PORTFOLIO POINT: When Chinese builders need paint and tiles, expect a jump in demand for raw materials used in both.
No sector of the mining industry has been a bigger disappointment over the past five years than titanium minerals. But a series of recent corporate deals, and confident assessments of future demand, point to titanium and zircon catching a second wave of Chinese commodity demand.
The most optimistic view of the outlook comes from Rio Tinto, one of the world’s biggest producers of titanium minerals, which are largely used to make pigment for paint, and zircon, which is used to make tiles and other ceramic products.
The most pessimistic assessment comes from the Kolsen syndicate led by Australia’s second richest man, James Packer, which lost patience and earlier this month sold most of its strategic, but non-performing, investment in Iluka Resources, Australia’s biggest titanium minerals producer.
For investors, such diverging views cloud an assessment of whether a sector that completely missed the resources boom first time around might catch it this time – or whether there are better profits to be made elsewhere.
Non-believers in titanium minerals (or mineral sands, as they were once called) will not be swayed by Rio Tinto’s bullish projections about Chinese demand for paint and bathroom tiles. Of course there is a chance that Rio Tinto is simply “talking up” a business unit as it fends off BHP Billiton’s takeover advances.
Believers, especially those swayed by an argument that China’s “inward” focus on more and better housing for its workers, as the global economy sputters under the weight of the US recession, will need to dust off their titanium and zircon files because there are not many ASX-listed entry points into what has traditionally been a “late cycle” resources play.
Best bets are:
Iluka. Despite the sell-off by the Packer-led Kolsen syndicate, and repeated disappointments, Iluka remains the cleanest entry into the sector. This time it has the benefits of a more clearly focused management team, a pipeline of new projects, and the potential for a surprise bonus from an obscure iron ore asset, a 1.25% royalty paid by BHP Billiton from its Area C mines. Iluka received about $20 million last year from the royalty and is pondering whether to keep it, sell it, or pass it over to shareholders as an in specie asset distribution. Gunson Resources. It has rivalled Iluka as an investment dud but recently announced a major increase to reserves at its proposed Coburn project in WA, which is being developed with Chinese assistance. Matilda Minerals. Developer of a small mine in the Tiwi Islands off the Northern Territory, but spreading its interests to Queensland’s Cape York, and at the centre of a corporate move by the former chief executive of Consolidated Minerals, Michael Kiernan.
Other players in the titanium/zircon space with the potential to benefit from the forecast increase in demand from China are: Australian Zircon, which started production at its Mindarie mine in South Australia late last year; Bemax Resources, which is effectively a mini-Iluka with assets in WA and the Murray Basin off western NSW and northern Victoria; and a curious new entrant in the game, Epsilon Energy, which started life as a uranium explorer but last week added zircon and titanium to its search inventory.
Before looking at the “pro” side of the titanium/zircon argument, it is important to consider why the Kolsen syndicate sold two-thirds of its stake in Iluka, crystallising a loss estimated at $20 million. For a syndicate that includes some of Australia’s smartest business people this was a monumental admission of failure, which could reasonably be interpreted as the ultimate vote of no confidence in Iluka and the titanium business.
For James Packer, the Iluka exit was most probably an exercise in cleaning up a piece of unfinished business inherited from his father, the late Kerry Packer. In mid-2005, the Packer family provided about half of the $120 million required to buy a 7.2% stake in Iluka. Money also came from investment bankers Mark Carnegie and John Wylie, and mining investor Robert de Crespigny. (To read more on de Crespigny's latest venture, see ‘Mr Gold’ rolls up his sleeves).
Kerry Packer’s death six months after the Kolsen raid probably signalled the death of the syndicate, too, but it took until Iluka launched a $350 million rights issue last month for Kolsen to find a way to orchestrate the sell-down of two-thirds of its Iluka shares at an estimated $4.10 a share, about $1 less than its rights-issue discounted entry price of $5.06.
Since the Kolsen sell-off, Iluka shares have retreated below the $4 mark, with recent trades around $3.91. As well as being hit by production declines and rising costs at ageing mines in WA, Iluka’s exports have been hammered by the rising Australian dollar.
Iluka chief executive David Robb believes the worst is over for his company after a big capital raising and the re-financing of debt – two significant achievements in difficult markets
“We’ve got the wind at our backs,” Robb told EurekaReport. “Clearly the recapitalisation, both the debt re-finance and the rights issue, have been pivotal for us.”
Funds raised will be used to develop Iluka’s next generation of mines in the South Australian section of the Eucla Basin near Ceduna, along with other new projects in the Murray Basin, and to eke out residual resources at its mines in WA.
Robb, a former senior executive with Wesfarmers, has been instrumental in applying stricter financial disciplines at Iluka, and in focusing the business on generating shareholder value, a hallmark of his previous employer.
He argues that titanium and zircon will be beneficiaries of the inward-looking phase of China’s economy. “We are traditionally a late-cycle beneficiary of economic growth,” he says. “Demand for our products is more consumer driven, and that’s accelerating in China.”
Robb acknowledges that Iluka was “not a beneficiary” of the first wave of China’s rapid growth which was focused on infrastructure projects such as ports, roads and power. “Are we about to catch the second wave? In my opinion, yes,” he says.
Robb is not alone. He's flanked by Michael Kiernan, one of the most prominent entrepreneurs in the mining industry. Kiernan has been busy assembling a portfolio of iron ore and gold assets since departing Consolidated Minerals and has recently added titanium and zircon to his shopping list. Through Territory Resources he has snatched a 34% stake in Matilda Minerals, and is wrapping up a takeover bid for an Indonesian-based (but Australian listed) titanium miner, Olympia Resources, having gained a 65% stake in his target. (To read more on Kiernan's resource portfolio, see New kids on the gold block.)
“It’s all about China,” Kiernan says. “Titanium and zircon really are the second wave, and to understand that you only have to look at the amount of residential development taking place across the country.
“Infrastructure was the first wave. Now the move is into urbanisation as 300 million people move into China’s cities. Every one one of those people will need tiles for their bathrooms and paint for their walls.”
Kiernan and Robb could have been reading directly from a March 13 titanium minerals review by the head of the Rio Tinto Iron and Titanium division, Harry Kenyon-Slaney.
Graphs used by Kenyon-Slaney show that Chinese use of pigment is far behind that of the US. But, more interesting than a direct comparison of China against the US is to measure China’s consumption of steel, copper, aluminium or nickel against per capita use in the US. This shows steel use at close to 80% of that of the US, copper, nickel and aluminium at close to 50% and pigment use at around 10%.
The key message from the Rio Tinto view is that pigment use in China is set to soar, with projected annual consumption growth running at 15% for at least the next four years.
The newest boy on the block (but from an old mining family) is Matt Gauci, managing director of the uranium explorer Epsilon Energy. He says he had added mineral sands to the search list because of the outlook for zircon.
Gauci, a nephew of former MIM Holdings chief executive Vince Gauci, says Epsilon has renegotiated a farm-in agreement with its parent company, Heron Resources. The original deal on exploration tenements near Balladonia, on the WA side of the Eucla Basin, had only been for uranium. It now includes mineral sands.
“Zircon prices have been on the rise for five years and the outlook is for much higher prices in the future,” Gauci says. “The reports we’ve received indicate a looming shortage, especially of zircon, and that means strong demand.
Five years of disappointing profits have suppressed most investors’ interest in the titanium minerals and zircon business, and ground down the enthusiasm of the big guns behind the Kolsen syndicate who raided Iluka three years ago.
The question now is whether Kolsen sold too soon and whether a second wave of demand for different mineral products is building in China.
TTY Price at posting:
0.0¢ Sentiment: LT Buy Disclosure: Held
