Inco's Wooden Guidance

What good is a bull market in metals if you can't get more of it out of the ground profitably? Investors might be asking themselves this question today about Inco (NYSE: N  ) . While the world's second-largest producer of nickel produced a good second quarter, guidance for the rest of the year wasn't especially encouraging.

Reported Q2 revenue climbed by 19%, in part because the price of nickel (as measured by trading on the London Metal Exchange) was 31% higher during the quarter than in the year-ago period. Adjusted net income was also strong, growing 52% and surpassing the mean analyst estimate.

Guidance for the rest of the year, though, was not so solid. Because of an unexpectedly long shutdown in Ontario and a slower ramp-up, the company cut its nickel production target for the third quarter from 125 million-130 million pounds to 110 million-115 million pounds. It also cut production estimates for copper and platinum-group metals.

With lower production and higher energy costs, the company is also forecasting higher production costs per pound of nickel. Compared with the $2.81 per pound seen in the second quarter, the company is now looking for $3.50-$3.55 per pound for the third quarter and about $2.85-$2.95 for the full year. That's whacking guidance down to between $3.45 and $3.55 a share -- well below the current mean of $3.85.

The company is hoping that this is just a blip. Overall, the market for nickel is still quite strong, though nickel inventories are being depleted as demand is exceeding available supply. And with reduced worldwide stainless-steel production in the second half of the year, the supply-demand imbalance is still projected to worsen.

Inco had better hope that the market for nickel stays strong because it's planning to produce a lot more of it over time. From somewhere in the neighborhood of 490 million pounds in 2005, Inco is expecting to grow production to 660 million pounds in 2008 and 700 million in 2009. With that sort of supply increase, continued strength in the price of nickel is going to require a lot more stainless steel, airplanes, and hybrid vehicles to be made in the next five or so years.

Of course, it's not really likely that nickel prices will stay as high as they are. Rather, prices will probably ease back to a more normal level as supply catches up to demand and customers rebuild their stocks. Nevertheless, so long as Inco can keep its production costs competitive, more supply should lead to more growth.

I'm not sure whether it's particularly Foolish to buy Inco shares just because you expect better demand for aerospace, hybrid cars, and/or batteries. Other companies, including Rio Tinto (NYSE: RTP  ) and BHP Billiton (NYSE: BHP  ) , offer some of that same upside with far more diversified businesses. Inco shares may well gain from this point, but as this quarter proves, it's not enough to just see higher commodity prices to make money off miners.

For more metal musings:

Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).


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