Company: Illuka Resources Ltd 


Share Price: $3.45

Market cap: $1.45bn

Recommendation: ‘Avoid’

After underperforming throughout the commodities boom, Iluka has earned a firm reputation as the ‘dog’ of the resources sector. With its share price recently at decade lows, investors may be hard pressed in seeing few opportunities for the stock outside a flea circus. So is this a fair presumption?

For the uninitiated, Iluka is one of the world’s leading producers of mineral sands, which includes zircon and titanium dioxide minerals such as ilmenite, rutile, synthetic rutile, and leucoxene. Iluka is the largest producer of zircon in the world, with an approximate market share of 34% and the second largest producer of titanium dioxide minerals with an approximate market share of 18%.

The largest application for titanium dioxide is as a white paint pigment, while zircon demand is dominated by ceramics. Both markets are leveraged to the building industry. Despite a subdued outlook on that front, management was surprising the market as recently as February with forecasts for higher mineral sands prices, underpinned by tight supply. The bullish commentary came on the back of two profit upgrades in late 2008 and saw the stock make a hard nosed attempt to break its three year downtrend.

 After underperforming throughout the commodities boom, was Iluka finally about to shine just as the backside was falling out from all other resource markets?

With new higher margin growth projects in the Murray and Ecula Basins poised to lead production, the stars seemed to be aligning….But over the last few month’s demand has not been as resilient as first thought, and management have been forced into production cut backs – no doubt after a serving of ‘egg on face’ at the latest boardroom lunch. Running the largest mineral sands producer in the world, if management don’t have a firm grasp of market conditions – then what chance do investors have?

The company now faces a heavy task of restoring investor confidence, and we wouldn’t be surprised to see a little more conservatism adopted when the time comes to flag an upward turning point in demand. In the interim, Iluka enters FY2010 with two new world class growth projects coming online, but a stagnant market to sell into. The stage 2 expansion of its existing Murray Basin operations, and stgelopment of the ‘greenfield’ Jacinth-Ambrosia project in the Ecula Basin together had the potential to double Iluka’s production of high value zircon and rutile. Both are due to come online over the next 12 months, however instead of expanding the company’s production profile they are now being used to replace higher cost production from legacy operations in WA.

Depending on how demand fairs, this strategy should at least insulate earnings, however the impact at this stage is unclear. In the absence of a clear value proposition, we are happy to wait for confirmation of improved demand. When that time does come, we don’t expect the stock to retain its ‘dog’ of a reputation. While it has a strong track record for underperformance, in an expanding mineral sands market, Iluka’s new production base should ensure that it finally delivers long overdue shareholder value.

In the interim, until all these stars align, we rate the stock an ‘avoid’. Heavy investment in its Ecula and Murray Basin growth projects has left its balance sheet somewhat fully geared. Meanwhile dividends have been suspended, and uncertainty in the mineral sands market doesn’t provide much substance for investing on the basis of earnings. On a positive note, the company does appear ‘asset rich’, with enormous tenure across southern Australia that could yield exploration upside outside of mineral sands. But surprises aside on the prospecting front, the stock’s recent rally has been driven by fairly soft volumes – suggesting that the market shares our cautious view.

Tim Morris is an analyst at Please note that simply publishes broker recommendations on this page. The publication of these recommendations does not in any way constitute a recommendation on the part of You should seek professional advice before making any investment decisions.


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