re: as i said - macbank pick of the day Trading Pick of the...

re: as i said - macbank pick of the day Trading Pick of the Day

24 October 2005
ZFX: Upgrades to Come

Macquarie Research Equities (MRE) has reconsidered its price target for Zinifex (ZFX) following its recent strong performance. MRE believe the stock will appeal to short term investors with a bullish view of the zinc market who may be prepared to overlook the current lack of organic growth opportunities.

The leveraged beast. Zinifex continues to adhere to its ‘no hedging’ policy, and thus remains extremely leveraged to movements in zinc prices and the AUD/USD exchange rate. Each ¢/lb increase in the Zinc price increases ZFX Earnings Before Interest Tax Depreciation and Amortisation (EBITDA) by approximately $pbl18m. In light of MRE’s top of market expectation for zinc prices, MRE has identified four key positive drivers for further performance:

Driver 1 – explosive market-wide upgrades. The market currently sits well below MRE’s expectation for zinc price in each of the coming three years. MRE’s average zinc price expectation for the three years 2006–2008 is US72¢/lb, compared to the market at ~US60¢/lb. Based on company stated sensitivities, in isolation this could mean average annual earnings upgrades of ~A$220m! Additionally, the market also sits well below the current spot price of US69¢/lb, and with significant deficits forecast between supply and demand, MRE believe the zinc price is much more likely to go up rather than down.
Driver 2 – further capital management. So far this calendar year, Zinifex has committed $90m to capital management, and MRE expect capital management to be an ongoing theme. MRE estimate that ZFX will generate ~$2bn (~A$4per share) of free cash between 2006 and 2010, providing significant opportunities for further capital management initiatives.
Driver 3 – any exploration success. News of any exploration success would provide a fillip for the Zinifex share price. The key strategic issue for the company remains its lack of long-term mine supply following the expected exhaustion of Century in ~2015. The discovery/acquisition of substantial zinc reserves would alleviate the longer term strategic concerns for this company to
complement the strong cashflow generation in the short/medium term.
Driver 4 – continued zinc price momentum. Evidence suggests that the market is trading ZFX as an equity proxy for the zinc price. The ZFX share price strongly correlates with the A$ zinc price. Continued positive momentum in the zinc price is likely to continue the positive performance for Zinifex. Based upon MRE’s expectation for the strong relationship to hold, MRE has revised their price target up from $5.00ps to $6.00ps. Zinifex at $6.00ps would still be trading on an average Price to Earnings multiple of approximately 5.5x for FY07–FY09, though it would be very stretched relative to MRE’s valuation of $4.23ps.
The key risks. MRE do note that, as for any statistical analysis, there remains risk in the price target method. Additionally, MRE highlight that ZFX relies heavily for profitability on one operation (Century), where a single supply disruption could prove costly.

Zinifex continues to trade on only 4–7x earnings over the next four years. Market-wide earnings revisions driven by the chronically tight zinc market will continue to drive the stock. MRE believe the stock will appeal to short term investors with a bullish view of the zinc market who may be prepared to overlook the current lack of organic growth opportunities. MRE reiterate its outperform recommendation.