Anthony Kavanagh | Portfolio Manager, Chester Asset Management |
No, we aren’t projecting a USD150/t iron ore price. Last year we wrote, A Different Kind of Portfolio Manager, wherein we argued Mineral Resources (MIN) was heavily discounted, trading at ~AUD15/share vs our AUD26/share valuation. Given the wide discount there wasn’t much need for over-enthusiasm on the upside but this note serves as an update and provides us the opportunity to revise one of the issues we had with our first note, the Mining Services’ valuation. Yes, we’re allowed to have issue with our own work. Rarely is the sequel better than the original but just as Adam Sandler made Grownups 2 sometimes the original was that bad/no-one saw it that it doesn’t hurt to have another go. For time poor readers we have worked backwards from our original note, providing an update on our valuation, followed by the detail on Lithium, Iron Ore and Mining Services, before rounding out with earnings implications.
Combining our work below into a valuation is easy enough but within our analysis we are left with some key questions which materially influences the fair value outcome, hence the multiple valuation scenarios below. These include:
a) Whether to accept the iron price implied by Fortescue Metals (FMG)?;
b) What is a reasonable multiple and hence valuation of MIN’s Mining Services segment as more contracts become sticky Life of Mine (LOM) type infrastructure deals?; and
c) How much of the theoretical value of future projects: Marillana, West Pilbara and lithium downstream, including the associated Mining Services upside is reasonable?
Source: Chester Asset Management
Hence MIN can be an AUD40/share stock, but we await the derisking of these future projects before getting too carried away. We further note in the near term, as Vale recovers lost production, we expect iron ore prices to soften and point this out as a near term headwind to share price performance.
Lower prices, operational issues, curtailments/mothballings, value destruction and bankruptcies. FY20 has been a challenging year for the lithium space, particularly spodumene producers. Despite Wodgina being put on care and maintenance during the year MIN’s lithium business has actually fared pretty well vs peers, with Management pulling off a stunning revision to their Albemarle deal and maintaining Mt Marion production albeit at ~breakeven earnings.
Wodgina (and Kemerton)
In August 2019 MIN and Albemarle announced a revised Wodgina agreement, moving from 50% selldown at USD1.15bn to 60% at USD1.3bn, comprising a cash component of USD820m plus 40% of two Kemerton 25ktpa hydroxide trains (USD480m). At the time, given depressed lithium markets we read the announcement expecting a catch, but apart from the probability of Wodgina downstream being reduced (and at the very least pushed out) we couldn’t find one. MIN was able to take more off the table at almost effectively the same economics and retain optionality over a Wodgina hydroxide plant. It came despite a material deterioration in market fundamentals and Albemarle scaling back their own downstream ambitions. With commissioning expected from Kemerton by late 2021 we believe the market is behind the curve on what it may contribute to earnings and valuation.
Source: Chester Asset Management (with reference to PLL Merchant Chemical Plant PFS, May 2020)
It appears likely Kemerton will be fed primarily from Greenbushes leaving Wodgina spodumene somewhat homeless. Although processing in China is likely, it isn’t unfathomable the Wodgina JV would revisit plans for an integrated project by investing in up to 100ktpa of lithium hydroxide capacity. Hence, we model a downstream option with an unrisked valuation of AUD950m for MIN 40%, but commencing FY2027! In addition, we model Wodgina spodumene at AUD750m (for 40%) meaning total unrisked value to MIN of ~AUD1.6bn compared to AUD1.2bn implied by the Albemarle deal (at cost).
Despite being somewhat breakeven at current spodumene prices (~USD500/t) we were concerned Mt Marion could be placed on care and maintenance, which would impact near term Mining Services earnings given estimates below. However, with 50% equity partner Gangfeng commissioning 25ktpa of (expansion) hydroxide capacity in Xinyu, and Mt Marion flagged as a source of feed, there is evidence to support MIN maintaining, and potentially expanding production in FY21. We currently value MIN 50% stake in Mt Marion at ~AUD350m, providing MIN steady state EBITDA of AUD90m p.a. assuming USD650/t real long term (LT) 6% spodumene prices.
It is also worth noting MIN has the option to take 43.1% of Mt Marion production, enough spodumene to produce 25-30ktpa of hydroxide. Given our valuation for Wodgina downstream an unrisked valuation associated with a plant could be >AUD500m. An unlikely development in the near term but a potentially attractive bargaining chip to keep Gangfeng honest.
Iron Ore Update
At the time of our last note iron ore (62% dmt CFR fines) was trading at USD120/t and Fortescue (FMG) at AUD9.00/share. We used our FMG model to guess what LT iron ore price was implied by the market. Today, although spot price is lower at USD105/t, FMG is ~AUD14.00/share. We acknowledge this as an imprecise science for imputing an iron ore price but for us remains a useful exercise. We currently use consensus USD66/t (real) LT as our assumed base case with USD78/t representing an upside valuation scenario which we use in our asset valuations.
Source: Chester Asset Management
MIN commenced operations at Iron Valley in August 2014 and the current production rate is 6-8Mtpa, with an ~10-year mine life (depending on price). The product is low grade (~59%) with high impurities, hence is heavily discounted. Per the table below we arrive at a marginal long-term valuation (ex Mining Services) for Iron Valley but note it is still quite profitable at spot prices. Refer table below for a summary of our valuation.
Koolyanobbing was acquired from Cliffs in August 2018 with an original project size of 6Mtpa, expanding to 8Mtpa, producing an ~59% product but at lower level of impurities to Iron Valley. In August 2019 MIN announced it had acquired Parker Range for AUD20m (plus 1% royalty) from Cazaly Resources expanding the exploitable resource in the Yilgarn. 3 months later, MIN announced a total Yilgarn resource >100Mt, an exploration target of 30Mt to 83Mt at Mt Richardson, and a revised production target of 11Mtpa. In February 2020 this target was increased further to 15Mtpa by year-end, subject to port and rail concessions. Refer table below for a summary of our valuation.
Source: Chester Asset Management
Marillana is a 50/50 JV between Brockman Mining (BCK) and MIN. The project has a reserve of ~1bn tonnes (of DID, 42% Fe ore), which via beneficiation has the potential to produce a ~61% product at over 20Mtpa. BCK appointed independent experts valued the project in December 2018 at AUD1,080m (NPV10, with 20% JV discount). We note MIN has previously suggested JV capex of AUD300m ex the majority of infrastructure with MIN providing processing, rail and port services on a contractor BOO basis. With an updated study on the project due very soon, we won’t try and nail the infrastructure solution, and expect most of our assumptions to require revision, but do expect MIN’s Next Generation crushers to be utilised, and suspect proximity to Iron Valley will provide synergy benefits with respect to logistics.
Source(s): Brockman Quarterly report September 2010, Brockman Study 19/12/2018, Chester Asset Management
West Pilbara (including Kumina)
In October 2018 MIN acquired the Kumina project from BC Iron (BCI) for AUD27m with up to AUD8m in additional payments. The project at the time had a resource of 78Mt at 59% Fe. In March 2020 MIN announced further BCI agreements including acquiring the Buckland Project for up to AUD20m plus a 1% royalty. Resources at the time totalled 283Mt at 57%.
A significant study for this project incorporating drilling results, feasibility on mine planning, and infrastructure is expected 2H 2020. The study will include the establishment of 3 operating mine sites (utilising MIN’s Next Generation crushers), a potential 380km medium gauge rail line, and 2 capesize berths at Port Hedland inner harbour. MIN has indicated it will bring in an equity partner for port and rail.
Given the early stage of the project, low transaction value, lack of details and the current reserves position, we lack conviction on valuation but provide the view below of theoretical upside. We await results of the study with interest.
Sources: Chester Asset Management with data from various announcements
Mining Services Update
Last year we detailed how MIN has transformed from a pure crushing business to a diversified services operation across the full life cycle and supply chain of mining projects. The historic growth of the business and the track record of Management has been quite impressive yet there still appears some market scepticism. We make the specific example of MIN’s FY19 AGM commentary.
Source: MIN 2019 AGM Presentation
Although it was somewhat vague, most businesses that make this kind of statement don’t usually see their share prices drop 5% the following day.
So, what does it mean, and will it be profitable growth? We understand the base of this comparison to be 2H FY19, given it was the AGM preceding this half and Management spoke at 1H FY20 to having already achieved 40% of the growth (1H FY20 was 40% greater than 2H FY19). We also understand the doubling of Mining Services doesn’t include any potential earnings from Wodgina, Marillana or West Pilbara.
Historic analysis of MIN’s half year results suffers from variability from: intersegment transactions and undefined construction earnings meaning EBITDA margins and revenue aren’t reliable without stripping this out. Hence, we feel it most appropriate to consider the ex construction EBITDA attached to production for a reasonable indicator of past earnings. The graph below from MIN’s 1H FY20 results presentation serves as the basis for our analysis which we have produced below.
Source(s): Chester Asset Management, MIN historic financials, MIN 2019 AGM presentation
Per above we arrive at AUD0.67m per 2015 rebased tonnes, hence doubling of 2H FY19 production could equate to HY EBITDA of ~AUD240m if MIN’s are able to maintain margins in line with the 5-year average. Although somewhat simplistic an analysis we note: Ex construction EBITDA margins have actually averaged AUD0.72m/t from 2H FY17, with a higher portion of internal contracts; and Ex Construction EBITDA margins were AUD0.73/t in 1H FY20.
Source(s): Chester Asset Management, MIN 1H FY20 results material
I.e. If MIN can deliver on their AGM commentary Mining Services could be annualising EBITDA of AUD480m by 2H FY22.
But back to my comments that this doesn’t include Wodgina, Marillana or West Pilbara (which may not ramp up until FY23+). Below we have tried assessing the potential upside from these contracts.
We take the following image previously provided by MIN to be very instructive. It is our belief that this shows the expected revenue from the Mt Marion LOM contract and the split of respective components of the “pit to customer” agreements.
Source: MIN FY18 results Presentation
Source(s): Chester Asset Management, with multiple input sources including MIN FY18 presentation
Based on historic margins we theorise that MIN generates ~AUD60m p.a. EBITDA from Mt Marion and could generate an additional AUD25m p.a. from Wodgina. Notably the Albemarle agreement appears to exclude mining (except crushing) and processing, which per the example are material cost centres.
Marillana and West Pilbara
As per the discussion above Marillana and West Pilbara loom as material opportunities and could lead to a step change in both Commodities’ and Mining Services’ earnings. We have trawled through historic announcements of various project proponents to develop a view on project economics, which will almost feel like wasted time as MIN publish studies in coming months. Nonetheless our analysis is presented below on the potential Mining Services opportunities associated with each. Refer above for key project attributes but in relation to Marillana, per MIN website it states they will enter into a life-of-mine BOO contract for crushing, processing and train load out as well as a mine-to-port transport and ship loading contract JV.
Source: Chester Asset Management, with multiple input sources including BCK Marillana 2010 Feasibility Study
Hence Marillana could add AUD150-200m p.a. in EBITDA and West Pilbara AUD250-300m p.a. but both projects remain subject to macro conditions, approvals, progress (including study completion), an investment decision, construction, etc.
Back to one of the issues we had with our last note, we used an EV/EBITDA basis of 5x to value Mining Services based on projected FY20 EBITDA. Our two key issues with it are that: a) the multiple is conservative; and b) capitalising FY20 ignores the growth potential discussed above. M&A deals for Pacific Energy and Zenith Energy show the potential disconnect between valuation for distributed mining infrastructure, particularly as a greater portion of MIN’s Mining Services Earnings transition to LOM infrastructure type tolling arrangements, away from external Mining contracts. We have reflected that in our comps table below and derive an EBITDA multiple of 6x as our new base and 8x as our high case under a capitalisation of earnings approach.
Source: Chester Asset Management, IRESS
We have provided our valuation update earlier but reiterate some of the key points and highlight what these could mean on an earnings, rather than valuation perspective below:
- The market appears behind the curve on Kemerton
- Despite some industry experts expecting recovery from 2H CY21 a recovery in lithium is not priced in
- The market remains skeptical on MIN’s ability to double Mining Services and the value of internal contracting
- Material upside exists from derisking / progressing development projects (Marillana, West Pilbara and Lithium Hydroxide)
We have chosen to present below what steady state earnings could look like in FY22 and FY23 to suggest upside risk exists to consensus (even prior to the contribution of earnings from development projects).
Source: Chester Asset Management, IRESS + Only 2 forecasts available for FY23, AUD690m represents the average
Let’s hope they keep crushing it.