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Morningstar | Not Only Clouds on the Horizon for Iluka but Some Sunshine, Too

The market appears to have been overly pessimistic of late in selling down Iluka’s shares. After peaking in May 2018 above AUD 12.00, the shares declined about 40% to recent lows of nearly AUD 7.00. We contend that concerns around a potential slowdown in demand for zircon and titanium dioxide feedstocks, and for prices to only fall from here, are overblown. Scars from the most recent multiyear price downturn are still fresh in investors’ minds, but we think conditions this time around are different. Key is the supply challenge facing the industry with undeveloped deposits of lower grades and quality than those now in production. In addition, the major mines in production are also generally facing challenges form grade declines and depletion.

Contrary to what may seem intuitive, we think the supply challenges will be a positive for the industry and Iluka, helping to preserve supply discipline. Relative to history, higher prices will be required to incentivise the new supply required to offset declines at maturing mines. It’s likely rutile, synthetic rutile, and zircon prices in particular will remain elevated for longer than the market thinks, due to the supply headwinds.

Those expecting a pessimistic outlook from Iluka and for prices to come under pressure were delivered a reminder that all is not bad. Iluka secured price increases for rutile and synthetic rutile of 9% to 11%, respectively, for the first half of 2019. This is somewhat stronger than we expected, and we raise our rutile price forecast for 2019 to USD 1,150 per tonne from USD 1,050 per tonne previously. Our 2019 earnings forecast rises 8% to AUD 0.98 per share as a result.

Iluka’s shares increased 9% on the day but this likely reflects the market’s overly pessimistic prior outlook, rather than a material improvement relative to our long-term expectations. The higher near-term rutile and synthetic rutile prices alone are not enough to drive a change to our AUD 10.50 per share fair value estimate.

As previously flagged, Iluka said demand for zircon was relatively soft in in the fourth quarter of 2019. Europe and India slowed more than Iluka expected, however the company says underlying demand remains strong. Ceramics producers were cautious with zircon purchases in late 2018, preferring to draw down inventories. However, in the absence of a material downturn, the drawdown on inventory reflects a source of demand for 2019 as downstream zircon consumers restock inventories from low levels. Iluka says the overall zircon market is balanced now but sees an emerging structural deficit and tightness in the future due to challenged supply. The company intends to continue to provide lower grade zircon in concentrate supplies to help meet demand.

The market for titanium dioxide feedstocks is strong, as reflected by the latest price increases. Iluka characterises the market as tight, reflecting supply side issues at a number of mines in 2018, including Iluka’s Sierra Rutile operations. The company expects strong demand in 2019 and for higher grade feedstocks, such as those produced by Iluka, to do well.

Iluka’s Production in fourth-quarter 2019 was a mixed bag, but volumes overall were in line with our forecasts. Zircon output was stronger than expected and beat full-year guidance thanks to better-than-expected mining grades at Jacinth Ambrosia. Synthetic rutile output was also above guidance. Rutile volumes from Sierra Leone were weak. Iluka had flagged issues from strikes and unplanned maintenance, but the volume reduction was worse than we anticipated. We expect improvements in 2019 as Iluka exhausts the current mining area and commissions two new expansions. Construction of both expansions remains on schedule.

We’re intrigued by Iluka starting a pre-feasibility study on its fine minerals deposit in the Murray Basin. The study is due to finish by the end of 2019. The company has been researching the ability to recover fine grained mineral sands since 2014 and believes they have a suitable processing technology. A test pit has provided ore for processing trials and we look forward to the results. If successful, the fine minerals deposits could provide a new large, long-life future source of zircon to replace Jacinth Ambrosia. Iluka will also undertake a final trial of its unconventional underground mining technology this year. The company seeks to confirm its viability this year. If successful, it would provide an important high-grade and flexible source of rutile supply for Iluka from the Balranald deposit.