Commodities | Jun 25 2010
This story features LYNAS RARE EARTHS LIMITED. For more info SHARE ANALYSIS: LYC
The company is included in ASX100, ASX200, ASX300 and ALL-ORDS
By Chris Shaw
Australia has a new Prime Minister in Julia Gillard, who has already indicated the government will enter negotiations with the mining industry with respect to the RSPT. These negotiations will be within a framework of returning the budget to surplus by 2013.
In the view of RBS Australia, the announcement the government is willing to negotiate with respect to the RSPT suggests meaningful changes to the policy are possible. The target of a budget surplus by 2013 makes for a greater challenge however, as any RSPT concessions that reduce future tax revenues will need matching policy adjustments.
Some of the possible options in RBS's view include cancelling proposed cuts to the corporate tax rate or the increases to the super guarantee rate. Given the likely need for some policy concessions, RBS suggests miners, energy stocks and developers and contractors are the potential winners from any changes. The latter is because some recently cancelled or deferred projects would likely be back in consideration.
Potential losers according to RBS include asset managers, as if previous policy proposals such as an increase in the superannuation guarantee rate are wound back the expected increase in terms of fund inflows won't occur at the same level as the original policy proposals had indicated.
Turning to the precious metals, Barclays Capital notes the palladium market has now been in surplus for the past nine years, the overhang ranging from around 500,000 ounces to more than two million ounces.
But in the view of Barclays these numbers hide the fact if it wasn't for sales of Russian state stocks palladium would have been in deficit in three of the past five years. For the year to April, Russian shipments are down 7% in year-on-year terms.
This may indicate a reduction in the level of Russian state stocks, Barclays noting Norilsk Nickel has estimated there is now only one to five years of additional stocks remaining. Norilsk expects no additional releases of palladium from 2011-2015, as it takes the view state reserve levels will now be maintained.
In terms of visible palladium stocks, Barclays notes GFMS estimates a total of 7.9 million ounces as at the end of 2009, which equals around one year of consumption. While some supply growth is expected this year, Barclays also sees strong demand growth as giving scope for the market to be balanced or move into deficit.
As well, Barclays notes if the trend is for Russian state stocks being depleted or released more slowly than has historically been the case, it creates an improved fundamental base for the metal longer-term.
Standard Bank has reviewed first half performance for commodity markets generally, noting the only commodities to post gains since the start of the year are palladium, gold, platinum and nickel. Since the start of the second quarter performance has been even worse, with only gold recording positive returns.
Fundamentals haven't fully driven price movements, Standard Bank pointing out for example both copper and aluminium have largely tracked each other in performance terms, this despite copper having by far the stronger fundamentals.
Going forward Standard Bank expects fundamentals will be more important in terms of price drivers, so it expects to see greater differentials in price movements over the balance of the year. Investor risk levels remain the key, Standard Bank suggesting when risk starts to be embraced again money will flow into metals once more, setting the stage for another sustained price rally.
Rare earth metals generally receive little coverage in the market, this despite what JP Morgan suggests is a positive fundamental outlook for the sector. Rare earth metals are used in a range of products such as consumer electronics, hybrid vehicles and environmental protection applications.
One exposure on the Australian market is Lynas Corporation ((LYC)), where JP Morgan has initiated coverage with an Overweight rating and $0.91 price target. The company is developing the Mt Weld project in Western Australia, where production is expected to commence by the end of this year. Output will go to an Advanced Materials Plant in Malaysia, from where finished products will be sold into the European, Asian and US markets.
Upside in JP Morgan's view comes from a Phase 2 expansion of the project, with Phase 2 valued at $0.56. This is included in the broker's base case valuation as it expects the expansion will be approved given the strong demand outlook for rare earth metals.
Lynas will become an alternative to Chinese supply and this is another potential positive in JP Morgan's view, as Chinese authorities have recently imposed various controls on rare earth exports to shore up domestic supply. This should deliver stronger prices over the medium-term.
Earnings for Lynas will take some time to come through, with JP Morgan forecasting small losses until FY12. The broker's Overweight rating reflects the view the current share price is not fully reflecting the potential valuation upside from Lynas delivering on an expansion of the Mt Weld project.
Further upside can come from executing further offtake agreements, while JP Morgan expects the completion of the concentration plant at Mt Weld should act as a nearer-term share price catalyst. JP Morgan is the only broker in the FNArena database to cover Lynas.
Copper and gold are seen as among the more favourable metal exposures going forward and in line with this Morgan Stanley has updated its view on Citadel Resources Group ((CGG)). The company is a producer of both metals via its Jabal Sayid project and the broker rates Citadel as Overweight within an "Attractive" industry view.
Production at Jabel Sayid is expected to commence in the final quarter of 2011, while full production will be reached in 2013. Citadel has a 70% share of production from the project, which is up from 50% as the company recently raised $250 million in new equity to fund the move.
A debt raising is expected to follow at some point, leading Morgan Stanley to suggest Citadel will then be fully funded with excess capital. This suggests a very strong balance sheet position, which is an advantage given the broker expects another commercial project will be announced over the next 12-14 months.
This is the Jabal Shayban copper/gold project, which has an initial gold equivalent resource of 467,000 ounces. The project is likely to become commercial if exploration success increases this resource to 1.0 million ounces or more.
As Morgan Stanley notes, Citadel is more leveraged to copper prices given copper output will be greater than that of gold. Copper production from Jabal Sayid is expected to be around 34,000 tonnes in 2011 and 41,000 tonnes in 2012, while gold output is forecast at 12,600 ounces next year and 15,200 ounces in 2012.
Morgan Stanley expects earnings to turn positive in 2012 and it is forecasting earnings per share of 4c that year, rising to 7c in 2013. The broker has a base case valuation on Citadel of $0.39, while a bull case scenario of stronger than expected commodity prices implies a valuation of $0.54. A bear case valuation of $0.28 has a 20% probability in Morgan Stanley's model.
Morgan Stanley rates Citadel as one of its two preferred copper plays on the Australian market. As with Lynas, Citadel is not broadly covered, the FNArena database showing only GSJB Were covers the stock. The broker rates Citadel as a Hold with a $0.40 price target.
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