Minefield: Miners with mixed prospects

Each with different resource stories, these mining stocks have very mixed outlooks.

Summary: Iluka Resources has strong growth potential as demand for titanium dioxide and zircon improves, while Buru Energy and Hot Chili are also tipped to outperform, but have higher risk. Paladin Energy is set to underperform, reflecting weak conditions in the uranium sector.
Key take-out: Iluka’s share price fell 15% last week, but it will be well placed to accelerate its output when demand for paint pigment and ceramic tiles picks up in the major consuming markets such as China.
Key beneficiaries: General investors. Category: Shares.
Iluka Resources (ILU): Outperform (under review).
Paladin Energy (PDN): Underperform (under review).
Buru Energy (BRU): Outperform (under review).
Hot Chili (HCH): Outperform (under review).

Iluka Resources (ILU): Outperform.

Sluggish demand for titanium dioxide, a basic ingredient in paint, caused Iluka Resources to disappoint the market with last week’s September quarter production report, though the sell-off looks more like a buying opportunity than the start of a long-term retreat.

Damage to Iluka’s share price, which fell more than 15% in a week of heavy selling, was caused mainly by the way the sales downturn was sprung. Management had earlier talked up the prospects for sales of titanium dioxide and the company’s other major product, the ceramic glazing agent zircon.

Any recovery in demand in the current quarter is unlikely to prevent Iluka, the world’s biggest independent producer of mineral sands (or beach sands as they were once called), from incurring a sharp profit fall in the year to December 31 and for the annual dividend to be slashed.

The problem for Iluka is that its leadership role in the “sands” industry means it also acts as a swing producer, trimming output when prices fall in order to maintain profitability – however marginal.

At current rates of production from its mines in Australia and the US Iluka is running at about 60% of installed capacity, thanks to self-imposed cutbacks.

In theory, when demand for paint pigment and ceramic tiles picks up in the major consuming markets such as China, Iluka will be well placed to accelerate output. This is one reason why most analysts have not lost faith in the stock, despite its fall from a peak last week of $11.54 to a low on Friday of $9.73.

Since hitting that multi-month low-point Iluka has been slowly clawing back lost ground to trade most recently at $10.12, and most brokers who follow the stock have retained their outperform recommendations.

The odd man out among the investment banks is Macquarie, which sees Iluka retreating further to a target price of $9.50 thanks to weak prices for mineral sands and zircon.

“Iluka has said that weakness in the third quarter is unlikely to be offset in full by stronger sales in the current quarter,” Macquarie said.

While acting as a useful warning, the Macquarie view is not widespread. CIMB Securities, J.P. Morgan, Merrill Lynch, and Credit Suisse have outperform recommendations, with those brokers all expecting higher mineral prices next year.

J.P. Morgan said industry data points to a recovery in titanium dioxide and zircon feedstock, adding that “it’s too early to suggest that the weaker demand in the September quarter was a trend.”

Anyone buying Iluka today is doing so on the strength of a forecast recovery next year when net profit is tipped to rebound to around $173 million after the company incurs a big fall this year to a lowly $20 million.

Despite Macquarie’s forecast of a share price decline to $9.50, other brokers see a share-price recovery ahead of the mineral market recovery. J.P. Morgan is tipping a 12-month price target of $12.85, Credit Suisse $12, and CIMB $12.10.

Paladin Energy (PDN): Underperform.

Once a star of the uranium sector when trading at more than $10, Paladin Energy has collapsed to less than 50 cents. And while some people believe it can’t drop further, there is a risk that Paladin is a “falling knife” with the potential to inflict pain on bargain hunters.

The problem with Paladin is a combination of relatively high-cost production at its two uranium mines in Africa, the low world uranium price, and the ongoing need for the company to raise capital to cover the revenue shortfall.

Promises of cost reductions and forecasts of a higher uranium price have not eventuated, with the net result being a string of heavy annual losses that are expected to continue into next financial year.

The consensus view of analysts who follow the stock is that it should enjoy a share-price recovery over the next 12-months, but that seems to be a view based on a sustained recovery in the uranium price and a recovery in sentiment towards nuclear power.

While uranium could make a comeback, it is worth noting that its supporters have been predicting a turn in the market for several years – without much joy. Adding to the negative outlook is a worldwide push into natural gas which has, in turn, cut the price of other fuel sources such as coal and oil, while in the background there is an increasing use of renewable power sources such as wind and solar.

Even Paladin’s supporters are finding it had to justify investment in the current market. UBS rates the stock as neutral, with a 12-month price target of 70c (52% above last sales at 46c), noting the high rates of “cash burn”. This suggests that “an asset sale is necessary within the next 12-months”.

John Abernethy also rates Paladin to underperform is his article Seven stocks that are not so magnificent.

Buru Energy (BRU): Outperform (high risk).

The next 12-months are shaping as a make or break period for Buru, a small oil and gas explorer with a big footprint in one of Australia’s most prospective regions for conventional and unconventional petroleum deposits – the Canning Basin in WA’s remote north-west corner.

Early modest success in finding a small oil pool in the Ungani well, and “wet gas” in tight rock formations (shale gas) has re-confirmed the theoretical potential for the Canning to contain large accumulations of petroleum.

However, repeated cycles of exploration and re-appraisal has never been able to make a major strike such as that predicted more than 30 years ago when the American company, Occidental Petroleum, discovered the Blina oilfield. This strike prompted a premature forecast that the region would prove to be “bigger than Libya”.

Buru has attracted heavy-duty financial and technical support for this latest phase of Canning exploration, with funds flowing from Japan’s Mitsubishi and the big aluminium producer, Alcoa, which wants extra gas for its south-west alumina refineries.

Developments scheduled for the next few months include upgrading oilfield equipment at the Ungani field and at an export facility at Wyndham, flow testing of the Ungani North well, and rock-fracturing programs in tight gas discoveries.

J.P. Morgan rates Buru as its preferred exposure to small ASX-listed oil and gas stocks, noting in a review of the sector that 2014 “is shaping as a critical year for the Canning Basin pure play as it progresses the conventional oil plays and tight wet gas plays in tandem”.

Other investment banks agree that Buru is set for a big year, but also warn that it is still largely an exploration punt and will need a big discovery to justify the high-cost of development in the Canning.

With the stock trading around $1.64 price forecasts look almost too tempting to be true. J.P. Morgan has a target of $3.18 on the stock. Deutsche Bank sees $2.90 as the target, and Macquarie says $2.80.

It is high risk, with potential high reward.

Hot Chili (HCH): Outperform (high risk).

High-grade copper intersections from drilling at its Productora project in Chile has sparked fresh life in the share price of Hot Chili, which had been sold off in line with the sliding price of copper.

With a best recent result of 71 metres assaying 1.6% copper and 0.4 grams of gold a tonne the Habanero prospect within the greater Productora area could signal a significant expansion of the known resource base at what is shaping to be a world-class discovery.

The latest drill results, which also include an even thicker intersection (181m assaying 1% copper), will be included in a revised resource upgrade for Productora.

On the market, Hot Chili shares have reacted positively to the latest assays, rising from a 12-month low of 39.5c as recently as two weeks ago to close at 50c yesterday after a rise of 5c (11%) on the day. Conditions have improved since August, when Hot Chili was given a neutral rating (click here).

Not widely researched because of its small-cap classification and a market value of just $166 million Hot Chili does have one strong supporter in Macquarie Equities, which rates it a stock that will outperform with a 12-month price target of 93c.

“Hot Chili views the (latest) results as particularly significant as they indicate a new east dipping trend of the mineralisation which the company believes could be repeated,” Macquarie said.

“We continue to be encouraged by the potential for resource growth at Productora, particularly along the deposits eastern margin.”

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