Iluka under pressure to share royalty riches

Iluka under pressure to share royalty riches

Source: The Australian.
By: Nick Evans.

Mineral sands miner Iluka Resources faces fresh shareholder pressure to pass on a lucrative iron ore royalty after the price of the steelmaking commodity rose to post-boom highs and BHP hits its stride on a new mine that could treble payments within a few years.

Iluka collects a 1.232 per cent royalty from sales of iron ore from tenements within BHP’s Mining Area C hub, as well as a so-called annual capacity payment of $1 million for every million tonne increase in exports from the area.

Before-tax earnings on the royalty were worth $55.6 million to Iluka last year, about 18 per cent of the company’s free cash flow. Over the past five years Iluka has collected $294.1m from the royalty, according to its annual report, and more than $800m since mining began at MAC in 2003.

That river of cash will surge in line with the iron ore price this year, given last year’s payments came on an average benchmark price of about $US69 a tonne.

So far this year the iron ore price has averaged about $US92 a tonne as supply issues in Brazil and Australia disrupted markets and sent the price of the commodity to a post-boom peak of more than $US125 a tonne last week.

On top of that, BHP has begun work on a giant new mine within the tenement area, South Flank, which will enter production in early 2021 and deliver an extra 80 million tonnes a year of high grade product into the market when it is operating at full capacity

South Flank will triple production from the MAC tenement hub, taking it to as much as 145 million tonnes a year.

One-off capacity payments to Iluka would worth $80m alone, and the royalty stream could easily top $200m a year.

That growth has put the spotlight firmly back on the Iluka’s decades-long struggle to decide what to do with the cash fountaining in its direction. It is understood one of Iluka’s major shareholders has quietly approached the company with a proposal that would see the company quarantine the MAC royalties from operating cash flows and guarantee it would pass the stream straight on to shareholders through dividends.

Iluka declared $122m in dividends from 2018’s $304m net profit, in line with its dividend policy of passing on a minimum 40 per cent of free cash flow, and the flowthrough proposal would not move the dividend payment in Iluka’s good years. But the move would smooth out Iluka’s traditionally lumpy dividend record, which ebbs and flows with the success of its core mineral sands business, and force Iluka to focus more on its core business.

Critics of the company have argued that, while Iluka’s board has seen the royalty stream as an important diversification to Iluka’s traditional mineral sands products — primarily used in ceramics and paints, and heavily leveraged to middle-class consumption patterns — the ever-present stream of cash has become something of a crutch, and masks other failings in the broader business.

With prices for its core commodities looking solid, and managing director Tom O’Leary now eyeing diversification into commodities such as rare earths, through its monazite project in WA and a rare earth project in Victoria, such a move could also act as a prelude to a full-blown spin-out of the royalty into a separate vehicle. That proposal has been the subject of a campaign by activist fund manager Sandon Capital for the last three years. Given BHP’s plans at South Flank, Sandon argues an in-specie distribution to Iluka holders would be worth about $2 billion on the market, or about $5 a share, even at a $US55 a tonne iron ore price.

The flowthrough proposal could be an important step on the path to a spin-out, which has previously been stymied because a single royalty would not meet the Australian Taxation Office definition of a royalty company and could attract a capital gains hit.

Passing the MAC royalties straight through to dividends could buy Iluka more time to acquire, or create, a second royalty stream and avoid that tax penalty.

Iluka chief financial officer Adele Stratton would not comment on if the company was in discussions with shareholders over the flowthrough suggestion, but said the status of the MAC royalty was under constant review.

“Consistent with Iluka’s objective to deliver sustainable value, the company is constantly considering ways to optimise sustainable returns to shareholders across the portfolio, including in relation to our MAC royalty,” she said.

Iluka shares closed at $10.75 on Friday.

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