citi report - $8.30 price target

Supply Crunch Coming

 Step Change in Prices ? Iluka hosted a bullish briefing on the mineral sands markets talking about a step change in pricing for both zircon and high grade titanium dioxide feedstocks in 2011+. We recently upgraded our price forecasts significantly, but we would not deem them to be a step change. If Iluka can deliver these price outcomes then there is upside risk to our 2011+ estimates, NPV and therefore target price. Iluka is Buy rated with a A$8.30/share target.

 Zircon Price of US$1,500-1,800/t ? Zircon prices of US$1,500-1,800/t, depending on by-product TiO2 prices, are required by 2015 to induce enough supply to meet conservative demand growth of 4%pa (China 8%pa and ROW 0%pa v 1990-2007 average of 18% and 1% respectively). We forecast zircon prices to peak at US$1,200/t in 2012 and remain flat through to 2015.

 Feedstock Markets Tightening ? High grade TiO2 markets are also tightening dramatically. Pigment markets are tight and to maximise production customers are requiring more of the high grade feedstocks that Iluka produces ? rutile and synthetic rutile. This is expected to drive a step change in prices in 2011 and move to shorter duration contracts (half yearly). We forecast a 14% increase in rutile and 26% rise in SR prices in 2011, a solid increase, but not a step change.

 Risks ? Zircon and TiO2 feedstock prices only represent <10% of final product prices so substitution rather than demand destruction would appear to be the biggest threat outside a double dip global recession. There are limited economic substitutes for zircon and no major substitutes in pigment. The trend towards porcelain tiles is a positive demand driver as this requires 10x the zircon of ceramic tiles. Only ~7% of Chinese capacity is porcelain v 75% for Italy, yet China is still the biggest market accounting for 40% of zircon demand.

Valuation

Our target price for Iluka is A$8.30/share based on a 50/50 combination of 10% discount to NPV and FY11e PE and EV/EBITDA multiples. Our ILU valuation (NPV) of A$8.30/share is based on DCF analysis using a 7.9% real, after tax, unlevered discount rate and a beta of 1.1. Long-term equilibrium commodity prices and other key assumptions are available in our Metals & Mining Strategy reports.

Risks

We rate ILU as High Risk, referencing a number of quantitative and fundamental screens. Key risks to our projected earnings, cash flows and valuation relate to weaker than expected commodity prices/economic growth and further appreciation of the A$. Iluka's assets are located within Australia and the US so country risk is low. Operating risk is moderate due to the number of producing assets. Positive risk factors are further exploration success and the sale of non-core assets. Favourable or adverse movements of these risk factors may cause ILU's share price to deviate from our target price.