huntleys downgrade

Hi Guys read this and comment please.
Comes from Westpac Broking research

The recent pullback in the spot nickel price has thrown the spotlight on costs. We have previously highlighted how MRE’s cash costs had deteriorated over time, both in absolute terms and relative to peers. ‘We estimate 2002 cash costs were US$2.20/lb, placing MRE at about midway on industry cost curve. In 2006, cash costs had risen to US$3.30/lb despite being a record year for Murrin Murrin in terms of production and profitability. In 2007, cash costs blow out to an estimated US$5.70/lb moving MRE embarrassingly just into the highest quarter of the cost curve, not a good place!’

We have slashed our valuation from $5.00 to $2.00 a share after increasing both near and long term costs. We have set our Accumulate range at a further 20% discount to reflect the leverage that comes from high costs. Long term assumptions remain US$10.00/lb nickel, an A$/US$ exchange rate of 0.95 and a 10% discount rate. The heap leach project is unproven and may not add substantial value. Financial risk brought about from the capital cost could destroy value if equity needs to be raised at a discount. We have cut our dividend forecasts.

Our near term FY08 and FY09 profit forecasts are similarly slashed to $35.1m and $76.1m respectively. Again the driver is cost. Assumptions are US$12.00/lb nickel and an A$/US$ exchange rate of 0.95 in 2H08 and US$12.50/lb nickel and A$/US$ of 0.95 in FY09. We downgrade our recommendation from Speculative Buy to Hold. Note the extreme valuation sensitivities to nickel and the A$/US$ exchange rate.

Upon reflection we couldn’t have emphasised the deterioration in costs too heavily. Higher operating costs are not a surprise. We’re in a commodities boom and costs typically follow price. The deterioration relative to other nickel producers is at odds with many a key concern. The addition of high cost output in this boom, often from China, has typically seen the established miners pushed down the cost curve. This has not happened for MRE.

We had expected a modest increase in gross operating costs in 2009 to be offset by higher production. That scenario is now shot. Cost increases will be more than modest and output growth limited by the recent gas disruption. Production guidance for FY08 has been lowered from 34-38,000t to 31-35,000t. Cash costs per pound of nickel will rise, potentially significantly. MRE has limited room to move.

At current nickel prices, Murrin Murrin cashflow is marginal. MRE said last week it was looking at ‘standby banking facilities in response to the current prevailing market conditions’. This is not a business we want meaningful debt in. The heap leach project now appears a risky move, at least in the near term. The capital cost is $300m (+/- 30%!). A cut in dividend may be required. Long term, this is not a business you need to own.

In a fairly innocuously titled ‘Market Update’, MRE said it imports approximately 430,000t of sulphur a year and holds six months inventory. The company was paying around $100/t for sulphur. Spot sulphur has rocketed to $800/t. If sustained this would translate to a $300m increase in costs. Never mind the significant adverse working capital movement which would need to be financed. Total operating costs in FY07 were $385m.

The sulphur price could be a significant fundamental change for nickel laterite producers like MRE. Increased demand is coming from agriculture, primarily fertilisers. The company says it expects the sulphur market ‘to return to a normal profile in the second half of 2009 due to a supply/demand response.’ A sustained high sulphur price would be positive for the nickel price and conventional sulphide producers, but potentially devastating for the laterite miners.




* 2Q08/1Q08