Nickel Outlook Key To Independence Group

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Independence Group is keen to discover more nickel and its quality product from Western Australia is sought after, providing a positive outlook for FY19.

-Ideally placed to benefit from tightening nickel market
-Significant cash flow forecast for FY19
-Yet valuation remains an issue for most brokers
 

By Eva Brocklehurst

FY18 production fell short of Independence Group's ((IGO)) guidance but brokers were not overly concerned and acknowledge the efforts the company is making to expand its nickel profile.

Credit Suisse observes the FY19 exploration budget for the two key assets, Nova and Tropicana, indicate a desire to discover more nickel. This supports the company's intention to invest capital and improve nickel payability (the percentage of the London Metal Exchange nickel price paid for ore).

Independence Group is ideally placed, several brokers suggest, to benefit from a tightening nickel market and higher prices, amid a bullish outlook on the take-up of electric vehicles.

UBS notes the Nova mine has a 10-year life and low costs, while free cash flow suggests a 13% yield for FY19. Ord Minnett expects demand from lithium ion batteries to grow to 205,000t in 2025, from 20,000t in 2017, and account for 8% of global nickel demand.

Despite this outlook, nickel appears to be one of the few commodities that is trading below its long-run real average price, although new sources of supply will be at higher cost and technically challenging.

Ord Minnett expects the nickel market will remain in deficit beyond 2018 as higher prices are required to incentivise new supply. The broker upgrades long-term nickel price forecasts to US$9/lb and is upbeat about the prospect for the nickel market and the strategic position of Independence Group.The company produces high-quality concentrate for a growing market and has an offtake agreement with BHP ((BHP)) to supply feed to the Western Australian Nickel West smelter. A sufficient return on this investment, for BHP, requires the smelter to operate efficiently beyond 2020, when the current offtake agreements expire.

This puts Independence Group and associate Western Areas ((WSA)) in the box seat, as their products are key blending items for the low-quality Mt Keith feed. Both sell 50% of their offtake to Nickel West and 50% to China.

In turn this supports, Ord Minnett believes, the potential for the companies to push for higher payability. The broker resumes coverage of Independence Group with an Accumulate rating.

The main issue for brokers is the valuation of the stock and, hence, UBS retains a Neutral rating. A combination of upside for the nickel price, higher payability and an extension to mine life is considered already factored in.

UBS calculates that assuming a US$10/lb long-term nickel price, 80% nickel payability and a 1.5x NPV multiple on Tropicana, the valuation would only lift to meet the prevailing share price.

Canaccord Genuity, not one of the eight stockbrokers monitored daily on the FNArena database, retains a Sell rating and $4.00 target on valuation grounds, although acknowledges the significant cash flow that is forecast for FY19, which should maintain the appeal for investors that want a low-risk exposure to diversified metal production.

Production

A soft March quarter left a stretched target for the following June quarter at both Nova and Tropicana. Nova production for FY18 was 22,300t, below guidance of 23-27,000t. The main problem was the mill liner at the processing plant but this is being replaced and management does not believe it will be an ongoing issue.

Grades improved in the quarter and mining rates were also above nameplate. This points to better production potential and a sustained performance going forward, UBS assesses. The next catalyst is an update for reserves.

Following an infill drilling campaign the company has been working on optimising Nova, yet nickel, copper and cobalt output were -7%, -4% and -16% lower than Macquarie's forecasts, respectively. The broker cuts earnings estimates for FY18 by -20% while making no changes to FY19.

At Tropicana FY18 gold sales for the company's 30% stake totalled 138,700 ozs. Here production was also lower than Macquarie expected. The softer result versus estimates reflected throughput that was -2% lower and milled head grade that was -3% lower.

Meanwhile, the transition to care and maintenance at Long occurred as planned. Production was 20% above Macquarie's expectations and ceased in May.

Targets

Independence Group has reached an agreement to acquire the Southern Hills tenements in the Fraser range. These tenements are contiguous to the Nova mining lease and the company has identified a number of drill-ready targets.

Independence Group will pay Creasy Group $21m to earn a 70% interest in the tenement and will then fund exploration through to a feasibility study. Dilution rights could mean the interest eventually increases to 95%, although this would require the Creasy Group to withdraw post the completion of the feasibility study.

In May, the company increased its equity interest in Orion Minerals ((ORN)) to 11%. Orion intends to use the proceeds to drill test copper-nickel-cobalt targets in South Africa as well as fast track the re-start of the Prieska zinc-copper project.

The database shows one Buy rating (Ord Minnett), four Hold and two Sell for Independence. The consensus target is $4.84, signalling -4.4% downside to the last share price. Targets range from $4.20 (Credit Suisse) to $5.40 (Ord Minnett).

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