Zircon Remains A Worry For Iluka

This story features ILUKA RESOURCES LIMITED. For more info SHARE ANALYSIS: ILU

By Greg Peel

Mineral sands producer Iluka Resources ((ILU)) has been a star performer of the past couple of years, seeing its stock price rise from around $4 in mid-2010 to $18 in mid-2011. Since then it's been a bumpy ride, albeit the share price has held up fairly well.

Iluka's fortunes have been tied to the global “rare earth” explosion, with the company's products being loosely equated with rare earths despite this being scientifically incorrect. Suffice to say the Chinese miracle has sparked a surge in demand for mineral sands products, being zircon and titanium oxide (TiO2) processed from rutile and synthetic rutile (which is actually also mined). Zircon and rutile are not so rare but are rarely found in large commercial quantities, and the world has been slow to develop new projects having been caught short by China's demand surge. The prices of zircon and rutile have thus skyrocketed accordingly, in line with other products deemed “rare”.

Iluka is the world's largest producer of zircon, which is used for glazing ceramics such as tiles, and the second largest producer of TiO2, which is the pigment that puts the white in “whitegood”. It is not difficult to understand that sales of these products are closely tied with China's economic performance in general and property market in particular. As such, Beijing's most recent attempts to take a hammer to property speculation has impacted on Iluka's product demand, mostly that of zircon.

As such, Iluka management had guided for a weak first half 2012 production result and the first quarter has proven guidance accurate. Indeed, at face value the result looked pretty poor, but there were some extenuating circumstances. Iluka moved a rutile mine in the Murray Basin and shut down a synthetic rutile kiln for maintenance in the period, which explained a drop in rutile production, and also had a shipment of TiO2 held up for some weeks, meaning related revenues are pushed out into the June quarter. Adjusting for these anomalies left most analysts reporting a result mostly meeting with expectations. Except for one other factor.

Iluka has been deliberately reducing its zircon production in order not to build up large stockpiles while Chinese demand takes a break, lest a price collapse is triggered. Zircon producers are few in number and Iluka the biggest, so there's been a bit of an OPEC thing going on in which all producers have been holding back to prevent mutually assured price destruction. Analysts had factored these production constraints into expectations but examination of the March quarter report – bearing in mind Iluka does not break down its general numbers in its report – has analysts calculating that the company has been unable to sell even its reduced zircon production and indeed that zircon sales were really quite weak in the quarter.

TiO2 prices rose over the quarter, helping to offset Iluka's lower rutile production, and analysts are confident price pressures remain to the upside. One presumes the Chinese will still by their first fridges and washing machines whether or not property prices are going up or down. Zircon is more closely tied to property construction however, and is thus more at the mercy of the Chinese property market and Beijing's policies in that regard. If demand remains under pressure, then Iluka has flagged it can further lower production to support prices. As analysts note, however, it would only take one global producer to break ranks and a sharp pullback in prices would be on the cards.

Iluka has indicated that 2012 TiO2 sales will be very much weighted to the second half, perhaps even as much as 30:70, BA-Merrill Lynch notes, so we have that to look forward to. On the zircon front, the Credit Suisse China property analysts are expecting ongoing strong construction in 2012 so the mining analysts are backing a rebound in zircon demand. Other brokers are also leaning towards a rebound, although caution has now crept in. The ubiquitous Chinese New Year affect impacted on the quarter, but really a lot is riding on Beijing's monetary policy and other ancillary policies. And let's not forget that China is not the world's only buyer of zircon. There is still Europe to consider.

The net response from brokers has not been one of altering any ratings at this stage and any fiddling of target prices have only left consensus about the same. Four of the brokers in the FNArena database have Buy ratings on Iluka, while the other four are on a more cautious Hold. The consensus target is a sturdy $20.61 compared to a current price of $17.27.

Aside from the AGM due in May, there will not be much in the way of direct “new news” out of Iluka until the next quarterly report. There is no spot market pricing to follow. All we can watch is any change in sentiment on global economic growth.
 

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