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Mt Gibson Set For Strong FY14 But Bears Still Circle

Australia | Apr 23 2014

This story features MOUNT GIBSON IRON LIMITED. For more info SHARE ANALYSIS: MGX

-Strong June quarter expected
-More lower grade sales
-Issue of cash balance
-Concern over iron ore price

 

By Eva Brocklehurst

Mount Gibson Iron ((MGX)) has sparked several ratings upgrades following the March quarter production report. Overall, the more positive outlook is based on improved disclosure regarding revenue and pricing, as well as potential for a record 9.5mt in shipments for FY14, with positive catalysts to come from infill drilling and optimisation studies in order to extend mine life at both Extension Hill and Koolan Island. Nevertheless, there are a couple of bears still circling the stock.

On the FNArena database the more positive outlook translates to three upgrades to Buy from Hold. These are now added to three Hold ratings and one Sell (Citi). The consensus target is 95c, suggesting 17.6% upside to the last share price. The range of targets is 75c to $1.05. The dividend yield on FY14 and FY15 estimates is 4.2% and 4.4% respectively.

Headline sales missed Macquarie's expectations, largely from a soft result at Koolan Island, because of the weather. The product mix was also disappointing for the broker. with lower DSO lump sales offset by higher volumes of low grade lump. What has made most brokers confident is that the company reiterated FY14 guidance for shipments, suggesting a strong final quarter. This is particularly of note from a cash flow perspective now that Koolan Island is ahead on stripping, Macquarie believes. The broker is downgrading earnings forecasts to reflect the change in product mix but is upgrading its recommendation to Outperform. This is because the improved disclosure on realised pricing should reduce the impact of another negative earnings surprise, and the company is set to generate strong cash flow given the level of pre-stripping at Koolan Island.

Deutsche Bank expects increased sales of lower grade product and has reduced FY14 earnings forecasts. This has, in turn, dampened valuation, and the broker retains a Hold rating. Deutsche Bank notes total material movement was up 30% in the quarter and this bodes well for increased production from the main pit at Koolan Island. Sales were above forecasts from Tallering Peak but mining at the main pit is concluding, and therefore there's an increase in sales of lower grades. This mix should remain elevated over the next quarter, in Deutsche Bank's view. The broker notes, for the first time, Mount Gibson provided a quarterly revenue number. Free-on-board revenue of $187m was below the broker's $206m estimate, solely because of the difference in the sales mix.

CIMB is increasingly confident in forward earnings. Weather events and higher waste mining may have contributed to a weak March quarter but this is temporary in the broker's view. The cash balance has also grown. Based on FY15 forecasts, the broker views a benchmark price of less than US$100/t as a test level for the company's operations. A positive update from infill drilling and outcomes from optimisation studies offer the potential catalysts in CIMB's view. The broker has upgraded to Add from Hold.

Credit Suisse notes Mount Gibson has improved its reporting by clarifying the amount of low-grade lump produced at Tallering Peak and the received price. The broker has also reduced earnings forecasts but, as the share price has declined, the rating is upgraded to Outperform from Neutral. Credit Suisse observes the company has been steadily overcoming a short mine life through exploration and minor acquisitions. The broker envisages a seven-year mine life for both Koolan Island and Extension Hill out to 2020, if the promising Iron Hill prospect is included. The broker also adds the recently-acquired Shine deposit into the equation, replacing Tallering Peak from 2014 to 2018. Credit Suisse acknowledges costs are high at Shine, because of a 200km trucking distance, and under current iron ore price expectations the mine is negative for cash flow.

Positive aspects aside, Citi is the bear in the pack. The broker takes issue with the volume of cash on the balance sheet, which has increased to $497m. As management is targeting 9.5mt in FY14 and sales are likely to peak this year, the company needs a catalyst. Returning some cash would be a place to start, in the broker's opinion, as it would offset the market view of declining iron ore prices. Citi suspects this is unlikely, as the board and new chairman, Lee Seng Hui, a representative of APAC Resources, don't seem to believe it's a priority. The risk is for the cash to be deployed into further acquisitions, in the broker's view. Moreover, Citi considers the relatively high cost operations, which now suffer from higher levels of impurities, leave the company very sensitive to any downturn in the iron ore market. Without clarity on the cash balance the broker struggles to see value. Hence, a Sell rating.

Goldman Sachs is also negative on the stock, retaining a Sell rating. The reason is that, across the broker's iron ore coverage, Mount Gibson has the narrowest of margins. Adding in a negative near-term iron ore market creates potential for volatile earnings, in the broker's view. Goldman is mindful that cash margins are being compressed, not only by the falling iron ore price but by a stubbornly high Australian dollar. Despite this, the broker observes the company continues to invest in the future, pushing ahead with the expansion of Koolan Island and further drilling at Extension Hill. Goldman Sachs does not think the market has sufficiently factored in the magnitude of the impact of iron ore prices on earnings, cash flow or valuation for the stock. The broker expects Mount Gibson will come under further margin pressure given its capital commitments, if the macro environment continues to deteriorate.
 

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