Iluka Raises Rutile Profile, But Will It Pay?

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Mineral sands producer Iluka Resources has raised its profile in global rutile production. Brokers emphasise higher prices are required to make the acquisition pay.

-Benefits to come from improved plant recoveries and a reduction in unit costs
-Expanding Sierra Leone operations would allow more work to be done on the hydrology mining concept
-Growth options within funding capacity but dividend may be suspended
 

By Eva Brocklehurst

Mineral sands producer Iluka Resources ((ILU)) has completed the acquisition of Sierra Rutile, an African-based miner, adding scale and long life to its portfolio.

This is a counter-cyclical investment which provides an additional 140,000tpa of rutile production. Iluka is proposing a number of changes to the operations, which could boost production to over 240,000tpa and lower unit costs to under US$500/t.

Even after factoring in improvements, Deutsche Bank considers the Sierra Rutile deal is value neutral at a long-run rutile price of US$1000/t (current spot US$750). Moreover, the mines require over US$200m in capital expenditure to expand production, and will be negative on free cash flow until 2020.

The broker also notes the mines are relatively low grade, in a remote part of Sierra Leone and 100% reliant on fuel oil as a power source. Deutsche Bank assumes some benefit in improved plant recoveries and a reduction in unit costs.

The deposits have a high heavy mineral grade of 6% but the valuable heavy mineral component is just 45%. The acquisition will provide a greater share of the high-grade rutile market for Iluka, and investing in the expansion of these operations would allow the company more work on the hydrology mining concept to be tested at Balranald.

The broker continues to rate the stock a Sell and expects realised zircon prices will continue to disappoint, as sales are now more skewed to lower-priced standard zircon and concentrate. Meanwhile, sales of synthetic rutile, two thirds of the company's feedstock sales, are largely fixed at around US$700/t.

Including spending on the $250-280m Cataby project, Deutsche Bank has Iluka trading on a free cash flow yield of 6% in 2017. Cataby should have a 7-8 year life and produce around 200,000t of synthetic rutile, 50,000t of zircon and 30,000t of rutile.

Incorporating the operations into forecasts results in a number of changes to Macquarie's estimates. After accounting for increased net debt of $180m the broker's sum-of-the-parts valuation increases 5%. The total cost of $473m will be funded through existing debt facilities.

Given planned expenditure at the Sierra Leone operations, and the likely construction of the Cataby project in Western Australia in 2018, Macquarie expects gearing to peak at 31% in 2017/2018.

Whilst believing the necessary growth options are within the company's funding capacity, Macquarie suspects that without a significant uplift in mineral sands prices, the dividend could potentially be suspended during the construction of new projects.

Nevertheless, the success of the bid cements the company's position as the dominant player in the global chloride titanium dioxide marketplace. It also skews the resource base further away from the predominantly sulphate Chinese pigment market.

As titanium dioxide is apparently the growth sector in mineral sands, the broker suggests that how the company addresses the other 50% of global demand represented by the Chinese market remains to be seen.

Macquarie upgrades to Neutral and believes improvements in mineral sands pricing and the Chinese property segment sentiment will be the key catalysts ahead.

Credit Suisse adjusts its cash cost structure as indicated by the company's guidance, including transaction fees, and lowers its Iluka corporate cost assumptions. The net impact is a 17% reduction in earnings for 2016. 2017 earnings estimates increase by 5%.

The broker considers the merger a positive development that should be earnings accretive and provide greater production options, allowing, perhaps, the deferral of Balranald.

When the deal was first announced in August, UBS estimated earnings per share accretion at 17% in 2017. Since then, the broker factors in a much lower earnings base for Iluka and has revised down earnings forecasts in 2017 to $41m from $158m.

On this basis, the broker expects accretion to be substantially more, perhaps around 70-80%. The acquisition adds scale and long life to the company's portfolio, although Iluka acknowledges the transaction requires feedstock prices to lift over coming years to justify the investment. UBS retains a Buy rating.

FNArena's database shows three Buy ratings, three Hold and one Sell (Deutsche Bank). The consensus target is $6.86, suggesting 5.1% downside to the last share price. Targets range from $5.30 (Deutsche Bank) to $8.10 (Citi, yet to update on completion of the acquisition).
 

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