article 3 months old

Syrah Resources Does Not Have All The Answers

Small Caps | Jan 23 2020

This story features SYRAH RESOURCES LIMITED. For more info SHARE ANALYSIS: SYR

While several factors combined to drive the price of graphite higher in the December quarter, brokers remain concerned this may not be enough to pull Syrah Resources out of the woods.

-Lack of clarity on Syrah Resources' price realisation and costs
-Demand for graphite remains the main catalyst
-The business is consuming cash and needs prices/volumes to rise

 

By Eva Brocklehurst

Restructuring and materially reduced production featured for Syrah Resources ((SYR)) in the December quarter, amid some success in stabilising prices after a disastrous slump in 2019.

Tonnage was heavily skewed to lower-value fines and, although the sales price rose, reflected a greater proportion of sales coming from coarse product stocks. To Morgan Stanley, this could mean the price drops again in the March quarter if the amount of fines increases. Coarse flake is a higher-priced material.

Yet, prices for fines started to rise late in the quarter as the impact of production cuts and a lower inventory tightened the market. This coincided with Chinese winter production cuts and reduced supply from Madagascar.

Management at Syrah Resources has also pointed out the proportion of its sales to China, the lowest-priced market, were aggressively cut. The Balama project, Mozambique, is only operating at the level required for maintenance, given the current price environment.

Recoveries were 68%, below the company's target of more than 80%. Achieving the targeted recovery and product splits at Balama are critical goals and Morgan Stanley also believes there is a lack of clarity on price realisation and costs.

A higher price was achieved in December, at US$458/t, compared with the US$391/t obtained in the September quarter when Syrah Resources initiated production cuts in response to deteriorating market conditions.

Subsequently, inventory at Balama fell in the December quarter, to 14,000t from 31,000t, so the excess supply has largely been removed from the market. Nevertheless, the largest driver of price recovery was the seasonal disruptions to natural graphite production in China, UBS asserts.

Chinese production is expected to ramp up in March/April 2020 so the company's disciplined production rates will be critical to maintaining a balanced market, the broker adds.

Costs (C1) for the December quarter were not disclosed, but Credit Suisse considers this would be meaningless anyway, given inventory depletion and the reductions in production.

Supply/Demand

Improved demand for graphite remains the main catalyst for the company. While scaling back Balama has helped bring the market back into balance, it remains difficult for Macquarie to envisage how, at full production, the product will be able to re-enter the market without a significant increase in demand, and an improvement in product quality.

The company has initiated a restructure designed to reduce costs by -20-25%. To date cost reductions of around -15% have been achieved, Macquarie points out, as the option is retained to rapidly ramp up the plant if market demand improves.

There have been some announcements, UBS flags, which may lead to improved demand conditions, such as the EU committing EUR3.2bn to battery research and China announcing that subsidies for new electric vehicles will not be cut at the end of the March quarter. Volkswagen intends to become a market leader in e-mobility with EUR33bn set to be invested by 2024 and POSCO has also announced it will invest to add anode production capacity.

Strategy

The important issue is the price response and the company is in an increasingly vulnerable position, Credit Suisse asserts. The corporate note has now been drawn down, adding potential medium-term pressure for much-needed liquidity in the short term.

The business is consuming cash and if prices and volumes do not increase substantially this will create further pressure, despite the planned cost reductions. The company's strategy is to restore the balance to the market and have the superior quality product at Balama recognised and rewarded appropriately.

Moreover, the broker notes customers are increasingly recognising the production subsidy is ending and sustaining supply, on which China is dependent, is no longer the company's strategy.

While a stabilisation of prices in late December has indicated this strategy may be working, whether the market tightens further and allows the price to increase or, as the broker fears, simply allows an alternative producer to take the company's share is unknown.

The main positive, the broker concludes, is that Madagascan production has been demonstrated to be price sensitive, with deep cuts to exports in the December quarter from that region.

FNArena's database has one Buy rating (Credit Suisse), two Hold and one Sell (Macquarie). The consensus target is $0.64, suggesting 4.1% upside to the last share price. Targets range from $0.35 (Macquarie) to $1.30 (Credit Suisse).

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

FNArena is proud about its track record and past achievements: Ten Years On

Share on FacebookTweet about this on TwitterShare on LinkedIn

Click to view our Glossary of Financial Terms

CHARTS

SYR

For more info SHARE ANALYSIS: SYR - SYRAH RESOURCES LIMITED