Iluka Poised For Upturn

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

-Signs of demand, price recovery
-Iluka well placed to benefit
 

by Eva Brocklehurst

Positive is the word on Iluka Resources ((ILU)). Brokers are increasingly of the belief that, after a very weak 2013, the cycle is finally turning for the mineral sands producer.

JP Morgan has made a case to support its view that Iluka is a compelling play. Firstly there's valuation. Near-term multiples may look high but the broker considers this simply reflects the current low point in the demand and pricing cycle. Moreover, 10% of the broker's valuation comes from an iron ore royalty which could be divested, potentially, to realise value.

Zircon demand is improving after two years of being below trend, JP Morgan observes. Free cash flow is expected to be stronger in 2014 as the company expects to sell more than it produces this year. Despite soft 2013 results, CIMB was also impressed with that aspect. The company has set production forecasts at 5% above 2013 levels, suggesting the cycle is turning. CIMB expects higher earnings, cash flow and dividends should ensue, as demand returns to more normal levels. Macquarie remains more cautious, but shed an Underperform rating back in January to favour a Neutral stance. The broker also considers the intention to increase zircon production volumes is a positive sign that demand is improving.

Inventories are also lean among consumers of the company's product, so there's little room for de-stocking to affect demand. One aspect of JP Morgan's case is that there's no evidence that the zircon intensity of use in tile is waning. In a recent study the company found newer tile types are using more zircon than older technology. Moreover, JP Morgan expects better demand and pricing for titanium dioxide feedstock in the second half. Credit Suisse expects improved prices, as the pigment producers have now de-stocked and the peak demand season is looming. Macquarie also thinks the turning point for titanium dioxide is near. How near is the question, but the broker acknowledges the increase in rutile sales in the second half of 2013 – from which titanium dioxide is derived for the pigment industry – could be the start of a recovery.

Credit Suisse found the 2013 result weak and expects 2014 to be just a little stronger. The broker also believes earnings recovery hinges on an improvement in pricing from trough levels. Here, BA-Merrill Lynch raises some concern regarding the company's outlook commentary, which suggested that short term pricing should be based on the fourth quarter of 2013, not on the higher average 2013 prices for zircon and rutile. Hence, this broker thinks prices in the first half are likely to be weaker than consensus estimates. Having said that, the leading indicators suggest to Merrills that conditions have never looked as good for at least eight quarters, so the longer-term outlook is rosy.

Iluka also has substantial leverage to the falling Australian dollar. JP Morgan calculates that every 1c change in the Australian dollar impacts the company's earnings by $10-15m over a full year. Iluka could be close to net cash by year end, with JP Morgan estimating net debt will decline to $69m. Credit Suisse also expects debt to be eliminated with the stronger free cash flow. The broker expects prices will lift in 2015 and hence earnings should head back towards long-term sustainable levels in 2015 and 2016. Still, Credit Suisse retains a Neutral call, believing this recovery is priced in. 

The company has a strong position in zircon, unique assets and an open register, all a plus in JP Morgan's view. UBS notes the market is very volatile and there a few players. To its credit, the broker notes the company has maintained healthy margins in a weak market by managing production and sales in line with demand in an effort to run down inventory. The key is whether prices can stabilise and volumes recover to pre-2012 levels. UBS expects a volume-led recovery in mid 2014, driven by higher plant utilisation, inventory draw from pigment producers and a demand-led recovery in zircon. Merrills also rates the company's assets as quality, and considers the stock well positioned in the event of a recovery in demand.

Iluka has four Buy ratings and three Hold on the FNArena database. There are no Sell ratings. The targets range from $9.00 (Deutsche Bank) to $14.40 (CIMB). The consensus target is $11.01, suggesting 17.2% upside to the last share price. The consensus dividend yield on FY14 forecasts is 2.9% and jumps to 5.0% for FY15.
 

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