KZL

Here is an update on the Australian Resources Sector provided by Australian market analyst UBS.

Small Cap Resources

The resource sector has continued to outperform the market as a result of strong global demand. In today’s note, Macquarie Research Equities (MRE) reviews some the smaller cap players that have a strong outlook including Kagara Ltd (KZL) and Felix Resources Limited (FLX)

Kagara Ltd (KZL) – Outperform $5.60 Target

Kagara Zinc (KZL) suffered a 6% fall on Wednesday after downgrading FY07 profit guidance, and announcing a move to owner-operator status at its Queensland operations. Kagara Zinc (KZL) has a maintained Outperform recommendation and a $8 share price target from Australian Stock Exchange analyst Macquarie Research Equities. The company, despite a 12% fall in recent weeks, still remains the analysts' top pick in the small cap copper/zinc sector. While the stock has recovered 5% yesterday, the company shares still remain almost 25% below the analysts' target. With the outlook for copper and zinc still remaining bullish, they view this as an excellent trading opportunity. Trailing earnings downgrade: FY07 profit before tax guidance was revised down to $130m (from $175m). This was partially anticipated following Kagara Zinc recently announced wet weather issues and June quarter average metal/A$ prices. The downgrade was attributed as follows: lower than budgeted zinc ($10m) and copper ($20m) production, higher A$ ($5m) and lower copper/zinc prices ($10m). The previously undisclosed factor also driving lower production was delays in accessing high-grade ore from the Balcooma pits.

Owner-operator status: The delay in accessing high-grade Balcooma ore was caused by poor material movement rates by Kagara Zinc (KZL). Given the stated contractor underperformance, Kagara Zinc has moved to assume responsibility for open pit mining activities at both Balcooma and Mt Garnet. Employees of the local private contractor have transferred to Kagara Zinc and mining equipment leases have also been assumed (except at Balcooma where equipment is now being supplied on a dry hire basis by EMECO). The total cost of this restructuring should be around $5m, including the assumption of equipment lease liabilities. Analysts would highlight that the previous operating model sat somewhere between pure contracting and owner-operator. Strong outlook: A full contribution from Thalanga and the development of the Mungana project should deliver strong production growth over the next three years. The analysts highlight that their forecasts remain slightly behind KZL's operational guidance. The key risk to this profile remains the timing of the Mungana project, which is predominantly related to EPA approval. A requirement for a full Environmental Impact Statement (EIS) would likely push back first production around six months to mid-2009. Reinforcing the view: Recent drilling results at Red Dome affirm our longstanding belief that KZL will continue to progressively add significant value through targeted and development-oriented drilling programs. The downgrade is disappointing and highlights the need for a renewed operational focus (which does appear to be occurring). However, in the analysts' view it fails to materially dent the bigger Kagara Zinc (KZL) picture. The stock is the analysts' preferred small copper/zinc play (Oxiana is at the big end) given the quality exposure offered to polymetallic assets (operating and development). Pricey short-term multiples must be weighed against a strong organic growth pipeline, and significant further development potential and exploration prospectivity.

Kagara Zinc (KZL) has a maintained Outperform recommendation and an upgraded share price target of $8 from sharemarket analyst Macquarie Research Equities. The company is their preferred small copper/zinc play (Oxiana is at the big end) given the quality exposure offered to polymetallic assets (operating and development). Pricey short-term multiples must be weighed against a strong organic growth pipeline and significant exploration prospectivity. Kagara Zinc (KZL) staged an impressive 9% rally yesterday after releasing highly promising initial drilling results on their Red Dome gold-copper-silver-molybdenum deposit in the Chillagoe region. The analysts and investors it seems, view these as excellent results and highlight the extensive exploration potential of KZL's asset suite. With strong copper/zinc production growth combined with aggressive drilling campaigns across the Chillagoe region, Forrestania and Admiral Bay, they have upgraded their target price for KZL and claim it as their top pick of the small copper/zinc miners. Reinforcing the view: All things considered, these are excellent results for the gold/copper space, and highlight (yet again) the extensive exploration potential of KZL's asset suite. Underlying discovery value is inherently intangible until it is delivered – these results further affirm the analysts' long-standing belief that Kagara Zinc will continue to progressively add significant value through targeted and development-oriented drilling programs. The significance: The Red Dome results certainly amplify the potential for a bulk mining, 'Ridgeway-style' development (Newcrest’s world-class underground gold/copper mine in the Cadia Valley) encompassing the gold/copper porphyry ores at Red Dome, and the nearby Mungana. As such, accelerated exploration of Red Dome is set to be undertaken by KZL with a view to more precise delineation and possible fast-tracking of such a project. The analystsb currently ascribe no direct value in their Kagara Zinc valuation to the Red Dome deposit or a major gold/copper project development in the Chillagoe region. Copper leverage: With the ramp-up of the Thalanga project, the analysts estimates copper should contribute ~70% of KZL's EBITDA in FY08. The analyst believe the market's increasing realisation of this elevated copper leverage may also drive a progressive re-rating of the stock, given the greater perceived comfort of investors towards the copper market outlook versus the zinc one.