Australia | Apr 04 2016
-March quarter cash burn surprises
-Flexibility to re-start mine development
-Supply shut down should reinvigorate price
By Eva Brocklehurst
Western Areas ((WSA)) offers an opportunity to leverage a recovery in the nickel price but the critical question is: when will this recovery occur?
In the meantime, the company has decided to shore up its balance sheet with a $60m placement to institutions and a further $10m envisaged from a share purchase plan. Western Areas will use the proceeds to make the final payment for the Cosmos acquisition earlier than scheduled at a discount, and for working capital.
Morgan Stanley expects a nickel price recovery. Excluding growth capital expenditure, a cash break-even nickel price of $5.20/lb is estimated. If current Australian dollar nickel prices persist the broker expects a net cash position will be maintained out to FY19.
Even under an aggressively lower nickel price, e.g. 15%, the broker believes the company will be net cash until the end of FY17. Such a fall in the nickel price is considered highly unlikely. After a 1.3% decline in global stainless steel production over 2015 the broker forecasts production to rise 2.4% over 2016.
Why is nickel a top commodity pick? Morgan Stanley observes minimal supply cuts ex China over 2015 and nickel is trading deepest within its industry cost curve, exhibiting the least amount of supply rationalisation.
Demand is now stabilising and there is an increasing number of significant supply curtailments, with possibly more to come, which should tip the market balance into deficit. On this theme, Morgan Stanley maintains Western Areas offers leverage to a nickel price recovery.
Now, with a larger buffer in the balance sheet and a reduced risk profile, the company also has the means to withstand any delay in this recovery, and the broker acknowledges a recovery may be challenged by elevated inventory levels. Morgan Stanley's base case puts the nickel price at US$5.38/lb in FY17 and averaging US$8.40/lb in the long term.
Bell Potter was already of the view that Western Areas was sufficiently well funded to manage decade-low nickel prices, but the company indicated its net cash position deteriorated sharply as a result of a continued decline in the Australian dollar nickel price and cash outflows.
Hence, the broker believes the company needs to deliver lower operating costs to retain a robust financial position. Bell Potter's investment thesis is predicated on Western Areas being a low-risk, pure nickel exposures. The broker, not one of the eight monitored daily on the FNArena database, retains a Buy rating and $2.70 target.
Deutsche Bank agrees that without deeper cost reductions the company will continue to burn cash if the Australian dollar nickel price does not rally. The broker was surprised by the cash burn in the March quarter which placed the balance sheet under pressure. Moreover, Deutsche Bank cannot as yet envisage a clear path to the cost reductions that are needed beyond June 2016, when vertical mine development will need to re-start at Spotted Quoll.
Free cash flow is expected to remain negative at spot prices for the foreseeable future. The broker estimates Western Areas could burn $20m per annum at spot prices of US$3.80/lb and a US76c Australian dollar rate. A nickel price of US$4.20/lb is needed, the broker suggests, to break even. This falls to US$4.00/lb if exploration and studies are suspended.
While sustaining capital is low, the company is of a view that a low level of capital expenditure can be maintained for 1-2 years. Should nickel prices lift the funds raised will provide flexibility to accelerate mine development again, UBS contends, envisaging the funds adequate for two years before cash balances tighten again.
The nickel price is not considered sustainable at current levels over the long term. Assuming the placement is completed at the floor price of $1.95, the broker's FY17 earnings per share estimates dilutes 18%.
Credit Suisse would prefer a rights issue to a placement, so all shareholders may participate and avoid valuation dilution. Nevertheless, it makes sense to the broker to raise the money and continue with growth initiatives, because supply shut-downs are nigh and this should lead to a recovery in the nickel price.
FNArena's database shows three Buy ratings, two Hold and two Sell. The consensus target is $2.34, suggesting 14.3% upside to the last share price. Targets range from $1.80 (Ord Minnett) to $2.90 (Morgan Stanley).
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