Category: Financial Markets
Business Strategy and Outlook
Iluka is a leading global mineral sands miner. Major mines are its Jacinth-Ambrosia mine in the Eucla Basin in South Australia, Cataby in Western Australia and Sierra Rutile in Sierra Leone.Iluka’s main focus is on managing volumes and the resulting impact on prices. Efforts to maintain margins and prices means sales volumes can fall in periods of weak demand as Iluka shoulders part of the responsibility for balancing industry supply, but Iluka can also flex production to increase its market share, or liquidate excess inventories, as prices rise. Maintenance capital expenditure is relatively modest, but expansions and reinvestment to prolong life are generally pursued when Iluka sees a need for new demand and potential for reasonable returns on investment. Conversion of resources to reserves is an obvious path to life extensions, but resources are likely lower-grade and higher-cost.
The balance sheet is relatively strong with net cash of around AUD 300 million at end-December 2021. Iluka intends to maintain a conservative balance sheet with no net debt on average through the cycle. This should provide the appropriate capacity to finance inventory build when necessary and invest through the cycle.Management values cash returns to shareholders, primarily through dividends, but will flex depending on investment needs.
Mineral Sands Prices Continue to Rise on Strong Demand, Raising Iluka FVE to AUD 9.70
Iluka Resources continues to benefit from booming mineral sands markets, with both the zircon and titanium dioxide feedstock markets continuing to bounce back after the COVID-19-induced weakness in 2020. Zircon sales of 355kt were up 48% in 2021, reflecting demand strength across all of the company’s markets. High-grade titanium dioxide feedstocks also showed strong demand, supported by production issues at Rio Tinto’s Richards Bay Minerals in South Africa. Rutile sales were up 27.8%, to 207.2kt, while synthetic rutile sales rose 164% to 305.9kt. The company’s synthetic rutile kiln 2 (SR2) at Capel operated at full capacity, producing 60kt during the quarter. Given the strength in global titanium dioxide feedstock markets, restarting synthetic rutile kiln 1, due in the fourth quarter of 2022, seems reasonable. Thus, Morningstar analysts raise the fair value estimate to AUD 9.70 from AUD 9.10 on higher mineral sands prices and a lower AUD/USD exchange rate.
Financial Strength
Iluka’s balance sheet is strong with net cash of around AUD 300 million at December 2021. Modest net cash at end 2015 turned to a relatively small net debt position with the acquisition of Sierra Rutile for AUD 455 million in late 2016. The subsequent improvement in prices meant debt was repaid by the end 2018. Iluka intends to maintain a conservative balance sheet and targets no net debt on average through the cycle. The company’s strategy is to build inventory during periods of weak sales demand. Excess inventories at the end of 2016 were about AUD 400 to 500 million. The excess inventories were largely liquidated through 2017 and 2018 as external conditions improved and sales volumes exceeded production. Iluka is expected to use cash flow for incremental organic growth projects, the potential expansion of Sierra Rutile, debt repayment and cash returns to shareholders (primarily dividends). In the medium to long term, cash flows will either be reinvested or returned to shareholders. Iluka’s total debt facilities stood at AUD 500 million at end-June 2021, maturing in July 2024. The debt profile gives significant financial flexibility to hold inventory or make opportunistic and/or countercyclical investments.
Bulls Say
- Iluka is an industry leader with relatively high grade zircon and rutile deposits. Supply can be withheld to defend prices and margins in times of weak demand.
- Management has improved company fortunes with a strong focus on returns on capital. Demand for zircon is likely to be bolstered by new applications such as chemicals and digitally printed tiles.
- Iluka has some diversification. The revenue mix is approximately half from zircon and half from high grade titanium products. Geographically, revenue is split between North America, Europe, China and the rest of Asia.
Company Profile
Iluka Resources is a leading global mineral sands miner. It is the largest global producer of zircon, and the third-largest producer of titanium dioxide feedstock (rutile, synthetic rutile) behind Rio Tinto and Tronox. Low zircon costs are underpinned by the high-grade Jacinth-Ambrosia mine in South Australia but reserve life is less than 10 years. The Sierra Rutile operations in Sierra Leone lack a cost advantage but expansions could bring some scale economies if they can be effectively executed. A 20% shareholding in Deterra Royalties brings exposure to the high-quality Mining Area C iron ore royalty. Iluka’s nascent rare earths operation at Eneabba is a low-cost source of rare earth oxides neodymium and praseodymium, albeit with a reserve life of only around 10 years.
(Source: Morningstar)
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.
Business Strategy and Outlook
AGL is one of Australia’s largest integrated energy companies. We believe it has a narrow economic moat, underpinned by its low-cost generation fleet, concentrated markets, and cost-advantages from vertical integration. Key attractions for shareholders include relatively defensive earnings, solid dividends, and relatively conservative gearing. Earnings are dominated by energy generation (wholesale markets), with energy retailing about half the size. Strategy is heavily influenced by government energy policy, such as the renewable energy target.
AGL has proposed a structural separation into two businesses; a multi-product energy retailer focusing on carbon neutrality and an electricity generator that will own AGL’s large fleet of coal fired power stations among other assets. It is expected to be completed in mid-2022.
AGL’s consumer market division services over 4 million electricity and gas customers in the eastern and southern Australian states, representing roughly a third of available customers. Retail electricity consumption has barely increased since 2008, reflecting the maturity of the Australian retail energy market and declining electricity consumption from the grid. Despite deregulation and increased competition, the market is still dominated by AGL Energy, Origin Energy, and Energy Australia, which collectively control three fourths of the retail market.
AGL’s wholesale markets division generates, procures, and manages risk for the energy requirements of its retail business. The acquisition of Loy Yang A and Macquarie Generation means electricity production significantly outweighs consumption by its retail customers. Exposure to energy-price risks is mitigated by vertical integration, peaking generation plants and hedging. More than 85% of AGL’s electricity output is from coal-fired power stations. AGL Energy has the largest privately owned generation portfolio in the National Electricity Market, or NEM.
Financial Strength
AGL Energy is in reasonable financial health though banks are increasingly reluctant to lend to coal power stations. From 1.4 times in 2020, we forecast net debt/EBITDA rises to 2.1 times in fiscal 2022. Funds from operations interest cover was comfortable at 12.8 times in fiscal 2021, comfortably above the 2.5 times covenant limit. AGL Energy aims to maintain an investment-grade credit rating. To bolster the balance sheet amid falling earnings and one-off demerger costs, the dividend reinvestment plan will be underwritten until mid-2022. This should raise more than AUD 500 million in equity. Dividend pay-out ratio is 75% of EPS
Bulls Say’s
- As AGL Energy is a provider of an essential product, earnings should prove somewhat defensive.
- Its balance sheet is in relatively good shape, positioning it well to cope with industry headwinds.
- Longer term, its low-cost coal-fired electricity generation fleet is likely to benefit from rising wholesale electricity prices.
Key Investment Considerations:
- Fiscal 2022 will be tough but high wholesale gas and electricity prices bode well for earnings recovery from 2023.
- The proposed separation of AGL’s retail and generation businesses will likely be somewhat value destructive due to potential duplication of resources and loss of scale benefits.
- The Australian energy sector is heavily influenced by government energy policy, particularly over emissions and utility bill affordability.
Company Profile
AGL Energy is one of Australia’s largest retailers of electricity and gas. It services 3.7 million retail electricity and gas accounts in the eastern and southern Australian states, or about one third of the market. Profit is dominated by energy generation, underpinned by its low-cost coal-fired generation fleet. Founded in 1837, it is the oldest company on the ASX. Generation capacity comprises a portfolio of peaking, intermediate, and base-load electricity generation plants, with a combined capacity of 10,500 megawatts.
(Source: Morningstar)
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.
Business Strategy and Outlook
Hess’ track record for efficiently allocating capital and generating value has been steadily improving for several
years. This had been a source of frustration for shareholders in the past. Before 2012, the firm was struggling
with persistent budget overruns and costly exploration failures, and the eventual collapse in its share price led
to a heated proxy fight with an activist investor (which it lost). Subsequently, the board was reshuffled, and
management began streamlining the company, selling midstream and downstream assets and rationalizing its
upstream portfolio. The current portfolio is more competitive, but the development cost requirements are
heavily front-loaded.
Currently, Hess is one of the largest producers in the Bakken Shale, with about 1,700 producing wells and about
530,000 net acres of leasehold. This includes a large portion in the highly productive area near the Mountrail-
McKenzie County line in North Dakota. Even with four rigs, it would take more than 10 years to develop this
position, and to conserve capital in the wake of the COVID-19 pandemic management is only running two rigs
(with a third to be added late 2021). Like peers, Hess has made huge strides with enhanced completions. It is
expected 180-day cumulative oil production to average 150 mbbls going forward (consistent with break-evens
of about $40/bbl. for West Texas Intermediate).
Hess also holds a 30% stake in the Exxon-operated Stabroek block in Guyana, which will be the firm’s core
growth engine going forward and is a game-changer for the company, due to its large scale and exceptional
economics. The block contains numerous confirmed discoveries already, including Liza, which came online in
late 2019. Economically, these projects appear around on par with the Bakken. But the up-front capital
demands are onerous–Hess’ share of the first development phase was over $1 billion. Six phases are currently
planned, culminating in gross volumes of about 1 mmb/d and management has suggested there is scope for as
many as 10 phases in the ultimate development. Total gross recoverable resources are a moving target, but the
latest estimate is over 9 billion barrels of oil equivalent.
Financial Strength
Hess’ Guyana assets are capital-intensive (it must pay 30% of the development costs, which run to $1 billion-$2
billion for each sanctioned phase of development; a total of six are currently planned and more than that are
likely eventually). And these commitments are heavily front-loaded. As a result, capital spending has
significantly exceeded cash flows in the last few years, leaving the firm with leverage ratios that are elevated
from the historical norm. At the end of the last reporting period, debt/capital was 57%, while net debt/EBITDA
was 1.8 times. The good news is that the firm’s liquidity backstop is very strong, as it prefunded a portion of its
Guyana commitment with noncore divestitures. The firm has a $2.4 billion cash war chest, and there is more
than $3 billion available on its credit facility as well. In addition, the term structure of the firm’s debt is fairly
well spread out, and there are no maturities before 2024 (other than a $1 billion term loan due 2023 and likely
to be paid in full with operating cash flows by the end of 2022).The firm does have a covenant requiring it to
Commodities – Energy
28 January 2022
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keep debt/capital above 0.65, though it isn’t expected to get close to that level (and if it does a violation would
still be unlikely because in the associated debt agreement capital is defined to exclude impairments).
Bulls Say’s
The Stabroek block (Guyana), in which Hess has a 30% stake, is a huge resource, with at least 9
billion barrels of oil equivalent recoverable.
The first phase of the Liza development is profitable at $35/bbl (Brent), making it competitive with
the best shale. Management expects similar economics from subsequent projects in Guyana.
Hess’ activity in Guyana provides geographic diversification and insulates it from domestic issues
(like antifracking regulations).
Company Profile
Hess is an independent oil and gas producer with key assets in the Bakken Shale, Guyana, the Gulf of Mexico,
and Southeast Asia. At the end of 2020, the company reported net proved reserves of 1.2 billion barrels of oil
equivalent. Net production averaged 323 thousand barrels of oil equivalent per day in 2020, at a ratio of 70%
oil and natural gas liquids and 30% natural gas.
(Source: Morningstar)
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal
financial situation, objectives or needs of any particular person.
