No Joy For Energy Resources Of Australia

With production being impacted by abnormally heavy rain in recent years, uranium producer Energy Resources of Australia (ERA) is looking at alternatives for dealing with the problem of unmanageable water inventory levels.

As part of this, management has unveiled plans to invest $80 million in a feasibility study on the installation of a brine concentrator, with capacity to treat up to 1.8GL/year of process water. Assuming the concentrator is approved, total capex would be in the order of $220 million, with commissioning in the second half of 2013.

On the news, BA Merrill Lynch suggests the concentrator, along with other measures such as lifting the tailings storage facility walls and hiring additional water treatment equipment, would assist in de-risking the potential for future plant suspensions. At the same time, there wouldn’t be any explicit offset from an increase in production arising from the capex spend.

Higher costs are unlikely to stop there, as JP Morgan notes ERA management also revealed an increase in rehabilitation costs. To date the increase is unspecified, the exact amount unknown until work is completed.

Factoring in the higher capex forecasts sees JP Morgan lower valuation estimates for ERA by 9-10% through FY13. Others have followed suit, with the likes of RBS Australia and Macquarie lowering earnings forecasts to reflect higher capex assumptions.

This impacts on price targets across the market, JP Morgan cutting its target to $9.50 from $10.50 previously. This remains one of the most optimistic targets for ERA, as UBS is the lowest in the FNArena database with a $4.00 target price. The consensus price target stands at $7.34, down from $7.91 previously.

Ratings on ERA are unchanged post the update, which means the market remains far from a consensus view with respect to the stock. The FNArena database shows ERA is rated as Buy twice, Hold once and Sell five times.

JP Morgan is behind one of the Buy ratings, seeing value given at current levels ERA is trading at a 44% discount to price target. The intention to look into water inventory options suggests an increased likelihood ERA can extend the life of operations via the additional capital investment. This supports JP Morgan’s preference for ERA over Paladin as preferred Australian uranium exposure.

The Sell argument is summed up by RBS Australia, which suggests there remains downside valuation and earnings risk from any further significant rainfall events. As well, a strategic review is likely to conclude the heap leach and Ranger 3 Deeps projects are not viable, which would further impact on valuation and sentiment in RBS’s view.

BA-ML takes a similar view and has stripped both projects from its model. The result is a revised valuation and price target of $4.20, down from $6.25 previously. With little exploration likely prior to water management issues being settled, BA-ML sees little scope for the share price to outperform medium-term.

Over the past year the trading range for the shares has been $4.98 to $15.37, the current share price implying upside of around 45% to the consensus price target in the FNArena database.

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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