Stronger Australian Dollar Crushing Iluka Earnings

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This story features ILUKA RESOURCES LIMITED.
For more info SHARE ANALYSIS: ILU
The company is included in ASX200, ASX300 and ALL-ORDS

By Chris Shaw

The quarterly production report for Iluka Resources ((ILU)) was a good news/bad news story, the good news being production was broadly in line with market expectations and capital expenditure requirements have been reduced.

The bad news was the strength of the Australian dollar and its impact on profits, JP Morgan pointing out each 1c movement in the currency has a full year earnings impact of around $8 million dollars.

While this will bring down earnings this year as evidenced by Merrill Lynch analysts cutting their 2007 forecast by 16% to $62 million, the greater fear is if the currency stays at current levels through 2008.

On UBS’s numbers this could create an earnings headwind of as much as $56 million, which leads the broker to forecast a loss of as much as $41 million for the company next year.

Merrill Lynch has also slashed its earnings estimate for 2008 by 85% but still expects the company to generate a profit in the order of $14 million, which in EPS (earnings per share) terms implies an outcome of 5.8c against its forecast of 26.1c this year.

JP Morgan has an identical EPS forecast for the current year but is slightly more optimistic on the 2008 outlook and is forecasting 22.5c, but it cautions the currency could impact and this suggests it sees downside risk to its number.

Currently GSJB Were is one of two brokers in the FNArena database to rate the stock as a Sell, forecasting EPS of 17.4c this year and 14.7c in 2008. While it sees some upside risk at current spot zircon prices the currency impact means overall the earnings risk remains to the downside, implying little chance for the shares to outperform. The other Sell recommendation comes from Macquarie (Underperform).

Merrill Lynch suggests for those investors able to ride out the short-term currency fluctuations the stock remains a Buy, as by 2010 the company should be well placed as Eucla and the second stage of the Murray Basin project will be on-stream.

It expects earnings per share could jump to as much as 96c by 2010, though this implies the Australian dollar declining to 72c against the US dollar by that time. It suggests the market would be happy to pay around 14x earnings for the stock at that time, so if its earnings estimate is close to the mark this implies a share price of around $10.00.

However, if the currency doesn’t follow the script the broker has given some valuation guidance, estimating at an exchange rate of 80c in 2010 the company should generate around 63c in earnings and this implies a price of about $6.30, while if the currency stayed at 90c it would imply earnings of just 29c, which equates to a price of just over $4.00.

With earnings estimates being cut virtually across the board target prices have also fallen, the FNArena database showing an average price target now of $5.75 compared to $6.43 prior to the production report.

Citi is the only broker to downgrade the stock on the back of the production report, moving to a Hold recommendation from Buy previously. This leaves the company as scoring two Buys, six Holds and two Sell recommendations. It has to be noted though that most Buy ratings come with a longer term tag.

The market agrees more with the sell side based on share price movements this morning as at 11.25am the stock was down 20c at $4.93, which compares to a range over the past 12 months of $4.86-$7.65.

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