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Iluka Resources Ltd – Exposed to Mineral Sands

The long life Sierra Rutile operation is the key source of rutile but lacks a cost advantage. It may come in time as the company expands and builds scale economies. The new Cataby mine bolsters zircon output and maintains feedstock for the production of synthetic rutile. Iluka’s 20% ownership of Deterra Royalties brings exposure to the high-returning iron ore royalty over BHP’s Mining Area C. It is the sole moat-worthy asset but comprises less than 10% of our fair value estimate.

Key Considerations

  • Iluka’s shares are undervalued with demand set to recover from coronavirus-inspired lows. Disruption to other suppliers is likely to see prices remain resilient despite lower demand.
  • As a large producer of both zircon and high-grade titanium dioxide products (rutile and synthetic rutile), Iluka has some ability to flex output to meet either weak demand and strong demand.
  • Reserve life is moderate at around 10 years but Iluka has a sizable resource base which covers at least 25 years of production at 2018 rates. We expect resources to convert to reserves as Iluka clears feasibility and technical hurdles.
  • 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 highgrade titanium products. Geographically, revenue is split between North America, Europe, China and the rest of Asia.
  • Mineral sands markets are relatively small. Sales volumes can go through periods of significant demand weakness, such as in 2008-09 and 2012-16.
  • The largest single source of demand for zircon is China, accounting for nearly half. China could throttle back on fixed-asset investment-driven growth, which may see subdued zircon sales volumes and prices. OThe Jacinth Ambrosia deposit is very high-grade, with a large component of high-value zircon. Reserve life is less than 10 years and it will be nearly impossible to replicate the returns and competitive position once depleted.

 (Source: Morningstar)

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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.

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Worley Ltd

Worley says its strategic transformation is accelerating as it increasingly supports customers moving to a low-carbon future. While traditional business continues to be an important part of Worley’s activities, sustainability is providing a higher rate of future growth and margin. The company says its work backlog at end of March 2021 had increased to AUD 14.1 billion, from AUD 13.5 billion at December 2020’s end, with activity levels on long-term projects returning and key project awards in both sustainability and traditional services. Sustain ability focused work comprises 29% of current aggregated revenue, but a considerably higher 45% of the factored sales pipeline (upcoming work). In the half to December, Worley delivered AUD 1.2 billion in sustainability revenue at more favourable margin.

Worley characterises the global market size for sustainable design to 2035 as approximating USD 4.5 trillion per year, of which its addressable share is estimated at 10%-20%. And for decarbonisation investment, its addressable share is estimated at 3% to 15% of a total USD 1.5 trillion annual spend. It’s a big market for a company with current annual revenue approximating just AUD 10 billion.

And despite having a similar risk profile to other services– not lump sum turn-key–sustainability activities have more favourable gross margins. This reflects their technically complex nature involving technology integration and modification to existing facilities, with often challenging logistics requiring expertise in scaling-up. This provides opportunities to embed automation and digital solutions. Worley is accelerating its digital technology to create high value solutions and drive margin improvement including in artificial intelligence and machine learning.

At around AUD 10.70, Worely shares are up 75% on March 2020 lows, and are currently only somewhat undervalued, in 3-star territory. Our fair value estimate equates to an unchanged fiscal 2025 EV/EBITDA of 7.2, a P/E of 15.4, and dividend yield of 4.9%. We still assume a five-year EBITDA CAGR of 9.5% to AUD 1.15 billion. Our 9.2% midcycle EBITDA margin assumption betters the five-year historical average to June 2020 of 7.2%. In addition to the historical period including COVID-19 imposts, improvement reflects both cost-outs and higher assumed sustainability margins.

Worley achieved run rate cost synergies from the ECR acquisition of AUD 190 million in April 2021, already factored in our base-case valuation. We mention this completed program simply in recognition of form–the program being completed on time and at considerably greater magnitude than the original target of AUD 130 million. Future cost-outs are to come solely from operational savings targeted at a total AUD 350 million by June 2022. Worley said it had banked approximately 70% of these on an annualised basis at the December 2020 mark. We estimate this leaves around 1.0% of EBITDA margin improvement left from this source. The balance of our forecast margin improvement can be expected to come via the return of volumes post-COVID over which fixed costs can be disbursed, and via higher margins from growing sustainability activities.

At end December 2020, Worley’s net debt excluding operating leases stood at AUD 1.2 billion, (ND/(ND+E)) 18.4% and annualised net debt/EBITDA of 2.4. Net debt/ EBITDA was somewhat elevated, reflective of the AUD 4.6 billion ECR takeover. We estimate current net debt little changed, but project sub-1.0 net debt/EBITDA by as soon as fiscal 2022 and an unleveraged balance sheet by fiscal 2025, all else equal. This includes assumption of a 75% payout ratio for a prospective plus 6.0% unfranked yield from fiscal 2023.

Source:Morningstar

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Fletcher Building materials businesses possess many strong brands

Commodities - Oil, Gold, Silver, Copper, Corn, Coal, Wheat and Coffee Beans isolated on white background. 3D render

At the group level, however, returns are below the cost of capital, as the firm has made poor acquisitions in adjacent segments and new geographies and suffered execution issues in the construction division. This has overwhelmed the positive impact of an unprecedented building cycle in Australia and New Zealand which peaked in 2018. Following the substantial losses sustained in its construction segment, Fletcher has taken corrective action–divesting its global Formica business and backing away from commercial construction projects which led to significant losses. But we’d like to have seen a more comprehensive restructure, involving a marked reduction in the group’s level of diversification. We’d advocate for Fletcher to re-focus the group’s attention on its businesses which are well positioned competitively. The potential for management to create value for shareholders is maximised when it’s free from the distraction that comes with the ownership of a plethora of disparate businesses.

The company operates across seven divisions: building products, distribution, steel, concrete, construction, residential and development, and Australia. We forecast improving EBIT margins across most divisions, with the most pronounced improvement in building products and Australia, but aren’t confident ROICs can sustainably remain above cost of capital. Nonetheless, strong brands, dominant market share in key categories, and control of distribution should help to sustain pricing and margins in the building products division, which generates around 6% of group revenue and 20% of adjusted EBIT. We see steady growth in revenue and slight margin expansion, resulting in mid-single-digit EBIT growth over the long term.

Financial Strength

With the balance sheet awash with liquidity, Fletcher also announced a NZD 300 million share buyback. With the cyclical revival of residential construction activity in New Zealand and Australia, we think the return of cash to shareholders is well-timed. With the buyback to commence in June 2021, we anticipate the lion’s portion of share repurchases will occur in fiscal 2022. Upon conclusion of the share buyback, we forecast leverage–defined as net debt/EBITDA including IFRS 16 lease liabilities–of 1.4 times at fiscal 2022 year-end, near the midpoint of Fletcher’s through-the-cycle leverage target of 1-2 times and up from 1 times at fiscal 2021 year-end. As such, significant debt covenant headroom exists relative to Fletcher’s leverage covenant, which is calibrated at 3.25 times net debt/EBITDA. While further capital expenditure will be allocated to Fletcher’s new plasterboard facility–with total project spending of an estimated NZD 400 million—other nonessential capital outlays have been pared back in order to minimise cash outflows in fiscal 2021. Management anticipates NZD 230 million in capital expenditure in fiscal 2021. We forecast full-year dividends of NZD 0.27 per share, reflecting a 70% payout of net income–near the top end of Fletcher’s targeted 50%-75% payout ratio.

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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.

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Woodside Petroleum – Ideally Placed

Under its watch, the number of LNG trains has grown from one to five, taking gross output to 16.4 million metric tons per year. This pedigree is unmatched in the Australian oil and gas space, and there’s more potential development in the pipeline if prices will allow. Missteps, including commissioning delays and cost blowouts during the China-driven resources boom, are now past. Woodside has demonstrated commendable conservatism in capital allocation over several years.

Key Investment Considerations

  • More than 80% of our Woodside fair value estimate derives from one product, LNG. LNG prices are referenced on a three-month running lag to the Japanese Customer Cleared oil price, so oil prices are key to any analysis.
  • Including Pluto Train 2 and Other Prospects, around 30% of our fair value estimate derives from projects yet to produce any gas, reflecting our expectation for substantial growth.
  • We are comfortable with a high proportion of value in development projects, given Woodside’s proven LNG delivery platform and first-mover advantage on the North West Australian coast.
  • As Australia’s premier oil player, Woodside Petroleum’s operations encompass liquid natural gas, natural gas, condensate and crude oil. However, LNG interests in the North West Shelf Joint Venture, or NWS/JV, and Pluto offshore Western Australia are the mainstay, and the low-cost advantage of these assets form the foundation for Woodside. Future LNG development, particularly relating to the Pluto project, encompasses a large percentage of this company’s intrinsic value.
  • Woodside is well suited to the development challenge. With extensive experience, it remains a stand-out energy investment at the right price. Gas is the fastest growing primary energy market behind coal, and the seaborne-traded LNG portion of that gas market grows faster still. China is building several import terminals, and so demand is likely to pick up, helping to move LNG pricing toward oil parity on an energy-equivalent basis.
  • Woodside is a beneficiary of continued global economic growth and increased demand for energy. Behind coal, gas has been the fastest-growing primary energy segment globally. The traded gas segment is faster-growing still, and Woodside is favourably located on Asia’s doorstep.
  • Woodside’s cash flow base is comparatively diversified, with LNG production making it less susceptible to the vagaries of pure oil producers. Gas is a primary component of Asian base-load power generation, instilling an element of demand stability, and is generally sold under long-term contracts.
  • Gas has around half the carbon intensity of coal, and it stands to gain market share in the generation segment and elsewhere if carbon taxes are instituted, as some predict.
  • The global economy is cooling off and demand for energy will follow suit, particularly if Chinese growth rates taper.
  • Technological advances in the nonconventional U.S. shale gas industry have the potential to swing the demand supply balance increasingly in favour of the customer.
  • LNG developments are hugely expensive, and the balance sheet is at risk until such projects are successfully commissioned.

(Source: Morningstar)

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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.

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Fletcher’s Turnaround of Its Australia Division Is on Firmer Footing in Late Fiscal 2021

In its home market, Fletcher has strong brands and a leading distribution channel, and it dominates market share in key categories. The building materials segment in general, however, is subject to easy product substitution, low switching costs, and limited pricing power, making a competitive advantage difficult to sustain. Together with a poor track record of acquisitions, Fletcher has been unable to earn a sustainable return above its cost of capital.

Key Aspects

  • A number of Fletcher’s businesses have good competitive positioning, including the PlaceMakers distribution business and its plasterboard operations. But earnings visibility and returns on capital are low, given a complex structure.
  • The recovery in New Zealand and Australian housing construction is nearing. However, the associated cyclical benefit to Fletcher’s earnings is priced in.
  • Fletcher has divested its Formica business and is backing away from commercial construction. But Fletcher could benefit from a more broad-based restructure to refocus on its core businesses.

Company Profile

Fletcher Building is the largest building materials company in New Zealand, after it emerged from the Fletcher Challenge group in 2001. Its diverse range of business interests span building product manufacture and distribution in New Zealand and Australia, as well as commercial and residential property development. Operations have been refocused on New Zealand and Australia, following divestment of the global laminates business in fiscal 2019.

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Cabot Oil & Gas Corp

So there is no need to pay for cryogenic processing to extract NGLs from its wellhead gas volumes (saving it around $0.20 per thousand cubic feet). And because natural gas flows more easily out of a reservoir without liquids, the wells in this area are typically characterized by very high daily production rates.

As a result, the firm is among the lowest-cost natural gas producers in the Appalachia region, and this competitive advantage enables it to consistently deliver very strong returns on invested capital. But there is one catch: The Company’s acreage contains enough lucrative Lower Marcellus drilling opportunities to last until the late 2020s. Beyond that, the firm will have to rely on the overlying Upper Marcellus layer for growth, and such wells are typically up to 30% less productive. So it would be a mistake to think that all of the 3,000 or so potential drilling locations that the firm has access to will perform at the same level as the stellar wells it is drilling today. However, when the firm pivots to the Upper Marcellus, it will be able to reuse existing roads and pad sites, and as there are no well configuration constraints in this undeveloped interval, it could enhance returns by drilling longer laterals. As a result, we expect well costs to decrease enough to offset the dip in flow rates, leaving potential returns unchanged.

Our primary valuation tool is our net asset value forecast.

This bottom-up model projects cash flows from future drilling on a single-well basis and aggregates across the company’s inventory, discounting at the corporate weighted average cost of capital. Cash flows from current (base) production are included with a hyperbolic decline rate assumption. Our valuation also includes the mark-to-market present value of the company’s hedging program. We assume oil (West Texas Intermediate) prices in 2021 and 2022 will average $60 and $58 a barrel, respectively. In the same periods, natural gas (Henry Hub) prices are expected to average $3.20 per thousand cubic feet and $2.80/mcf. Terminal prices are defined by our long-term midcycle price estimates (currently $60/bbl Brent, $55/bbl WTI, and $2.80/mcf natural gas).

  • After the Cimarex merger, the firm will have ideal real estate in the lowest-cost oil and natural gas basins, amplifying returns and boosting product and geographic diversification.
  • By focusing on dry natural gas in the Marcellus, Cabot avoids NGL processing fees that would otherwise drive up production costs
  • The firm is one of the few oil and gas producers that can consistently generate excess returns on invested capital at midcycle commodity prices.
  • Cabot has less than 10 years’ worth of drilling opportunities targeting the prolific Lower Marcellus interval, and well performance could deteriorate when it is forced to pivot to the less productive Upper Marcellus.
  • The firm’s midcontinent assets have significantly higher break-evens, and expanded development in the region could dilute returns.

About Cabot Oil & Gas

Houston-based Cabot Oil & Gas is an independent exploration and production company with operations in Appalachia. At year-end 2020, Cabot’s proved reserves were 13.7 trillion cubic feet of equivalent, with net production that year of approximately 2,344 million cubic feet of natural gas per day. All of Cabot’s production is Marcellus dry natural gas.

(Source: Morning star)

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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.

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Oil Search– Investment outlook

The USD 19 billion PNG liquefied natural gas, or LNG, plant went a long way toward countering stagnating traditional oilfield productivity monetising isolated, but high-quality, gas resources. PNG gas is liquids-rich, which increases its value, but the entire proposition carries substantial risk because of investment needs and sovereign uncertainty. We expect near-term capital expenditure commitments to continue with expansion of the 29%-owned PNG LNG project, which produces 8.6 million metric tons per year. Production and earnings increased materially with the first LNG output in 2014. Oil Search has a debt-heavy balance sheet, as LNG was fully debt-funded.

Key consideration

  • More than 80% of our Oil Search fair value estimate derives from just one product, LNG. LNG prices are referenced on a three-month running lag to the average  oil price. Any analysis of fair value depends on the successful prediction of oil prices and the maintenance of the link between them.
  • Current earnings multiples are high, but the future is key. Earnings will rise when three additional PNG LNG trains are completed.
  • We are not entirely comfortable with such a significant proportion of value in one project, particularly with PNG sovereign risk. We apply a high discount rate to our fair value estimate.
  • Active in Papua New Guinea, or PNG, since 1929, Oil Search operates all producing oil fields in the country. The company has a long and profitable history of Highlands oil production, but the future value lies in substantial gas resources that were quarantined by a lack of infrastructure and high capital costs.
  • Oil Search can service its $2.3 billion in net debt using LNG and oil cash flow. OGroup equity output tripled to 29 million barrels of oil equivalent with the startup of the PNG LNG project and can grow further with completion of additional trains.
  • Past PNG LNG equity sell-downs by independents AGL Energy and IPIC were at prices considerably above levels credited in Oil Search’s share price.
  • Capital costs may escalate in this difficult operating environment. The foundation LNG project cost blewout by $3.3 billion to a colossal $19 billion.
  • Shareholders could see more heavy capital expenditure with a third PNG LNG train and other development projects.
  • Oil Search is an all-or-nothing bet on PNG LNG. Single development- project risk and sovereign risk are concerns.

 (Source: Morningstar)

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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.

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Chevron Corp

The proposal neither defined precise timelines nor imposed methods for doing so. Chevron already has in place Scope 1 and 2 reduction targets for 2028. Scope 3 emissions present a different challenge, however, given their relative amount and the fact they occur during use or combustion of oil and natural gas that takes place outside the company’s control. In 2019, Chevon’s Scope 3 emissions composed 91% of its emissions from total products sold.

Our research suggests the only currently feasible, scalable method to reduce Scope 3 emissions is through reduction in production through decline or divestment. Otherwise most any use of oil and natural gas, except as chemical feedstock, will produce Scope 3 emissions. Carbon capture could potentially do so for natural gas when used for power generation but currently lacks the scale and economic viability. Otherwise, new and emerging technologies would need to be developed.

Given the proposal calls for a reduction in Scope 3 emissions, not a reduction in Chevron’s emissions intensity, investment in renewable power would not suffice, either. Divestment, however, only reduces the company’s emissions and does nothing to address global net emissions.

A proposal for Chevron to produce a report on whether and how a significant reduction in fossil fuel demand, envisioned in the IEA Net Zero 2050 scenario, would affect its financial position and underlying assumptions just failed to pass, garnering 48% of votes cast.

Profile

Chevron is an integrated energy company with exploration, production, and refining operations worldwide. Chevron is the second-largest oil company in the United States with production of 3.1 million of barrels of oil equivalent a day, including 7.3 million cubic feet a day of natural gas and 1.9 million of barrels of liquids a day. Production activities take place in North America, South America, Europe, Africa, Asia, and Australia. Its refineries are in the U.S. and Asia for total refining capacity of 1.8 million barrels of oil a day. Proven reserves at year-end 2020 stood at 11.1 billion barrels of oil equivalent, including 6.1 billion barrels of liquids and 29.9 trillion cubic feet of natural gas.

Source:Morningstar

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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.

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Origin Energy– Outlook Is Poor

To drive earnings growth, Origin developed the Australia Pacific liquefied natural gas, or APLNG, project, which started exporting LNG from Queensland in 2016. But the project saddled the firm with too much debt and earnings have disappointed because of the low oil price. We forecast a sharp deterioration in earnings and credit metrics in fiscal 2021 on lower oil prices and headwinds in the utility business.

Key Considerations

  • Profits are supported by the relatively defensive utility business, while the oil price is a swing factor.
  • The massive Australia Pacific LNG project should generate strong cash flows in fiscal 2020 but recent falls in oil and spot LNG prices suggest major downside in 2021.
  • Origin’s credit metrics are forecast to deteriorate significantly in 2021 and could require remedial action.
  • Origin’s energy markets division is one of Australia’s largest energy utilities. It has some competitive advantages from being a major player in the concentrated national electricity market, or NEM, and vertical integration. But its generation fleet lacks cost advantages to major peers, and it’s difficult to build a moat in the competitive retail market.

  • Origin is one of the largest energy retailers in Australia, with more than one third of the market. Energy retailing is not a moat business, as the product is commodity-like, while barriers to entry and customer switching costs are low.
  • The Australia Pacific LNG project is the largest coal seam gas to LNG project in Australia and could significantly increase earnings if oil prices strengthen.
  • Origin’s energy retail business is the market leader and should benefit from cost-saving initiatives. OOrigin’s cash flow base is diversified, and the company is less susceptible to the vagaries of the market than a nonintegrated energy provider.
  • The value of APLNG is highly uncertain, given volatility in the oil price and the relatively high operating and financial leverage.
  • Falling wholesale electricity, gas and carbon credit prices have created a headwind for earnings. Retail price caps and competition should force Origin to pass lower wholesale prices through to customers.
  • The oil price slump should hurt earnings and credit metrics in 2021.

 (Source: Morningstar)

Disclaimer

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.