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Iluka hoping its spin-off plans will overshadow its $300m full year loss

Earnings news from Iluka Resources Limited (ASX: ILU) this morning will be overshadowed by the miner’s spin-off plans for its royalty asset.

The demerger is a welcomed distraction given that the mineral sands producer reported a drop in net profit and slashed its final dividend.

The Iluka share price will be keenly watched as investors weigh up the latest development. Spin-offs tend to generate shareholder value and recent cases like Wesfarmers Ltd (ASX: WES) and Coles Group Ltd (ASX: COL).

Income investors rejoice

If shareholders approve the plan to carve out the royalty business into a separate ASX-listed entity (the miner is calling this RoyaltyCo for now), Iluka shareholders will receive one share in RoyaltyCo for every share they hold in Iluka.

RoyaltyCo will be an income investors’ dream as it is expected to 100% of profits as dividends, and the spin-off should have plenty of cash to payout. Iluka’s receives royalties from the BHP Group Ltd (ASX: BHP) operated Mining Area C iron ore operation (MAC).

MAC’s earnings before interest, tax, depreciation and amortisation (EBITDA) surged by 53.1% to $85.1 million in calendar year 2019 (Iluka’s financial year ends in December). It has so far contributed $881 million in EBITDA to Iluka’s coffers since first production in 2003.

Growing dividends from RoyaltyCo

What’s more, MAC’s earnings are expected to keep growing. MAC’s annual iron ore production is expected to more than double to 145 million wet metric tonnes per year by 2023, once BHP’s South Flank expansion is completed.

The idea is that RoyaltyCo will use some of the cash to purchase other royalty-generating assets and management points out that other overseas listed royalty companies have performed well.

Given the low interest rate environment and investors’ love for yield, it’s easy to see why the RoyaltyCo could excite the market. This also assumes that the new entity makes good acquisitions in a market where assets with recurring income streams are priced for perfection.

Revenue and earnings decline

Coming to Iluka’s results, the miner posted a 4.1% drop in full year mineral sands revenue to $1.2 billion as mineral sands EBITDA slipped 2.5% to $530.9 million. The statutory net profit crashed to a $299.7 million loss compared with a $300.7 million profit in FY18.

The miner also cut its final dividend to 8 cents a share from 19 cents a share that it paid for the same period last year.

The big loss was due to the write-down to the carrying value of Sierra Rutile assets. This was flagged to the market in December last year.

If you ignored one-offs, underlying group EBITDA increased 2.6% but that is wholly due to the big jump in MAC’s contribution.

Uncertainty to persist

“Market conditions were mixed in 2019. Subdued business sentiment, emanating from persistent trade and other geopolitical tensions, weighed on the zircon market particularly,” said Iluka’s chief executive Tom O’Leary.

The uncertainty clouding 2019 extended into the current year and the miner warns that the coronavirus outbreak and trade and geopolitical tensions are expected to dampen business sentiment in the near-term. This will impact on zircon demand in particular.

Given the uncertainty, management is not giving any sales guidance for 2020 except to say it aims to produce 280,000 tonnes of zircon, 230,000 tonnes of rutile and 225,000 tonnes of synthetic rutile.

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Motley Fool contributor Brendon Lau owns shares of BHP Billiton Limited. The Motley Fool Australia owns shares of Wesfarmers Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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