Iluka Shines On Zircon Recovery

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

-Zircon market rebounding strongly
-Titanium dioxide slower but stabilising
-Iluka to benefit from improved construction
 

By Eva Brocklehurst

Iluka Resources ((ILU)), the world's largest producer of zircon, surprised many brokers with substantially increased zircon sales in the June quarter. Production for the quarter was 33% lower. Overall, mineral sand production was down 29% for the first half of 2013. So, what has happened? Iluka has made inroads into zircon inventory to increase sales, with a stock drawdown in the quarter of around 92,000 tonnes. Mineral sands revenue was down 42% on the prior corresponding half. That decline was largely because of lower realised prices and weak sales volumes for the high grade titanium dioxide business, the whitener feedstock used in paint and paper manufacture.

So what was positive? Zircon sales jumped 143% in the first half against the first half of 2012. Zircon, used for glazing in ceramics, has seen rising demand in the first half of the year and prices have stabilised after the decline from the peaks in 2012. Iluka now expects zircon sales in 2013 will exceed revised production guidance of 280,000 tonnes. Rutile/synthetic rutile sales, from which comes titanium dioxide, will be in line with production of around 200,000t. Rutile sales were down 34% and synthetic rutile by 80% in the first half. The decline in synthetic rutile sales was largely expected, as the company previously announced it would stop producing synthetic rutile in the June quarter.

The most impressive indicator for JP Morgan was a 73% quarter on quarter increase in revenue to $242 million, as this highlights the amount of leverage the company has to improving market conditions. The broker rates Iluka as a preferred stock in the resources sector with its unique assets, good balance sheet and, importantly, improving market conditions and pricing.

Macquarie remains one of the more pessimistic brokers, seeing little valuation support at current levels and retaining an Underperform rating. In contrast, CIMB finds the report highlights a more buoyant outlook for zircon and while the titanium dioxide market is weak, ongoing supply discipline and increasing demand should tighten the market in 2014. This has led to a 56% and 31% increase in the broker's 2013 and 2014 earnings estimates, respectively. Increases to 2014 and 2015 sales estimates and small increases to longer term price forecasts have increased the net present value by 33% and CIMB's target price by 21% to $12.65. Hence, CIMB has chosen to upgrade the recommendation to Outperform from Neutral.

BA-Merrill Lynch follows a similar line and considers Iluka is highly leveraged to improvement in demand for mineral sands, which looks to be in the early stages of recovery from a trough. Moreover, Iluka has a strong balance sheet and has stated it will leverage this to invest, a good counter-cyclical call in Merrills' view. Potential catalysts include the results from pigment and paint producers in coming weeks, which are a useful forward indicator of titanium dioxide demand.

CIMB believes price support and increased sales of zircon will continue to bode well for Iluka over the medium term. There may be a risk of further downside in the short term for titanium dioxide prices, but the broker is confident that Iluka and Rio Tinto's ((RIO)) discipline in curtailing uneconomic production will tighten the market within the next 12 months.

Iluka produces around 35% of zircon and titanium feedstock on a global basis. Merrills thinks delivery of two major new projects, which are higher margin, with subsequent expansion to the sales book should provide the necessary impetus to reshape the company's asset portfolio.

Deutsche Bank thinks a little history is worth taking note of. The year 2011 was a strong demand year in combination with a re-stocking cycle and 2012 was a complete contrast. Demand fell and buyers of zircon and titanium feedstocks had excess inventory. By the second half of 2012, producers were taking action by reducing mining rates and selectively targeting lower zircon grades in an effort to reduce inventories. Now, it appears the zircon market is rebounding. The first half focused on drawing down finished product stockpiles but, with improved conditions now evident, the broker observes the company recommenced shipping to the Western Australian processing facilities from its mining hub in the Eucla Basin.

The broker also thinks the titanium dioxide market is getting better, but will remain dependent on demand coming out of North America. Price rises put through by sellers to date have been resisted somewhat, given still subdued conditions. Nevertheless, construction industries are key end-markets, driving sales of paints and coatings, and the US makes up 25-30% of the titanium end-use market. Recovery in that quarter is what brokers will be watching with interest on Iluka's behalf.

On the FNArena database the stock has four Buy ratings, three Hold and one Sell. Post production report the consensus target price has risen from $10.64 to $11.45, now indicating 2.2% upside to the last share price. Targets range from $9.30 to $12.85.

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