing tonnage and cutting development capex at the Forrestania mines. Sustaining capex is expected to lift in FY18 to $38m before reducing to $27m per annum in FY19. The two offtake agreements at Jinchuan and Nickel West expire in early 2017 and both are being tendered this quarter. The company advises these tenders are an opportunity to test the market and the demand for its premium blending concentrate. This has a desirable iron to magnesium ratio which could mean higher nickel pay.
Macquarie agrees that a change in the current structure and rates for the offtake agreements could present a major positive catalyst for the stock. Production volumes were better than the broker expected but free cash flow was weaker, largely because nickel-in-concentrate sales volumes were 11% lower than forecast and terms for payment for sales to Nickel West were longer. The beat on production numbers reflected higher mining rates at Spotted Quoll.
C1 cash costs averaged $2.53/lb in the quarter, around 4% above what the broker anticipated. The company released an updated resource estimate for the New Morning deposit, with the bulk of the upgrade coming from near-surface material. This suggests to Macquarie an open pit development is possible in the medium term.
Nickel demand has improved this year on the back of good Chinese data and Deutsche Bank envisages the momentum will continue into 2017. Still, nickel inventories remain high and the lift in the price in June/July could mean loss-making producers hoping for higher prices stay in the market longer. The broker agrees Philippines and Indonesian supply remain the key drivers of price.
It remains unclear whether the Indonesian government will allow the export of laterite ore by companies constructing downstream operations. Meanwhile, the Philippines government has offered miners a chance to respond to recent suspension notices, which suggests some may be able to continue mining if acceptable plans are presented to fix environmental infringements.
While it is clear to Deutsche Bank the stock has leverage to the nickel price, Western Areas is estimated to be currently pricing in a flat $9.50/lb price, well ahead of the $6.10/lb spot price. Hence, the broker retains a Sell rating.
FNArena's database shows two Buy, one Hold and four Sell ratings. The consensus target is $2.38, suggesting 10.9% downside to the last share price. Targets range from $1.83 (Citi) to $3.00 (Credit Suisse).
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