Price Uncertainty Clouds Iluka’s Outlook

This story features ILUKA RESOURCES LIMITED, and other companies. For more info SHARE ANALYSIS: ILU

-Price upturn elusive as yet
-Positive inventory, more cash
-Uncertainty over developments
-Kenmare a possible catalyst
 

By Eva Brocklehurst

Doubts are creeping into the outlook for Iluka Resources ((ILU)) as the promise of substantial improvement in mineral sands prices remains elusive, for 2014 at least. 

First half results were better than expected but Deutsche Bank observes the company is running behind on operating costs and capex guidance. Following an indicative offer for Kenmare on June 26, Iluka is now considering whether it can add further technical expertise to that company's Moma asset. Deutsche Bank suspects Iluka has reached a point where it needs to consider whether it has the required assets for the long term. In this case, Kenmare could offer exposure to the sulphate market. Iluka's balance sheet remains in good shape but, with $375m in finished product and $406m in work-in-progress, inventories appear very elevated.

Credit Suisse is no wiser after the June half result. The broker struggles for a reason to buy the stock and does not believe the company is making evaluation easy. There was no information on developments and long-term aspirations lack detail. The company commented that prices remain well below an inducement to produce, while grades and quality of global deposits are falling. Credit Suisse observes that this statement led analysts to conclude that the Balranald project may not be viable, but this is not the implication the company intended. The broker builds the Balranald project into modelling in 2016, but acknowledges timing remains uncertain. Credit Suisse surmises that the company is hoping to find a cheap mining method and, in the meantime, a conventional mine will not be developed.

The broker does like the Metalysis investment, as it exploits the promise of increasing demand for titanium dioxide. However, the only information forthcoming on that front is that tantalum powder production remains the focus of the recommissioning, as it offers near-term self-sustaining cash flow. Any action on Kenmare could be the catalyst for Credit Suisse, but this too is up in the air. The rating stays at Underperform.

The next year will subdued for sales and pricing, in Macquarie's opinion, and therefore there is little value in the stock, which is trading at a premium to valuation. Hence, another Underperform rating. Macquarie doubts a significant recovery in prices is likely in 2014. The broker continues to view the reactivation of the synthetic rutile kiln as a key earnings driver. The broker also noted the company has signalled it may wait for further innovation to make the Murray Basin projects more attractive. Iluka remarked that producers were continuing to flex supply of zircon, but Macquarie observes Rio Tinto ((RIO)) is producing at 95% of 2011 levels and Tronox at 80% on an annualised basis, while Iluka compares at 60%.

Price stability may turn out to be the main positive. Citi believes this to be the case, given the recent volatility in the mineral sands industry.  Iluka is primed to respond to improvement in demand, given its inventory position. The ability of the company to meet the broker's 2014 sales forecasts rests with the strength of the recovery in feedstock markets over the rest of the year. A drawing down of inventory over the next year or so should drive strong free cash flow, in Citi's view.

The beat in the first half was mainly from positive inventory movements – the company sold more than it produced. This message, reflecting market improvements, boosted BA-Merrill Lynch's confidence in the signs of a rebound. There is a gap in demand for paint and the resultant response in pigment feedstock, but momentum is gathering pace. Merrills expects several factors in the supply-side of the market may lead to higher incentive prices for titanium dioxide and zircon. These factors include a falling chloride/sulphate ratio, declining zircon grade and increased trash as a percentage of heavy minerals grades.

The company's comment regarding opportunities for mergers & acquisitions was couched in terms of the commercial and financial logic, and where value can be enhanced from the opportunity. To Merrills this can be boiled down to simply "where we bring more than a cheque book". Iluka has identified growth options around existing operations and in new areas such as Sri Lanka. Nonetheless, decisions have not been made and the broker suspects Iluka may need to look at funding options to develop these projects.

CIMB agrees that the current prices of mineral sands are not attractive enough to spark the required production to meet long-term demand. There are few catalysts for higher prices, other than broad-based increase in demand. CIMB does not believe the US and Chinese housing data is strong enough to convincingly signal any upturn in key product prices. Still, the company has a competitive cost position and production flexibility, as well as a strong balance sheet, and this means it is well placed for when markets tighten and prices tick higher.

Material price rises may have been pushed out to mid 2015 but JP Morgan is also relieved the company is witnessing stability in mineral sands markets. With sales of synthetic rutile re-commencing. conditions are in place for a reactivation of the kilns. As the timing of development projects is contingent on market conditions JP Morgan believes this implies a delay to operations at Balranald. The broker retains an Overweight rating.This makes up one of five Buy ratings on the FNArena database. There is one Hold (Deutsche Bank) and two Sell. The consensus target is $10.01, suggesting 11.9% upside to the last share price. Targets range from $7.50 (Macquarie to $13.10 (CIMB).
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms