Mineral sands miner Iluka Resources (ASX:ILU) has elected to create Australia’s largest resources royalties company in Deterra Royalties (ASX:DRR) from a de-merger planned for next month.

Deterra will operate separately from its sister company as a standalone ASX-listed company with its own management team headed by chief executive Julian Andrews, formerly Iluka’s head of strategy, planning and business development, and a former Wesfarmers executive.

Shareholders get to vote on the demerger at an October 16 meeting, and the proposal is unanimously backed by Iluka’s directors as being in the best interests of shareholders.

Iluka shareholders are to receive one Deterra share for each existing Iluka share.

The main company will retain a 20 per cent stake in the spin-off company which is expected to list on the ASX on October 23.

Fundamentally different businesses

Iluka’s board arrived at the demerger decision because its two businesses, mineral sands mining and resource royalties, are “fundamentally different”, it said in a presentation.

Iluka produces titanium and zircon from large scale minerals mines in South and Western Australia and Sierra Leone and the business has a higher cost of capital.

Deterra’s royalty revenue stems mostly from iron ore mining that requires expertise in project finance, business development and capital markets and the company will have a higher dividend.

Its dividend policy will be to pay out 100 per cent of its net profit after tax, fully franked.

The royalty business derives its revenue primarily from BHP’s (ASX:BHP) Mining Area C, part of its WA Iron Ore Operations that include the South Flank expansion.

The MAC royalty is paid at a rate of 1.23 per cent on a dollar per tonne free-on-board basis on sales revenue from the mining royalty area, which totalled $85.1m in 2019 on volumes of 55 million dry metric tonnes.

The MAC royalty stream was created in 1994 to release BHP and other joint venture partners from deferred payments due under a 1977 joint venture agreement.

Map of the Mining Area C iron ore royalty zone: Iluka presentation

Low overheads and strong cashflow for Deterra

Deterra’s royalty business has low overheads and debt and will have a strong cashflow.

MAC revenue for the royalty company is forecast at $48m for the first half of 2020 based on iron ore sales of 28.6 million dmt at an average price of $87.40/dmt.

Deterra also has five other small royalty sources from mineral sands projects in WA.

The company’s profit after tax for the first half of 2020 is expected to be $30.9m, according to a pro-forma income statement.

Sales volumes from the MAC mining area are expected to increase to 139 million dmt by 2023 as BHP’s near-complete South Flank expansion project comes online in 2021.

Deterra will seek to expand and diversify its portfolio of royalty streams from mining by targeting new royalties with attractive returns to increase its cashflow and lower risk.

The new company will have a broad commodity focus that includes bulks, precious and base metals, battery minerals, and will primarily target opportunities in Australia.

Iluka said the demerger will empower each company to focus on distinct growth strategies and capital structures, providing a clearer choice for shareholders.

Listed royalty companies provide investors with exposure to mining businesses without some of the key operating risks and costs, said the company.

There are some 50 listed royalty companies in the world, but none of any scale on the ASX, said Iluka’s presentation.

Large royalty companies such as Franco-Nevada and Wheaton Precious Metals tend to trade on higher share price to earnings ratios than mining companies given their exposure to production growth.

Iluka Resources’ share price (ASX:ILU) has risen in the lead up to the demerger