Atlas Iron: Too Many Irons In The Fire?

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-Rail solution badly needed
-Many plans on the drawing board
-Part sale of McPhee Creek required?
 

By Eva Brocklehurst

Junior iron ore miner Atlas Iron ((AGO)) may have delivered strong production results and record iron ore sales in the September quarter but the company remains in an expansionary phase. The question is as to whether the company will have enough funds to accomplish what it needs to do and where best to allocate expenditure. Then there's the worry about getting access to railways to haul the iron ore to the port.

The company's shipment rate has just reached 10mtpa and should rise above 12mtpa in FY15, as the new Mt Webber mine starts operations. Credit Suisse believes growth beyond 14mtpa will be difficult using trucks on the highway, as distance is becoming a haulage cost barrier, rising to over $20/t with regard to Mt Webber. The company needs a rail solution to unlock expansion potential, Credit Suisse points out. The company is optimistic that a rail agreement will be obtained this year but the broker thinks it is too risky to model on this basis. Moreover, Atlas Iron's needs are demanding, if the rail is to handle all planned developments across the Pilbara. The company has admitted to looking for a total package and this is why there's no rail haulage deal in place as yet. Timing remains key, as the company really needs to find periods when the owner of the rail is under utilising the infrastructure.

So, without a rail deal, Credit Suisse cannot justify a target price beyond $1.10 per share and at that level the valuation is full. The recent run in the share price has captured the value and the rating is downgraded to Neutral from Outperform. Free cash flow yield forecasts are only moderate for FY15, as expenditure continues apace, but the broker is hopeful that yield should expand in FY16, although new mine plans may appear on the drawing board.

Credit Suisse observes that the company's received price of $117/t for iron ore in the September quarter generated healthy earnings of $91m, but that all went into expenditure on port and mine developments. Gross cash declined to $378m. P/E multiples don't work adequately for this stock, in the broker's calculations, because of the high depreciation charges on short mine lives. On profit & loss terms the mines look poor, although cash generation is better than the accounting suggests. In particular, mine life extensions occur as exploration continues at the site, so the depreciation charges can tend to fall later in the life of the operations.

CIMB acknowledges the potential for the stock to outperform while the iron ore price remains around US$130t. It's just that the iron ore price is expected to weaken over the next 12 months. The end result is a downgrade in rating to Underperform from Neutral.

Citi is the third broker covering the stock on the FNArena database to downgrade on the back of the September quarter production report. Production, shipments and realised price were considered well and good and Citi is more bullish on iron ore but, as per Credit Suisse, the broker believes the challenges are around accessing rail and securing funds for the next stage of development. Fortescue Metals ((FMG)) may come to the rescue in providing the rail haulage but then, Citi wonders, just what will it cost Atlas?

Atlas posted September quarter production results with record iron ore sales of 2.4 million tonnes, representing a 8% quarter-on-quarter increase and consisting of 2.0mt of standard fines product and 400,000t of lower-grade ore. Mine production of 2.9mt exceeded shipments, resulting in a 45% increase in ore stocks to 1.6mt, which should help to offset any shortfall in production in the upcoming wet season in the Pilbara.

The outlook lacks clarity, in JP Morgan's view. There were some developments in the "Horizon 1" plans, with Abydos commencing production during the quarter, Mt Webber ramping up to first mining and commissioning at Utah Point Stockyard 2 now mostly complete. The "Horizon 2" projects are where most of the concerns lie. The company has now suggested McPhee Creek could be part sold, despite still being in the pre-feasibility stage. The studies are based on rail spurs to connect the project to existing rail systems and JP Morgan notes this means either Fortescue's or Hancock's proposed new rail lines. Upside could come from mine life extensions, proceeds from part sale of McPhee Creek and/or development of Horizon 2 projects. It's just that little value can be ascribed to these plans at this stage.

The existing mines performed strongly and exceeded Deutsche Bank's estimates, due to a rebound at Pardoo and Wodgina.The broker notes the development of the Abydos and Mt Webber mines is on track and Horizon 2 studies and discussions with rail haulage providers have progressed. The use of an existing car dumper and stockyards appears to be a critical component of the rail access negotiations and therefore project capex, in Deutsche Bank's view. Furthermore, Horizon 2 will not be value accretive at a rail access charge above $15/t. Deutsche Bank believes McPhee Creek is diluting value at a rail access fee over $15/t and only a large sell-down of this project will change that.

BA-Merrill Lynch is the most upbeat and retains a Buy rating – the only one on the FNArena database. Merrills remains focused on the feasibility study that's underway for an expansion of Mt Webber to 6mtpa from 3mtpa. The broker doesn't see the juggling act as such a problem. Earnings and production estimates have been raised. During FY14, the broker expects the Pardoo and Mt Dove operations will gear down as the mine lives expire, while Abydos and Mt Webber ramp up.

There are four Hold rating and three Sell ratings on the database. The consensus target price is $1.01, suggesting 0.9% downside to the last share price. The range of targets is 72c (Deutsche Bank) to $1.49 (Merrills).
 

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