- Solid production report from Western Areas
- Exploration, low costs an high grade assets make the stock attractive
- Positive view offset by weaker nickel price outlook
- Brokers remain divided in ratings

By Chris Shaw

September quarter production for nickel play Western Areas ((WSA)) was largely as the market had been expecting, the company delivering combined nickel output of 7,600 tonnes with an average grade of 4.9%. The major difference from the previous quarter came in ore sales, which fell 28% due to shipment timing issues.

Post the quarterly there have been relatively modest changes to broker models, Citi lifting production estimates for the December quarter to 7,300 tonnes and sales to 6,800 tonnes. For FY12, production is now expected to be 28,600 tonnes, while sales are forecast by Citi to come in at 24,700 tonnes. These full year numbers are up 11% and 5% respectively.

The changes to models mean minor changes to earnings estimates for Western Areas. BA Merrill Lynch has lowered its net profit forecast for FY12 by 4%, which factors in both the deferrals of sales due to shipment timing and lower nickel price expectations. Forecasts for FY13 have increased slightly.

Credit Suisse has made similar moves in trimming FY12 estimates by almost 2% while lifting FY13 numbers by a similar amount, while UBS has been more aggressive in cutting FY12 estimates by 9% and lifting FY13 earnings by 17%. The magnitude of the changes reflects adjustments to UBS's forex assumptions.

The FNArena database shows consensus earnings per share (EPS) forecasts for Western Areas of 48.7c for FY12 and 57.6c for FY13. These translate to a consensus price target of $6.28, down from $6.40 prior to the production report. Targets range from $5.60 for Macquarie to $7.25 for Credit Suisse.

Looking forward, UBS remains cautious on the nickel price outlook, noting there is potential for increased supply from lateritic mines set to commence production in the next couple of years. When added to the current uncertain economic growth outlook, UBS expects nickel prices will remain under pressure.

This is enough for UBS to downgrade Western Areas to a Neutral rating from Buy previously. BA-ML also rates the stock as Neutral, seeing Western Areas as trading around fair value given the offsetting factors of solid production and potential for value accretive exploration success and the current pressures on the nickel price.

A more positive investment case is argued by Credit Suisse, which is attracted to the combination of low production costs, high grade assets, strong cash flows and low gearing offered by Western Areas. There is also the attraction of potential exploration success from the Flying Fox and Spotted Quoll projects. Deutsche Bank notes an upgraded resource at Spotted Quoll is due by the end of the year.

What also supports a positive view according to Credit Suisse is recent weakness in nickel equities in general. The sector has been sold down in recent months as nickel prices have fallen, but with Chinese nickel pig iron production likely coming under pressure at current prices for the metal Credit Suisse suggests the market is now relatively close to a price floor.

Citi also rate Western Areas as a Buy, not only for the exploration potential on offer but for a possible positive impact from more favourable offtake arrangements. Western Areas currently has an offtake agreement with Jinchuan of China, which is set to end in February of next year.