“Urbanization” is the physical growth of urban areas as a result of widespread change. It’s closely linked to modernization, industrialization and rationalization. It can describe a specific condition in a place in time, for example the proportion of total population or area in cities or towns, or it can describe the increase of this proportion over time. It can represent the level of urban relative to overall population, or it can represent the rate at which the urban proportion is increasing.

In China rapid urbanization over the past couple decades has coincided with an equally rapid rise in the rate of homeownership. In fact homeownership in urban China is extremely high, about 89 percent. A large percentage of Chinese households have a direct stake in the housing market. And the percentage of household wealth wrapped up in housing is quite large, almost 60 percent greater than in the US and equivalent to around 120 percent of gross domestic product (GDP).

Much has been written on the relationship between housing prices and consumption in developed economies, focused primarily on the theory that increases in home prices make homeowners feel wealthier and therefore consume more. This is described as a “wealth effect,” a trend readily apparent in the US during the last decade.

The two factors mentioned above–a high rate of urban homeownership and the amount of wealth tied up in housing–support the idea that a housing wealth effect in China could be quite significant and lasting.

At the same time there hasn’t yet developed in China significant secondary market for housing, and homeowners are restricted from taking out home equity lines of credit. Many Americans took out home equity loans to finance higher consumption, effectively converting their domiciles into ATMs, so this latter is probably a good thing.

A secondary market is likely just a matter of time, given the rate of urbanization and the consumptive desires already unleashed as the Middle Kingdom has climbed up the global value chain.

Floor Space

Iluka Resources Ltd (ASX: ILU, OTC: ILKAF, ADR: ILKAY) makes a key ingredient, zircon, in coatings for ceramic tiles. For CEO David Robb China’s urbanization is all about increases in gross floor space. Everyone has their favorite China stats. Mr. Robb’s favorite factoid, cited during the company’s conference call to discuss 2011 results, is that China will build the equivalent of the entire floor space of Europe in the next 10 to 15 years.

What’s compelling is what comes next, beyond this explosive phase for the Middle Kingdom so many seem to lament lately: “And we’ll then have to do it again in 30 years’ time, on a rolling basis, obviously, given that they typically build buildings to last some 30 years versus Europe at 100 years-plus.”

Skylines in China–across Asia, for that matter–are unrecognizable from what they were 15 to 20 years ago. Some have sprung from the ground, others have been entirely recast, Shanghai, Singapore, Kuala Lumpur. And the first generation of housing has actually been torn down and replaced. At both the commercial and industrial level as well as the housing level there remains significant potential for new floor space. Rising incomes–helped by housing, but also by China’s progression up the global value chain to higher-wage work–and associated desires for more living space should make the per capita figure grow, too.

This begs a fundamental question about the forces unleashed during the course of China’s–and Asia’s–development: Will the aspirational Chinese consumer settle for an outcome that gives them less square meters per capita than Taiwan, for example, only reaching this benchmark by 2025? And will this Chinese consumer settle for less, generally, than what post-Industrial Revolution middle classes in the West enjoyed?

Iluka Resources is a bet that China and the rest of emerging Asia will follow a trajectory similar to those traveled by developed economies, and that aspiration and a “wealth effect” will continue to exert a powerful influence on global supplies of and demand for all manner of resources, many of them found in Australia or worked globally by Australia-based firms.

As Mr. Robb pointed out during his recent earnings presentation the countries that happen to be leading global growth in the 21st century also happen to be tile-and-ceramics-centric than developed economies, which has its roots in culture. On a global basis, therefore, Iluka is well positioned for a shift in the heretofore common relationship between GDP growth and tile demand. China, Asia-Pacific, Central and South America, Africa and the Middle East are broadly taken to be the next growth engines for the world economy, and rates of tile use are higher in these regions than in North America and Western Europe.

The New Iluka

Management described their company as “New Iluka” when introducing headline 2011 numbers. The second item on the list of “2011 Key Features” that kicks off Iluka’s presentation to investors of full-year results is “Balance sheet = net cash.”

This snapshot item does capture the essence of what was a transformational year for a company with a durable position in its market and a reasonable opportunity for significant upside for the dividend and the share price over time.

On the ground the biggest development was Iluka’s ability to realize significantly higher prices for its two key products, and those price increases were absorbed by its customers and appear to making their way through the value chain. At the same time revenue surged on price increases and relatively stable volumes costs were contained. Revenues were significantly higher, which, combined with Iluka’s modest capital appetite “produced an order of magnitude difference in free cash flow” that fueled the aforementioned No. 2 “Key Feature,” the transformation of its balance sheet.

Iluka is a mineral sands producer and a play on the long-term transformation of China’s economy. But it’s the major producer of zircon globally and the largest producer of high-grade titanium dioxide-based products, rutile and synthetic rutile. Based in Perth, Western Australia, it has major operations at home and right here in Virginia.

Although the Middle Kingdom is and will drive and support the long-term health of the business use of tiles for flooring is a deeply ingrained aspect of some Eastern cultures. Management is secure in its ability to keep up with and fend off any technical challenges to its products’ dominance–it makes the primary ingredient in coatings for floor tiles and a key ingredient for pigments used in paint-making–though history has demonstrated that such events are slow-moving. This means, now with a strong balance sheet, Iluka can focus on growing market share and building wealth for investors.

The company also has a royalty associated with a tier one iron ore operation, AE Portfolio Aggressive Holding BHP Billiton Ltd’s (ASX: BHP, NYSE: BHP) Mining Area C province in Western Australia. But its key outputs are rather rudimentary. Iluka obviously benefits when new construction drives demand for tiles and paint.

Less obvious, apparently, and in light of recent reactions to an announcement about a downward adjustment to China’s gross domestic product (GDP) growth target, is that a middle class, rapidly flowering in the Middle Kingdom, is a resource-hungry group.

China’s urbanization is far from over. And what’s been built over the past decade and a half will soon require upgrade, refurbishment, even rebuilding.

It’s important to understand, too, where Iluka is in the building process. Housing starts in China have tapered, causing some to warn of a US-style housing bust. Iluka’s key metric, however, is housing completions, the time when consumption of a tile occurs. Completions in China were up modestly in 2011 and are expected to double in 2012.

Iluka’s concerns in China go well beyond housing, as demand for titianium oxide as well as zircon from chemicals and other manufacturing industries has been strong. There’s no question a potential lull in China’s growth will harm Iluka in the short term.

The good thing is that Iluka has taken advantage of the enormous opportunity fiscal 2011 created, that is management zeroed out debt, positioning the company to benefit should its informed-on-the-ground forecast about China’s trajectory prove true.

Net profit after tax (NPAT) grew an astounding 1,400.8 percent to AUD541.8 million, and free cash flow was AUD589.6 million, or AUD1.41 per share. Mineral sands revnue was AUD1.54 billion, a 75.7 percent increase over 2010, while group EBITDA rose 221 percent to AUD305.1 million. Interest costs declined by 35.9 percent, and the company reduced its “gearing,” or net debt, from 21.8 percent to nil.

Mineral sands sales volumes–including zircon, rutile and synthetic rutile–were down 4 percent. By product, zircon sales volume up 7.5 percent, rutile sales rose 10.8 percent and synthetic rutile declined 28.9 percent. Mineral sands revenue grew on higher prices and higher volumes for zircon and rutile are partially offset by a stronger AUD (USD1.03 versus USD0.92). Unit cash production costs were flat at AUD538 per metric ton.

Management described the production performance as “excellent,” as output was in line with expectations, was also well within cash cost guidance for its integrated, flexible production base. Iluka also recorded a net increase in ore reserves and mineral resources. 6.84 million metric tons of heavy mineral ore reserves were added during the year, a 25 percent increase. Following depletions and adjustments Iluka’s net reserves rose 13 percent. Mineral resources of 10.14 million metric tons were added in 2011, a 9 percent year-over-year increase; after depletions and adjustments the net increase was 6 percent. Importantly, roughly a quarter of revenues come from each of the major economic and geographic regions of the world.

Management has made a “higher commitment of funds and resources to global exploration effort.” Return on equity better than 40 percent during 2011 suggests the company is doing good things with invested capital.

As for the balance sheet, Iluka reported a net cash position as of Dec. 31, 2011, after transformational year. The question is what it will do with the flexibility it’s gained. This is an aggressive situation because we are essentially banking on management’s conclusion that the price increases realized in recent years do in fact represent a “step change” and that they are durable. These changes in prices for zircon and high-grade titanium dioxide have passed through to the next layer in the value chain.

As of early 2012 zircon prices are approximately 30 percent higher than the average for 2011. High-grade titanium dioxide prices are roughly double the average for 2011. On this basis Iluka “feels confident looking forward to 2012.”

Mr. Robb continued: “We’re confident advances we have made in terms of our technical capabilities, our ability to run a variety of ilmenites into our kilns, our ability to produce new products from those kilns and our ability to monetize low-value tailing strings, for example, augurs well for shareholders for the future.” Iluka has also used its bountiful 2011 cash flow to invest more in research and exploration. The company is attempting to “refresh” its resource bases but continues to exploit existing areas such as the Eucla Basin, the Murray Basin and the Perth Basin with the bulk of its capital expenditure.

Titanium dioxide, according to management, is the underrated element of the portfolio. The last couple years have been driven by uptake of zircon and new pricing; now management is noting a similar type of trend for titanium dioxide.

Iluka is a large company with a market capitalization of more than AUD7 billion. It’s a member of the ASX 50. The company will report fiscal 2012 (end Jun. 30, 2012) results on Aug. 23, 2012. Iluka’s production and exploration report for the quarter ending Mar. 31 is due Apr. 12. The company will hold its annual general meeting May 23 in Perth.

The next dividend dates will be announced Aug. 23 along with results for the six months to Jun. 30, 2012.

It trades with significant volume on its home board, the Australian Securities Exchange (ASX); you can buy the equivalent of these ASX-listed shares in the US over-the-counter (OTC) market under the symbol ILKAF.

Management’s dividend policy is to “provide a floor rather than a specific number.” The floor is currently 40 percent of free cash flow. For 2011 it was actually 53 percent, a sign that management appreciates the cash-generative qualities of its business and that, while it can and will look for ways to prudently invest, it sees it as entirely reasonable that a good percentage of what operations generate be returned to shareholders.

Iluka Resources is a buy on the ASX or on the US OTC market using the symbol ILKAF up to USD18.

The Bank of New York Mellon Corp/Deutsche Bank Americas Holding Corp jointly sponsor an American Depositary Receipt (ADR) representing five ordinary shares of Iluka Resources. The symbol for the ADR, which trades on the US OTC market, is ILKAY. Your broker should have no problem executing a “buy” order for the ADR and shouldn’t charge you any extra fee or commission to do so.

The ADR conveys the same currency impacts, up and down, as if you owned the ASX-listed share or the OTC-traded facsimile. The custodian of the ADR will extract a fee for handling currency conversion and other transaction fees.

Since the ADR was introduced Feb. 4, 2011, it has generated a total return of 96.8 percent. Volume is about 5,000 shares a month. Five-year average monthly volume for OTC-traded ILKAF is about 15,000 shares.

If you buy Iluka Resources through the ADR, don’t pay more than USD90.

A Bank Apart

Australia & New Zealand Banking Group Ltd (ASX: ANZ, OTC: ANEWF, ADR: ANZBY) announced that is has received a license to conduct retail business in the yuan in China, making it the first Australian bank to earn such approval.

ANZ said in statement the new license would allow its subsidiary, ANZ China, which has 20 percent stakes in China’s Shanghai Rural Commercial Bank and Bank of Tianjin, to provide customers with local currency deposits, mortgages, “bancassurance” (or insurance) and wealth management products and services.

This is a significant step in ANZ’s effort to compete with HSBC Holdings Plc (London: HSBA, NYSE: HBC) and Standard Chartered Plc (London: STAN, OTC: SCBFF) as a regional lender in Asia. The Australia-based bank, which in 2011obtained a license to operate in India, wants to generate 25 percent to 30 percent of earnings from Asia by 2017.

As for results for the three months ended Dec. 31, 2011, ANZ reported a 4.1 percent increase in underlying profit, though management cautioned that credit growth was unlikely to return to pre-Great Financial Crisis levels anytime soon. Unaudited underlying net profit after tax (NPAT) adjusted for non-core items was AUD1.48 billion, up from AUD1.4 billion a year ago.

ANZ Bank reported that mortgage lending rose 2.4 percent sequentially, 1.5 times system growth, while deposits gained 3.6 percent, or 1.3 times system growth.

Net interest margin, the difference between what it pays to borrow and what it receives to lend, narrowed about 1 basis point from the prior corresponding period; this figure, however, doesn’t include ANZ’s global markets business. At the bank’s Australian business, the net interest margin narrowed 9 basis points “due to higher funding and deposit growth.”

Management noted that its term wholesale funding program for 2012 is “in line with 2011” at around AUD20 billion, and ANZ is ahead of schedule with about AUD9 billion raised year to date. The bank’s Tier 1 capital ratio was 11 percent as of Dec. 31. 2011.

In a statement accompanying the earnings release ANZ CEO Mike Smith noted, “There will not be a return to the level of credit growth that banks experienced pre-crisis for the foreseeable future, particularly in our major domestic markets in Australia and in New Zealand, as consumers reduce their gearing and businesses pace investments.

“Gearing” is another word for borrowing. Here you can see Mr. Smith’s motivation for expanding into non-Australasian markets. ANZ’s developing foothold outside its home markets is one reason why investors have turned buying eyes its way so far in 2012, giving it a Big Four-best 9.6 percent price-only increase.

Westpac Banking Corp (ASX: WBC, NYSE: WBK) is up 5.6 percent, National Australia Bank Ltd (ASX: NAB, OTC: NAUBF, ADR: NABZY) is up 3.5 percent and Commonwealth Bank of Australia (ASX: CBA, OTC: CBAUF, ADR: CMWAY) is down 0.5 percent, though it’s paid a dividend so posts a total return of 2.3 percent.

Since AE’s Sept. 26, 2011, inception ANZ has generated a total return of 24.3 percent in local terms, besting NAB (18.4 percent), Commonwealth Bank (14.8 percent) and Westpac (14.3 percent) as well as the S&P/Australian Securities Exchange 200 Index (11.4 percent).

In US dollar terms ANZ is up 35.4 percent since late September, besting the 22.1 percent total return posted by the S&P 500.

Australia & New Zealand Banking Group–our favorite among the Big Four because of its broader Asia exposure–is a buy under USD22.

Salt of the Earth

Ridley Corp Ltd (ASX: RIC, OTC: RIDYF) is the biggest animal feed and salt producer in Australia.

Investors have been happy to back the Asia story as it relates to the mining sector. But they’ve yet to embrace its likely impact on demand for Australian agricultural produce and salt, which will support Ridley’s business in coming years.

Ridley got started in 1987 as a stock feed manufacturer. In 1990 it purchased Barastoc Stockfeeds, and these operations now comprise Ridley AgriProducts (RAP). RAP is Australia’s largest commercial provider of stock feed and animal nutrition supplements. It holds an approximate 25 percent share of the available market, that is the approximately 50 percent of total stock feed demand that isn’t vertically integrated into large farming operations.

RAP sits neatly between grain handlers and livestock producers, adding value in the livestock/protein industries with a focus on poultry, pigs and dairy.

Ridley acquired Cheetham Salt, the largest producer and refiner of salt for sale into the Australian market, in 1992. Cheetham’s salt is sold to several industries, including water treatment, stock feed, food manufacturing, chemicals and the pool sector. In 2011 Ridley acquired primary chicken and fish specialist protein meal supplier Camelleri Stockfeeds for AUD35 million.

Fiscal 2012 first-half net profit after tax (NPAT) was AUD11.9 million, down 25.5 percent from AUD15.9 million during the first half of fiscal 2010, on the return to a normal tax rate of 26 percent following a one-off adjustment the prior period. Revenue from continuing operations grew 1.3 percent to AUD378.3 million from AUD373.6 million.

Operational EBITDA (earnings before interest, taxation, depreciation and amortization) was AUD20.9 million, up slightly from AUD20.6 million in the prior corresponding period. Ridley AgriProducts generated EBIT for the half year of AUD14.9 million, up from AUD12.8 million. Cheetham generated EBIT of AUD6.5 million, down from AUD7.8 million because of higher salt production and supply chain costs.

In December 2010 Ridley finalized a new AUD169 million bank debt facility to replace a AUD150 million cash advance due for repayment in December 2011. The new facility includes term debt available to be drawn down in tranches, with terms of between two and four years. “Gearing,” or net debt, rose to 41.2 percent as of Dec. 31, 2011, because of the Camilleri acquisition.

Ridley’s board declared a total cash dividend in respect of fiscal 2011 of AUD0.075 per share; it last cut its dividend in September 2008. For the interim period it will pay AUD0.0375, flat with the year-ago rate. Ridley Corp is a buy under USD1.30.