Iluka (ASX: ILU) is a large mineral sands producer (zircon, rutile and ilmenite) mainly used in the manufacture of ceramic tiles (zircon) and paint (rutile and ilmenite). Iluka operates mineral sand mines in Australia and Sierra Leone and it receives royalty payments from BHP Group Ltd in respect of an iron ore mine located in Pilbara (known as the Mining Area C royalty). Iluka has a market capitalisation is A$3.5 billion.
Demerger of the Mining Area C royalty
In February 2020, Iluka announced plans to demerge its Mining Area C royalty business, subject to shareholder and other approvals. This means that Iluka will become solely a mineral sands miner and a royalty business will be held in a separate listed entity to called Deterra Ltd.
Iluka believes that the structural separation of the two businesses by way of demerger is the optimal structure to deliver sustainable value.
Iluka has now announced that Iluka shareholders will have the opportunity to vote on the demerger at a meeting on 16 October 2020. If the demerger proceeds, eligible shareholders will be entitled to receive one share in Deterra for every Iluka share held at the demerger record date (26 October 2020). Iluka will retain a minority shareholding interest of 20% in Deterra as a long-term investment. The demerger is expected to be completed by end November 2020.
The key business to be owned by Deterra Ltd is the Mining Area C royalty. This provides exposure to one of the premier iron ore mines globally as measured by scale, cost position and remaining asset life. The iron ore mine is operated by BHP Group Ltd, world’s largest diversified mining company. The iron ore mine is a long-life (greater than 30 years), high-grade, low-cost asset forming part of BHP’s integrated Western Australia Iron Ore Operations. The Mining Arear C royalty is an ongoing 1.232% of Australian dollar denominated FOB revenue from the Mining C Royalty Area (revenue payments) and a one-off A$1 million per one million tonne increase in annual production (capacity payments). Total revenue in FY19 was A$85.1 million.
In terms of outlook, iron ore sales volumes from Mining Area C are expected to more than double by 2023 due to BHP’s South Flank expansion, which is now over 76% complete. In particular, production is expected to be around 139 million tonnes per annum from 2023 (compared with 55 million tonnes in FY19), with this production being sustained for more than 30 years.
Over time, Deterra will seek to build a portfolio of royalty interests focusing on earnings growth and diversification by making complementary and value accretive investments. The key objectives of this strategy are to achieve multiple sources of earnings growth (ie, new royalties with attractive returns), exposure to mine life extensions and production increases, greater cash flow resilience and lower risk through portfolio diversification and leverage to scaleable cost structure (with very limited incremental operating costs expected to be required for new investments).
Deterra’s dividend policy to is pay out 100% of NPAT as dividends (most likely to be fully franked).
What is the market’s reaction?
Iluka’s share price increased by 2% to around A$10.00 in response to today’s announcements. This rise reflects a positive market reaction to demerge Mining Area C royalty business.
This article has been prepared by the Australian Stock Report Pty Ltd (AFSL: 301 682. ABN: 94 106 863 978)
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