Timing The Upturn For Iluka

Mineral sands group Iluka (ILU) reported a messy interim profit result, the headline loss of $56 million including a number of impairment charges, restructuring costs and one-off adjustments. As Citi notes, it also reflected a collapse in demand during the period.

The other key issue facing the company is the outlook for zircon sales, which JP Morgan notes management cut in conjunction with the profit result from around 300,000 tonnes to something in the range of 200-250,000 tonnes for the full year.

On the plus side, the broker notes recent guidance for rutile and synthetic rutile sales has been retained, while RBS Australia also points out the group’s Western Australian operations showed signs of better performance during the period.

There was nothing in the result to change JP Morgan’s view the stock remains a long-term earnings recovery and restructuring story, not least because the near-term earnings outlook continues to be weak. Macquarie agrees as while it sees long-term upside in the group’s portfolio of assets the short-term suggests little earnings upside in 2010.

But upside could come quickly in the view of Bank of America Merrill Lynch. BA-ML suggests there is scope for the de-stocking cycle in minerals sands to end sooner rather than later, which would set the company up nicely for a big rally. UBS agrees, upgrading the stock to a Buy on the expectation there will be re-stocking in the zircon market that will be enough to erode the share price discount to its current valuation of $4.41 on net present value terms.

Citi is similarly positive on a likely re-stocking process, while it also points out with a limited inventory overhang in the industrial sands markets at present, there is scope for prices to run quickly to the upside. Macquarie counters this by pointing out the company has a policy of stockpiling while it waits for prices to improve, so if the anticipated price recovery doesn’t come through then earnings will remain under pressure.

At least the company is in a stronger financial position as it waits for prices to improve, UBS estimating net debt of around $466 million at the end of the year will be well within the $650 million of facilities it has in place. As well, Citi notes debt will fall quickly in 2010 as capital expenditure falls and cash flows strengthen.

Different expectations with respect to the timeframe of any improvement in mineral sands demand is creating a wide range of earnings forecasts, as broker earnings per share (EPS) numbers for 2010 range from JP Morgan at 2.2c to Citi at 18c and RBS Australia at 33.2c. This again highlights how quickly the company’s earnings could turn around once prices do recover.

But as Deutsche Bank notes, there is no way of knowing when such a turnaround will occur, so while Deutsche Bank has lifted its price target to $3.95 from $3.25 it retains its Hold rating on the stock. RBS Australia also sees no short-term catalysts to push the shares higher, especially as it is still some time before the company’s higher margin growth projects come on stream.

Both Citi and UBS have upgraded to Buy ratings post the earnings result so the FNArena database now shows a total of three Buys, one Accumulate, four Holds and one Underperform, with an average price target of $3.98, up from $3.65 prior to the result.

Shares in Iluka today are little changed and as at 1.20pm the stock was down 2c at $3.63. This compares to a trading range over the past year of $2.70 to $5.40.

Greg Peel

About Greg Peel

Greg Peel joined Macquarie Bank in 1986 and acquired trading experience in equities, currency, fixed income and commodities derivatives, ultimately being appointed director of equity derivatives trading. He later published In With The Smart Money (a plain English guide to the mysterious world of financial markets and derivatives) and acted as a consultant to boutique investment funds. In 2004 Greg joined FNArena as a contributing writer. He is now a director and principal of the company. Greg compliments the journalistic background of the FNArena team with lengthy experience as a financial markets proprietary trader.

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