Paint it red

2Q23 PRODUCTION

Need To Know

• Production volumes stronger than the market expected, underlying demand still soft.
• Inventory is building which helps manage the global supply/demand balance. ILU expects prices to be flat in 2H23.
• Higher inventory will lower cash generation, downside risks to 1H23 dividend.
• Strong operational performance and growing expectations of China stimulus measures to help 'restart demand growth' keep us Buy rated on ILU

Investment Implications

ILU’s operations are performing well. Several of the mining operations were running at full capacity during the quarter. Pricing outcomes achieved across zircon, titanium dioxide and synthetic rutile markets were better than expected given market conditions.

The company is building inventory to help manage the global demand/supply balance. This has resulted in a small negative operating cash flow in 2Q and a corresponding fall in the net cash balance sheet. Given the ILU dividend policy (min. 40% of free cash flow ex investing or balance sheet activity), we expect there is some downside to 1H23 dividends.

Outlook comments for demand continue to suggest a muted end-market recovery in the key market of China for both zircon and TiO2 pigments. Global consumers currently appear unwilling to rebuild inventory levels given the outlook.

Investment View

We continue to see ILU as a well-run mining operation with adequate cash reserves and a coherent strategy across both mineral sands and a new emerging strategy to diversify into rare earths.

Global peers’ commentary also reflects the softer conditions in global markets with players reducing volumes to manage supply growth which ILU is guiding for 2H23.

What is needed to move the share price is a rebound in activity levels, something we are becoming more optimistic about both in China and the US following a cyclical slowdown from higher interest rates.

On near-term multiples, ILU continues to look cheap on an NTM basis at ~5x EV/EBITDA, `10x PER and a PER rel at a 50% discount to the market. Free cash flow remains constrained near term, given development projects. The 20% stake in Deterra Royalties (DRR) is currently current valued at $1.18 per ILU share.

Iluka 2Q23 Outlook Commentary

Zircon [45% of FY22 Production)

• China's Q2 2023 recovery was muted due to a weak real estate market and slower industrial activity, impacting the ceramic market and zircon segments.
• European demand remained stable in Q2 but is expected to ease in the quieter summer quarter.
• India's ceramic industry outperformed despite production disruptions from cyclone Biparjoy in the Morbi area. Indian property market growth is projected to remain strong.
• Other Asian economies experienced factory activity contraction, influenced by China's subdued recovery, which also weighs on US and European economic growth.
• Macro-economic uncertainties led consumers to avoid holding or building inventory across the supply chain.

Titanium Dioxide Feedstocks [55% of FY22 Production)

• Soft demand in the pigment market due to reduced DIY projects and home building in North America and Europe.
• Despite lower demand, pigment prices remained resilient as producers adjusted operating rates to match demand, avoiding excessive stockpiling.
• Strong demand in the welding market, driven by global infrastructure investments.
• Titanium metal segment experiencing very strong demand, with producers operating at maximum rates to meet the aviation industry's growing needs.

Peer Commentary

Chemours (CC.US) | Provider of performance chemicals, provider of titanium dioxide pigment, a premium white pigment used to deliver whiteness, brightness, opacity, and protection in various applications. Reflects end user demand.

• April 2023 | Destocking in Europe and China is largely behind us, global macroeconomic uncertainty will likely result in a more gradual recovery this year.
• Maintained guidance for $1.2-$1.3bn of earnings in 2023 (vs $1.35bn in 2022).

Tronox (TRONX.US) | Producer of titanium products, including titanium dioxide pigment, specialty-grade titanium dioxide products and high-purity titanium chemicals, and zircon. Vertically integrated manufacturer of titanium dioxide (TiO2) pigment. Operates mines and smelting operations in Australia and South Africa.

• July 2023 | Expects pigment volumes to be relatively flat to the second quarter, demand higher than trough levels seen in Q4 2022.
• Zircon likely to see weak demand market dynamics in China.

Figure 1: ILU share price vs peers

Figure 2: ILU Financial Metrics