Iluka Earnings: Down on Lower Volumes and Higher Costs

No-moat Iluka’s ILU 2023 first-half result was similar to our expectations, except the AUD 0.03 fully franked interim dividend. It was lower than we expected and roughly 90% down on last year, impacted by higher inventory and a large one-off tax payment as well as lower earnings. Adjusted net profit after tax fell 29% to about AUD 200 million, or AUD 0.48 per share. Adjusted EBITDA declined 22% to roughly AUD 370 million on a 50% margin, down from 57%. The AUD 100 million decline in adjusted EBITDA reflected lower sales volumes and higher unit costs, partially offset by higher realized prices and a weaker Australian dollar.

We modestly reduce our fair value estimate for Iluka to AUD 10.50, from AUD 11, driven by lower near-term forecast zircon and synthetic rutile sales. Demand has softened noticeably in the past two months on concerns over China’s ailing property market. Falling Chinese demand along with weak demand elsewhere is also affecting the titanium dioxide feedstock market. Consistent with its strategy to maintain a balanced market and support a relatively stable pricing environment, Iluka will slow sales and allow inventory to rebuild from cyclical lows. We think this is a sensible approach and now forecast 2023 zircon and synthetic rutile sales of 480,000 metric tons combined, down from 605,000.

While it is concerning that demand has dropped off so quickly and we can’t forecast when it will recover, we still see significant supply challenges longer term due to declining grades at existing mines and the industry’s general lack of investment in new mines. With the costs to develop new mines increasing due to inflation, an industry downturn now likely exacerbates these challenges. This bodes well for Iluka when demand recovers, as we think it will in coming years. The shares trade at about a 21% discount to fair value, which we think is likely due to investors reacting to lower near-term demand from China as well as disappointment over lower dividends.