Life After 40 - Time to Go Overseas?
Anthony Kavanagh, Chester Asset Management
22 June 2021
Twelve months ago we wrote our second note on Mineral Resources (ASX: MIN) titled "Can Mineral Resources be a $40 stock?". Within seven months our question was answered with an emphatic yes. Like all good sequels that enjoyed debatable success, we thought why not go a trilogy? We realise we may sound a bit like a broken record suggesting parts of the company remain underappreciated but hopefully some of the areas highlighted in this note make it less pointless than the Karate Kid III movie.
As a recap, from our last note we felt the market was: underappreciating the quality and growth potential of Mining Services; behind the curve on iron ore projects; and mispricing lithium optionality. Ultimately some of this boiled down to being under-covered, which appears to no longer be the case with increased broker coverage. This probably brings with it reduced ability for unique insight but we still see a couple of interesting parts of the business that present meaningful upside to market (sell-side) valuations and the share price, including:
Our updated valuation is presented below with more detail following.
Source: Chester Asset Management
12 months ago, we summarised the lithium market in FY20 as follows: "lower prices, operational issues, curtailments/mothballing, value destruction and bankruptcies". With hydroxide prices now ~USD15,000/t CFR into North Asia and 6% spodumene (SC6) ~USD700/t, share prices up multiples in 12 months, lithium contracts being agreed and consolidation taking place, the tables have certainly turned.
Obviously, prices are now up but we ask ourselves has spodumene become more attractive? Since the days of Standard Oil markets have been debating the appropriate economic split between upstream and downstream operations. It is not an easy question, and like many in markets can be answered by supply and demand fundamentals. When lithium markets were oversupplied spodumene was bid down to marginal cost of production (lower in some cases as entities like Alita/Tawana and Altura went into administration) however 2021 has seen the market tightening and prices reflecting that. Furthermore, with upstream producers expressing an increased desire to vertically integrate the spodumene left over for the hydroxide refineries is limited, so the margin available to upstream producers potentially increases. Companies like Pilbara Minerals (PLS) are even going a step further: by creating an exchange to sell spodumene into and investigating a midstream product with Calix (CLX).
Source: Pilbara Minerals Corporate Presentation, May 2021
Hence we see a natural progression for downstream players, facing potential spodumene shortfalls to also seek increased integration via JV tie-ups/ acquisitions. Given the political climate it seems likely FIRB would stymie attempts to acquire Australian operators by certain players and see greater integration between African upstream (hardrock) entities and China downstream players to avoid these players ending up like the HBO show Ballers (1). As we commenced writing this note, supportive of our thesis, it was announced Gangfeng would pay Firefinch (FFX) USD130m for a 50% stake in the Goulamina mine in Mali.
This preamble is a long-winded way of saying anyone with uncommitted spodumene should receive a greater share of value for it. Before the market got tight MIN was already planning for this and recent announcements have reinforced a desire to convert all spodumene to hydroxide within their own supply chains.
Mt Marion continues to perform strongly with a steady run rate of ~450ktpa, recoveries (>85%) and costs (~USD350/t CFR) best in class. Although we don't have updated reserves/ resources on the project MIN point to the project having a 20+ year mine life. We now value MIN 50% stake in Mt Marion at ~AUD560m assuming an ~20 year mine life, providing MIN steady state EBITDA of AUD90m p.a. (ex Mining Services) (2).
In relation to Wodgina planning is currently underway to restart the mine after it was placed on care and maintenance in November 2019 following construction. Given greater scale, lower strip ratio, higher grade and more favourable cost structure, potential exists for Wodgina to have a far superior cost structure to Mt Marion, albeit we await clarity on what this may look like.
MIN had previously suggested a cost of USD296/dmt at 65% recovery for 750ktpa of SC6 but given the learnings from Mt Marion (and other operators) we see potential for production at a higher rate and lower product spec (5.5-5.8%) at improved recovery and cost.
We now value MIN 40% stake in Wodgina at ~AUD1,060m assuming a ~30 year mine life, providing MIN steady state EBITDA of AUD150m p.a. (ex Mining Services) (2).
Lithium Hydroxide - International Opportunity
We reiterate our view that Kemerton will likely be fed by Greenbushes and MIN's owns 40% even if it's not fed by Wodgina. Furthermore, Kemerton being fed by Greenbushes does not alter MIN's ultimate ambition of converting all of their spodumene (both Wodgina and Mt Marion) to hydroxide. Given quoted costs in China for downstream(3) vs more than double that in WA it is likely we see JVs established in China as the likely location of hydroxide refineries. We have provided an updated summary of our lithium hydroxide valuations below.
Source: Chester Asset Management (with reference to various announcements around lithium hydroxide plants)
At the time of our last note iron ore (62% dmt CFR fines) was trading at ~USD105/t and Fortescue (FMG) at AUD14.00/share. We admitted 12 months ago we weren't predicting >USD150/t and still expect at some stage prices will roll over but MIN has certainly benefited from that strength. Due to our complete inability to predict the iron ore price we continue to use our FMG model to interpret a long term (LT) iron ore price implied by the market with FMG at AUD22.00/share. We continue to acknowledge this as an imprecise science but for us remains a useful exercise. Notably we now acknowledge that previously we had only modelled reserves but appreciate that higher iron ore prices would see resources convert to reserves. Hence we've added an additional scenario showing the implied iron ore price from 100% resource conversion.
The outcome of this is we continue to use consensus USD66/t (real) LT as our assumed base case 62% Fe price (after 3 years using ~consensus) but flex this to USD80/t LT as an upside scenario.
MIN notably at their most recent AGM announced a strategy around the four hubs of: Utah Point, Yilgarn, Ashburton and Southwest Creek. We provide an update on each of these below.
Currently MIN are exporting Iron Valley tonnes from Utah Point but in addition will export Wonmunna, Lamb's Creek and Wedge Iron Ore through the port. MIN is currently developing a 10 year, 14Mtpa mine plan for the hub (within 12 months). Iron Valley and Wonmunna will form the base of production. Wonmunna was notably acquired (Q1 FY2021), developed and commenced production (March 2021) in the space of 6 months, showing all of the benefits of Next Gen Crushing plants referred to in this document. The all in cost of acquisition and development for 5Mtpa of capacity was quoted at AUD126m with output potential of 10Mtpa for "little additional capital cost".
The Yilgarn hub consists of infrastructure at Carina and Koolyanobbing. MIN is currently in the process of finalising a 10 year mine plan that includes Koolyanobbing, Parker Range and Mt Richardson. Planned capacity for the hub is 13Mtpa.
Valuations of Existing Operations
Source: Chester Asset Management, Mineral Resources Announcements
The latest with regards to the Ashburton iron ore project is that it is anticipated to be construction ready in August 2021 with a 2 year development (so first production 2H CY23). The project hub has been earmarked as 25-30Mtpa. The key sources of supply for Ashburton are Bungaroo South and Kumina.
Notably, recently a subsidiary of MIN has also bought a 15% stake in Aquila resources that has a 50% stake in the Australian Premium Iron JV. I.e., MIN now has effectively 7.5% of the API project. Baowu owns 42.5% while US company AMCI and South Korea's POSCO each own 25% of API. The key project of the JV is the 40Mtpa West Pilbara Iron Ore project. It was reported MIN paid AUD10m for the stake which also gives them exposure to Eagle Downs Coking coal project in QLD and Manganese assets in South Africa. We watch with interest how this asset may play into the strategies around Ashburton and Southwest Creek.
Southwest Creek (SWC)
In our previous note we provided a model for a 20Mtpa Marillana operation. Since then, MIN announced the desire for the business to be a 40-50 Mtpa operations consolidating more than just Marillana but also Ophthalmia and other stranded deposits. MIN has also announced that farm in agreements under the JV with Brockman had been satisfied and the JV had been amended(4) to include the Ophthalmia Project. Hence at least half of the SWC is proposed to come from Marillana/Ophthalmia.
MIN are still competing for berth rights (3 and 4) at Southwest Creek which are reserved for emerging / junior iron ore miners. Although there is no guarantees around access there are certainly other options if they aren't successful in securing rights. Hence we are surprised to see little value reflected in analyst valuations for the project.
Valuations of Growth Projects
Our valuations for Ashburton and SWC are summarised below. Notably capex is a key area of uncertainty however we have provided analogues below to drive our assumed capex figures.
Source: Chester Asset Management with input from BHP, RIO and MIN announcements
Source: Chester Asset Management, with input from various ASX announcements
Per our analysis the market seems to be pretty consistent (now) in how they value MIN's Mining Services division at ~6-7x EBITDA. We continue to believe a higher multiple is warranted given: the sticky nature of the business, the IP in their crushers and the greater portion that is effectively locked in for life of Mine Operations. However, we use 6x EBITDA as our base and 8x EBITDA as our upside case within our valuation.
Certainly, one of the key areas we had noted in our last note, being the market not recognising the earnings growth of the segment, has played out as MIN's has delivered material growth and even softly upgraded the 'guidance' on the division to a doubling of production for calendar year 2019 within 3 years.
Source: Mineral Resources FY2020 Results Presentation
As we previously noted historic analysis of MIN's half year results suffer 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 and what that could mean for future earnings.
Source: Chester Asset Management, with input sourced from MIN half year results
Hence assuming reasonably consistent EBITDA margin we calculate the guidance implies ~AUD585m EBITDA at end CY22 (from annualised AUD460m 1H FY21). We believe this to be exclusive of both the key iron ore growth projects and any international deals that could be struck (refer below).
We have rolled forward and updated our assessment of what the 2 key growth projects could deliver in sustainable EBITDA for the Mining Services division below.
Source: Chester Asset Management, with multiple input sources
Mining Services - International Opportunity
Maybe it is just us but we are quite excited about the potential for MIN to take its crushing capabilities overseas. As a reminder the NextGen 2 Crusher is IP of MIN. MIN recently signed an agreement with Metso Outotec ("Metso"), whereby Metso will market the crushers internationally, however they still do not have the ability to sell plants without MIN's agreement.
The benefit of the NextGen Crushing plants are:
In addition to Wonmunna, one of the new NextGen 2, 12Mtpa crushing plants has recently been commissioned at BHP's Mt Whaleback mine.
Source: MIN Site Tour presentation April 2021
Some investors may look at the potential for MIN to go overseas as potentially risky but there would be ways to strike commercial terms that would not involve operatorship, such as:
Additionally, if MIN were to retain operatorship they could be selective in jurisdictions such as avoiding certain parts of Africa.
What is the TAM of the international opportunity?
This is a tough question to answer given the information isn't readily available but we have performed a crude analysis below. Global crushing appears a relatively competitive market with multiple operators. Research suggests that Sandvik is the leading provider with ~14% of a USD11bn market with Metso number 2(5). Given the portability and cost vs traditional options we don't see why a Next Gen solution can't start to represent a meaningful slice of the global crushing market.
Below we have conducted a theoretical exercise that conceptually estimates annual crushing additions outside of Australia at ~400Mtpa.
Source: Chester Asset Management with inputs from various sources
What could commercialisation look like?
Under a contractor model, assuming similar economics to the Australian operations, MIN 50% share and a build-up of 5 years on these contracts over a longer period we can see scenarios whereby the international opportunity can generate meaningful margin to MIN.
Source: Chester Asset Management
i.e. under these assumptions a 20Mtpa contract could generate AUD30m p.a. in EBITDA, MIN share being AUD15m but 1 of these p.a. for 5 years could mean cumulative AUD75m in recurring EBITDA in 5 years' time.
An alternative to this model could be a sale of crushers for which MIN's take a royalty. A hypothetical example of what this may look like is presented below.
Source: Chester Asset Management
We iterate both of these models are hypothetical and the international opportunity is at a very early stage. Management has not provided indication of the likely commercialisation model or LT potential.
The WA onshore energy scene has seen some excitement over the past 5 years and MIN hasn't been too far off the scent. Recent discoveries such as Waitsia(6) and West Erregulla. indicate there is a lot of prospectivity in the Perth basin.
Like most things that they do MIN's energy exploits aren't a flash in the pan based on recent successes but part of an orchestrated plan to replace diesel with micro LNG for internal purposes and as a service to clients.
Source: Mineral Resources 2021 Investor Day
MIN has an enormous land package in the Perth Basin (7,300 sq km gross acreage) and North Carnarvon Basin (6,300 sq km). The difficulty for us trying to analyse it is that they haven't really announced any leads or prospects. We do know that MIN has announced the potential to drill 2 wells in FY22 and 2 more in FY23. The first of these is targeting the Lockyer Deep prospect. We note you don't normally drill wells without identifying a prospect first. The differential between Warrego and Strike Energy provides some insights into how the market is valuing the highly prospective Perth Basin Acreage, which we have used to impute a potential value for MIN's acreage.
Chester Asset Management
We appreciate the market has more colour on STX upside via the key prospect of South Erregulla(7) but see no value being ascribed to MIN's energy assets in market valuations.
Vertical Integration is the goal
Looking at MIN's energy ambitions another way MIN has previously stated that diesel costs more than AUD140m p.a. Converting diesel to gas would materially reduce greenhouse gas emissions and ongoing reliance on 3rd party suppliers as well as save them money. In their FY20 sustainability report MIN notes total diesel consumed of 3.4 PJ. If we assume costs to the wellhead of ~AUD2.00/GJ for Perth Basin and AUD3/GJ for piping and conversion to LNG all in costs could equate to ~AUD5/GJ. The opex savings could exceed AUD120m p.a. based on FY20 energy requirements. Ignoring the cost of converting the transport fleet to micro LNG at 6x EBITDA this equates to ~AUD700m of value. Notably however with MIN's growth ambitions future diesel requirements and savings would be significantly greater than the FY20 levels. Additionally if MIN were to make a material discovery we believe they would look to offer an integrated energy solution involving gas as an additional pillar within Mining Services.
Steady State Earnings
The following table represents our projection of the steady state EBITDA of MIN if the growth opportunities outlined in Iron Ore, Lithium and Mining Services are delivered within a 5 year timeframe. Cleary there are some immediate pressures around labour availability so this is a very hypothetical example but we thought worth highlighting the opportunity to develop MIN into a AUD3bn EBITDA p.a. business would clearly lead to a business much larger than the current AUD9bn market cap.
Source: Chester Asset Management
Keep on crushing it MINs
(1) For those not familiar with the show the production ceased after 5 years because the Rock was unavailable
(2) Assuming USD650/t real long term (LT) 6% spodumene prices.
(3) USD200-250m for 25ktpa of capacity for hydroxide
(4) Refer ASX announcement 23/4/2021
(5) (VIEW LINK)
(6) A reminder that in December 2017 MIN previously bid for AWE (for its 50% share of Waitsia)
(7) Identified as potentially connected to West Erregulla (Best estimate 1.6 Tcf gas with Geological Chance of Success at 57%)
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