Poor Production Report Costs ERA

This story features ENERGY RESOURCES OF AUSTRALIA LIMITED, and other companies. For more info SHARE ANALYSIS: ERA

By Chris Shaw

A very ordinary production result was how RBS Australia viewed the third quarter production report from Energy Resources of Australia ((ERA)) as output fell short of both guidance and market expectations.

Production for the three months was 911 tonnes, which compares to broker estimates that had been for more than 1,000 tonnes. RBS notes the shortfall was driven by low ore grades, though on the plus side access to higher grade ore has been re-established after what was a prolonged wet season.

The quarterly result means three successive quarters of weak production, forcing management at ERA to lower full year production guidance for the second time this year. Output is now expected to be 3,900 tonnes, which is well down from original guidance of something close to the 5,240 tonnes achieved in 2009.

The shortfall in production means ERA needs to purchase material in the market to meet existing sales commitments, something UBS notes will act as a drag on earnings this year.

This second downgrade to production guidance is particularly disappointing to BA Merrill Lynch, as the broker was operating on the understanding higher grade ore had started to be accessed back in July. This leads the broker to suggest ERA must regain the market's confidence with respect to production in 2011 and 2012 before more positive views on the stock return.

UBS agrees, as the latest downgrade means there is a lack of clarity with respect to ERA's production profile following the end of open pit mining and through to the end of the mining lease in 2021. Credit Suisse takes a similar view, suggesting while there might be deep value in the stock this cannot be clarified until ore reserves and the production outlook becomes clearer.

The other issue for ERA, in BA-ML's view, are currency movements which are currently going against the company while ore grade uncertainty is creating a higher cost profile. Factoring all this in sees BA-ML slash its earnings estimates for this year, the broker's earnings per share (EPS) forecast being cut by 70% to 43.7c.

In 2011 BA-ML is forecasting 103c, while in 2012 its forecast is for EPS of 126c. Deutsche Bank has also cut earnings forecasts by 31% in 2010 and by 14% in 2011, its new EPS estimates standing at 43c this year, 81c in 2011 and 118c in 2012.

UBS has been similarly aggressive in cutting its forecasts for this year by more than half and in 2011 by more than 17%. The broker notes earnings risk remains to the downside, as if forecasts were marked to market for current forex values earnings could be a further 25% lower than UBS's new forecast.

The changes post the production report leave UBS forecasting EPS of 37c this year, 115c in 2011 and 135c in 2012, while consensus forecasts according to the FNArena database stand at 48.7c this year and 111.8c in 2011.

Following the disappointing production report brokers have been quick to downgrade ERA, BA-ML being particularly severe in cutting its rating to Underperform from Buy previously. BA-ML recommends Paladin ((PDN)) for those investors seeking exposure to the uranium sector.

UBS and Credit Suisse have also pushed through downgrades in ratings, the former to Sell from Neutral and the latter to Neutral from Outperform.

According to the FNArena database this leaves ERA as rated Neutral or Hold three times, Sell four times and Buy just once, this courtesy of Deutsche Bank. For Deutsche there remains enough long-term growth potential from the underground and heap leach operations and enough value in the stock at current levels to justify retaining a positive view.

Deutsche Bank has a price target on ERA of $16.70, down from $17.00 prior to the production report. This is well above the target of BA-ML, which has fallen to $15.00 from $18.00, while UBS has cut its target to $12.50 from $14.00. The average price target for ERA according to the FNArena database is $14.63.

Shares in ERA today are weaker despite the broader market trading higher and as at 12.00pm the stock was down 35c at $13.18. This compares to a trading range of $12.51 to $27.00 over the past year and implies upside of around 11% to the consensus price target in the database.

Click to view our Glossary of Financial Terms