Is Iluka's price fall overdone?
PORTFOLIO POINT: Iluka is poised for a rebound, Norwest and AWE investors will need to go with the gas flow, and Resolute shareholders are in a war zone.
Iluka Resources (ILU)
There are always good reasons for a company having its share price cut in half, but in the case of Iluka Resources the trashing it has copped over the past few weeks for reporting production cutbacks has been a gross over-reaction.
The first problem for Iluka was that it rose too far, too fast, soaring by 270% in less than 12-months from around $5.20 to an all-time high of $19.46 last July.
Driving Iluka to the title of the Australian stockmarket’s top performer in 2011 was its status as a world leading producer of the specialty minerals zircon and titanium dioxide, plus expectations for higher prices for those products, plus a possible deal involving a lucrative iron ore royalty, plus takeover rumours.
Management did little to hose down that rampant speculation, perhaps pleased that after years of playing second fiddle at the Australian resources party it was fun to be recognised as a highly-profitable business in the unique position of being able to exert some control over the price of its products, thanks to an ability to switch output on and off.
The second problem was a sales-volume update from Iluka’s chief executive, David Robb.
If Robb had delivered a clear message about future zircon and titanium dioxide output in an easy to understand way, the reaction of the market might not have been so savage. But Iluka shares fell 24% in one day, compounding the decline from last year’s peak price, and knocking another $1.1 billion off the market capitalisation of the stock. Yesterday, fearful investors again slashed Iluka’s share price by more than 5%, to a 12-month low of $7.92.
Robb’s explanation for providing a wide (and barely understandable) range of future possible mineral sales, is that he doesn’t know exactly how much product will be sold. In the current market, such uncertainty is worse than disaster.
Having gone up too far last year, it’s a fair bet that Iluka has gone down too far this year, and the best test of that is to ask other producers of titanium dioxide how they see the outlook for the material which is an essential ingredient in pigment used to make paint.
DuPont, the US industrial giant, disagrees with Iluka’s view of the titanium market. Its president of Titanium Technologies, Boo Ching Chong, told the Reuters newsagency a few days after Robb’s downbeat view that: “Recent comments regarding market demand for titanium dioxide in the second half of 2012 are not consistent with DuPont’s view and overstate the softness in the pigment industry.”
Other observers seem to agree that Robb has been overly negative, including some of the world’s biggest investment banks, which do not see Iluka’s forecast of lower tonnage necessarily flowing in full into prices for titanium dioxide and zircon, an essential ingredient in ceramics.
While one big bank, Morgan Stanley, cut its share price target for Iluka to $8.80, two others, Citi and Goldman Sachs, were largely unmoved. Citi sees $18 as the price target over the next 12-months and Goldman sees $16.20 as a price target, but also has $19.14 as its discounted cash flow valuation of Iluka.
Goldman’s view is based on an assessment that Iluka’s profits will not be savaged by the expected tonnage cutbacks, forecasting relatively flat earnings of $534 million in the current calendar year, before doubling next year to $1 billion.
Whether Robb has panicked, or DuPont is dealing in different commodities, or Morgan Stanley has a clearer view of Iluka than Goldman is not the point.
The reality for investors is that the world will continue to use ceramics and paint, no matter how tough economic conditions, and Iluka has the production firepower to exert pricing pressure on those commodities, and at its current share price of around $9.04 it has been oversold.
Norwest Energy (NWE) and AWE (AWE)
Testing the historic oil and gasfields around Dongara, about 300km north of Perth, for overlooked reservoirs of gas trapped in layers of shale and sandstone has been a slow process thanks to environmental objections and a shortage of equipment to do the job.
From next month the logjam will start to break with “fracture stimulation” or “fraccing” equipment expected to be on site soon to investigate whether the layers of hard and previously impervious rocks can be forced to release trapped gas and, hopefully, more valuable liquids.
Despite their isolation from the major gas-consuming markets on the east coast the Dongara fields rank as the second most important in Australia for the budding business of shale oil and gas production.
A combination of high demand from big mineral processing industries, and existing infrastructure such as two passing pipelines, means that any shale gas found will be snapped up by companies keen to break the stranglehold on more expensive gas piped more than 1,000km from WA’s north-west gasfields.
So far, the best results from shale gas testing in Australia have been delivered by Beach Energy at its Cooper Basin tenements in South Australia. It seems certain to be the first commercial producer of the gas that has revolutionised the US energy industry.
AWE and Norwest could be second cabs off the shale-gas rank thanks to their joint ownership of the Arrowsmith No.2 well, which is the site of the first significant testing of fraccing technology in WA. AWE has a 44.25% stake in the well and Norwest a 27.9% interest.
News flow from the testing, which is scheduled to start by the end of the month, will be keenly watched by the oil industry because of its potential game-changing significance.
However, because there is more than 1,000 metres of shale and sandstone to be tested the process could take several months, with each of the four layers being tested and analysed.
Exploration and technology risk are moderately high. Data from drilling the original Arrowsmith wells more than 30 years ago did show gas in the beds of shale.
Getting it to flow is what the fraccing experts will now attempt, and until that happens both stocks deserve an amber rating.
Resolute Mining (RSG)
It is probably awfully unfair to Resolute to pin a red warning label on the company given that it is winning where others have failed in successfully processing the complex gold-bearing ore found in the Syama mine in the central African country of Mali.
But, events far beyond the control of Resolute are bearing down on the mine and the country itself, depressing the view of the stock from an amber rating last September to code red today.
What’s happened is that heavily-armed Islamist revolutionaries have taken control of the northern half of Mali, and they seem unlikely to stop there, earning the country the unfortunate tag of “Africa’s Afghanistan” in one recent news report carried by the local broadcaster, SBS.
European leaders are worried about the potential for Mali to become a springboard for terrorist attacks in Europe given the relative proximity of the country and the arsenal of weapons which have moved across the border from its northern neighbour, Libya.
Resolute denies that it has a security issue, but investors are not so sure. Over the past few months, as fighting in Mali has moved further south and the militants in the north set about creating a new state ruled by Shariah Law, the company’s share price has sagged.
From a peak of $2.21 as recently as early February Resolute has fallen to around $1.26 even as gold production at the Syama mine rises and an expansion project started.
It is possible that whoever ends up in control of the southern half of Mali will not harm the Syama mine, which is an important contributor to the country’s shrinking tax base.
The problem for investors is to assess whether Resolute will remain a welcome guest in a country undergoing dramatic change.