The Mineral Sands Bonanza

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

– Mineral sands price forecasts continue to rise
– Iluka price target increases continue to follow
– Alkane is a stock with potential
– It ain't over yet
 

By Greg Peel

Zircon is used in ceramic glazes to make them non-transparent and to provide protection against, amongst other things, ultraviolet light. Titanium dioxide is similar but is specifically used as a pigment for paints. It's a colour is a brilliant white, and thus when one observes any “whitegood” one is staring at a TiO2 coating.

Why is this important? Because China cannot get enough of the stuff.

The two minerals are ubiquitous across the globe in sand form and are hence known as “mineral sands”. But while they might be everywhere, they are rarely found in anything more than tiny deposits. Commercial exploitation of mineral sands requires unusually large deposits and they are few and far between. China doesn't have anything like enough of its own to service its manufacturing export and burgeoning domestic economies. Which is why it has to import from companies such as Iluka Resources ((ILU)).

Iluka's share price peaked around $9 in 2006 but by mid-2009 it had fallen to around $3. The problem is that up until more recently, the demand/supply balance and cost of production made mineral sands export a very low margin game. Given the low margins, Iluka's earnings were very much open to the impact of a strong Aussie dollar, and many an investor has been constantly frustrated over the years by Iluka's currency-related earnings downgrades. But the picture now is a very different one.

The rapid ascent of the mineral sand demand curve out of China and other emerging markets has run far away from the discovery or development of new global mineral sands resources. Prices have been going through the roof at a pace far exceeding any increase in production cost. The result is once tight margins have become increasingly wide margins, and the wider the profit margin the less relative impact from movements in currency. So imbalanced is global mineral sand demand/supply now that Iluka has been forced to ration its customers.

In the meantime, the Aussie dollar has surged to levels unseen since its 1983 float. Such movements understandably put off wary potential Iluka investors for a while but as the prices of zircon and titanium oxide just kept climbing and climbing, the share price of Iluka eventually had to follow. As such, Iluka shares are currently trading around $14 – some 366% above their 2009 low.

The steepness of the rise in mineral sands prices and the subsequent Iluka share price rise has caught conservative and wary resource sector analysts out, given the rule of thumb in valuation is to constantly assume spot price spikes are temporary prior to the regression or “normalisation” of prices back to longer term averages. Over the past month, however, Deutsche Bank has lifted its 12-month Iluka share price target to $15.00 from $12.00, Credit Suisse to $15.60 from $14.00, UBS to $16.00 from $12.00, and RBS to $16.09 from $14.33.

But they've all been trumped by Citi, which has now lifted its price target all the way to $17.00 from $12.50. By way of explanation, Citi suggests “Iluka is riding the crest of a wave as pricing power is now firmly in the hands of producers in very tight zircon and TiO2 feedstock markets”. What's more, Iluka boasts production expansion opportunities.

The target upgrade follows significant upgrades to Citi's mineral sands price forecasts, driven by strong demand, constrained supply, and “producer discipline”. In other words, the producers have been milking it. Citi has not shifted its long term price forecast at this stage but admits there is considerable potential upside, to both the long term price and all the shorter-term price assumptions.

Citi expects Iluka will now restart its idle capacity in Western Australia. The company has the capacity to ramp up WA mining and to increase Eucla Basin production by 20%, all of which could deliver an extra 100ktpa on top of the analysts' current 500ktpa capacity assumption.

As a result of the forecast price upgrades, Citi has upgraded its Iluka earnings forecasts by 50% in 2011, 75% in 2012 and 162% in 2013, which all feed into the target price increase. Aussie dollar sensitivity remains a risk, but a far more diluted one given rapid margin expansion. The company now also has a very strong balance sheet, the broker notes, which could be put to acquisitive use.

You won't get any argument out of RBS Australia. The broker has today published its top ten trading ideas for the resources sector and Iluka is on the list.

RBS notes an indicative price for zircon in China of around US$2700/t compared to Iluka's effective freight-on-board price at present of US$1600/t. The analysts are expecting a 10% increase in TiO2 pricing for July but the analysts expect both prices to continue to surprise on the upside.

For the same reasons, RBS also has included in its Top Ten Alkane Resources ((ALK)). Alkane has just signed the first in what the analysts expect will be many memoranda of understanding (MOU) for future offtake from the Dubbo Ziconia Project. The DZP is projected to have a mine life of 75 years on current resource assumptions.

Alkane offers exposure to zirconia, niobium and rare earth minerals, RBS notes. RBS is the only broker is the FNArena database covering the stock at present, and has a Buy with a target of $3.01 (last price $1.84).

By contrast, all eight database brokers cover Iluka, with five on Buy but three on Hold given the proximity of the stock's trading price (last $13.84) to their (lower end of the range) price targets.

Citi had been at the low end of the target price range at $12.50 but has now moved to the top with $17.00, leaving JP Morgan now as low marker on $13.50. JP Morgan lifted its target to $13.50 from $10.70 last month on the same day Macquarie moved to $14.50 from $13.50 and BA-Merrill Lynch to $16.00 from $12.00.

Quite a chase. 
 

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