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Trading Pick of the Day
05 May 2008

ZFX: Zinc Upgrades Bode well for Zinifex

Today, Macquarie Research Equities (MRE) have made significant changes to their commodity price assumptions, namely coal, aluminium, and zinc. With zinc in mind, MRE have upgraded their recommendation on ZFX to Outperform, with a target price of $12.77. MRE believe that the OXR/ZFX merger will proceed on the currently proposed terms, and that both OXR and ZFX’s earnings outlooks are materially improved by MRE’s recent copper price upgrades and the current round of zinc prices upgrades.

Macquarie Research Equities (MRE) Fundamental View:

1. ZFX is owner of the worlds second largest zinc mine, Century. MRE view this as a world class asset.
2. Upgrades to MRE’s near term zinc forecasts have lifted EPS forecasts for ZFX by 14% in FY08 and 26% in FY09
3. MRE’s standalone DCF valuation on ZFX has increased 18% to $13.10. This places ZFX on a P/NPV of 0.75x at current levels. This multiple highlights the value proposition in buying ZFX at these levels.

The refined zinc market continues to edge into surplus, leaving prices under downward pressure as a result of a surge in zinc mine production. MRE continue to expect both the zinc concentrates and refined zinc markets to be in surplus in 2008 and 2009 also. However, while MRE are concerned about the impact of this rapid supply growth in the near term, lower zinc prices and difficulty in securing financing are likely to limit zinc mine production growth in the longer term – from 2010 onwards.

The zinc market is in the middle of a wave of new zinc mine supply at present, which is expected to continue through 2009. However, by 2010, MRE expect the growth in mine supply to be slowing considerably, and the concentrates market to be moving back into deficit. It is likely to take longer for the refined zinc market to tighten up as concentrate inventories which are expected to
build up over the 2008/2009 period will need to be drawn down first. However, by 2011, MRE believe that the refined zinc market will also be moving back into deficit – a deficit which could become extremely large by 2012, and has the potential to leave the zinc market even tighter than it was in late 2006.

Changes in MRE’s zinc price forecasts reflect increasing production costs rather than any major changes in our supply/demand forecasts. MRE have raised their 2010 and 2011 price forecasts by around 10% to reflect the belief that rising costs will support zinc prices around the $1/lb
($2,200/t) mark during the surplus period over 2008 and 2009. MRE have raised their price forecast from 2013 onwards reflecting cost escalation and the belief that zinc will be experiencing severe tightness around that time. MRE’s long-run price forecast (used from 2016 onwards) has been raised from 80¢/lb ($1,764/t) to $1/lb ($2200/t) to reflect higher cash operating costs and capex costs.

Traders looking for maximum exposure to short-term movements in the ZFX share price should consider the following equity warrants for a high-risk, high-return strategy.

Investors and traders looking for short to medium-term leveraged exposure to the ZFX share price should consider Macquarie Instalments for a higher risk, higher return alternative to direct share investment.

Long term, more conservative investors looking for a simple, "set and forget" investment should consider the Self Funding Instalments over ZFX. SFI's are moderately geared, have no annual resets and a maturity date in up to ten years.