A different kind of portfolio manager

In our quest to evolve as fund managers we are constantly reading. Reading the likes of Peter Lynch, Warren Buffet (Alice Schroeder), Joel Greenblatt, Barton Biggs and Jack Schwager to understand what makes portfolio managers great. The list below is by no means exhaustive but includes some of these key attributes identified in our reading:

a) Have a long track record of performance.

b) Have an alignment of interest with other investors.

c) Show a high level of focus yet be flexible and diversified.

d) Have a strong repeatable process, yet be ever evolving.

e) Invest ahead of the curve in unloved or undiscovered opportunities.

In our minds Mineral Resources’ management display many of the traits of a successful portfolio manager, we see them as strong stewards of capital and are attracted to their approach to literally look at anything in the Pilbara (WA) that can make them money.

a) Since listing between FY2007 to FY2018 they have grown total investor returns at an impressive 29% p.a. (20% p.a. eps CAGR).

b) Management owns 15% of the business (MD Chris Ellison personally owns 11.6%).

c) They are resource focused but somewhat agnostic to how they make money and have services spanning: mining (iron ore, lithium, graphite, manganese, etc.), mining services (crush, drill and blast), transport (haulage and port logistics), infrastructure (bulk ore shuttle system “BOSS” and port), manufacturing (carbon fibre components, synthetic graphite, etc.) and energy.

d) From what was once a pure crushing business MIN is now a completely diversified mining service provider (and miner) for a mix of external and internal (profit share) projects.

e) MIN’s investments in loss making/early stage iron ore mines: Iron Valley, Koolyanobbing, Marillana and Kumina; and, pre-boom in lithium mines: Mt Marion and Wodgina, show an ability to identify early stage opportunities and their sell-down of Wodgina displays a high degree of capital discipline.

Below we detail why MIN remains a key holding of the Chester High Conviction Fund and we continue to invest alongside management as we see a combination of valuation support and earnings insight for what we perceive as a quality company.

Disclaimer: we are conscious preparing a sum of the parts valuation to espouse that MIN is undervalued isn’t original, but we felt it appropriate for the completeness of this note.

Mining Services
As discussed above since IPO, 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 evolution and growth of the business model has also seen MIN shift from providing services purely to third parties to primarily internal, profit share projects.

Source: MIN 2018 AGM Presentation

This provides increased earnings certainty as MIN is somewhat guaranteed to retain the contract over a project’s economic life. Key contracts include:

· Wodgina – 30-year mine life: crushing, accommodation and maintenance, mine to port haulage, ship loading and shipping.

· Mt Marion - 20-year mine life: mining and haulage, crushing and beneficiation, remote power services, road haulage, port handling, ship loading.

· Yilgarn (Koolyanobbing) - five to six years plus extensions: accommodation, mining and haulage, crushing and screening, train load-out, rail rolling stock, remote power services.

Below are the earnings for the division over the past three years and our expectation for FY20.

MIN has provided 2H FY19 guidance of AUD151-171m and commented “earnings are expected to increase as mining services under life of mine (LOM) contracts continue to ramp up at three internal sites”. The midpoint of this is AUD161m and given management’s comments that “increase is expected to be sustainable in future periods” we assume this level holds for FY20 (per table above).

Given the uniqueness of MIN’s diversified offering the market has at times struggled finding companies to comp the business against. Below we table a conglomerate of peers but feel the earnings certainty and LOM contracts; capability of management; historic & projected growth; and, level of diversification of MIN could afford a higher multiple than some peers ie. in the table below MLD has a contract life of <4 years (order book/annualised revenue) vs MIN's key LOM contracts.

Despite the averages of the above, for conservatism we assume an EBITDA multiple of 5x FY20 to value MIN’s Mining Services business.

Iron Ore
At times the market seems to ignore the optionality in MIN’s Iron Ore business. Since the tragic tailings dam collapse at Corrego do Feijao (late Jan 2019) the iron ore price (62% dmt CFR fines) has rocketed to ~USD120/t. Although debate about the long-term implications to supply continues, the share prices of iron ore miners, particularly FMG, implies a structural change in the long term (LT) price of iron ore which we feel hasn’t been reflected in MIN’s share price.

We have input consensus (FY20) prices and the implied LT FMG iron ore price into our model for each of MIN’s assets to determine an appropriate valuation. We summarise our findings below.

Iron Valley

MIN commenced operations at Iron Valley in August 2014 and the current production rate is 7-8Mtpa, with an ~10-year mine life (depending on price). The product is low grade (~59%) with high impurities, hence is heavily discounted. Even using a USD64/dmt 62% Fe LT price we arrive at a marginal long-term valuation (ex Mining Services) for Iron Valley but see material near term earnings (refer table below).

Koolyanobbing
The asset was acquired from Cliffs in August 2018 and has a project size of 6Mtpa, expanding to 8Mtpa. It currently has a five to six-year mine life which could expand with exploration success. The product is similar grade to Iron Valley (59%) but has a lower level of impurities hence has a much higher realised price. Within our DCF we value Koolyanobbing at ~AUD550m (AUD2.90/share).

Marillana
On 22^ndJanuary 2019 MIN fortuitously entered a JV with Brockman for 50% of Marillana. The project has a resource of >1bn tonnes, with the ability to produce a 60-61% product at over 20Mtpa. Hence the project has a long >20-year mine life. We note, per Brockman’s 1H FY19 report independent experts had valued 50% of the project (pre Corrego do Feijao incident) at NPV10 AUD543m, however, given the market cap of Brockman ~AUD300m as its primary asset we ascribe AUD200m to MIN’s share of the JV in our valuation (AUD1.05/share).

Kumina
In October 2018 MIN acquired the Kumina project from BC Iron for AUD27m with up to AUD8m owing in additional payments. The project has a resource of 78Mt at 59.1% Fe. We ascribe only purchase price in our valuation but believe valuation could be materially higher.

Iron Ore Earnings
Detailed below is our outlook for MIN’s Iron Ore earnings for FY19 and FY20 using historic (Q4 FY19) and consensus (FY20) iron ore prices.

Lithium

Mt Marion
On 21^st December 2018 MIN announced it would outlay AUD51.9m for 6.9% of the project from Neometals (NMT), taking its equity position to 50%. This outlay implies AUD376m for MIN’s 50% of the project. Although this is below our DCF valuation of the project, for conservatism we use the lower value in our sum of the parts below. We further note that there has been a material reduction in quoted spodumene pricing, which we factor into our forward earnings projections.

Mt Marion Earnings

Wodinga
MIN executed an agreement last year with Albemarle to sell-down 50% of the Wodgina project for USD1.15bn. The deal is expected to complete Q4 2019 at which time MIN will receive USD1.15bn (AUD1,640m) minus tax. This supports MIN’s remaining 50% interest (DCF validated) being worth ~AUD1,640m.

Furthermore, the deal gives Albemarle the responsibility for selling and marketing all the spodumene concentrate produced. Hence, with an eye to CEO Luke Kissam’s comments “if demand is not there, we won’t run the plant”, and uncertainty around full ramp-up, we see Wodgina spodumene sales as the biggest unknown in projecting MIN’s FY20 earnings. We see a downside case that Wodgina is constructed but no tonnes produced in FY20.

Valuation and Projected Earnings

Sum of the Parts

* Refer disclaimer above

Projected Earnings

Refer above for projections by division/asset. Further note that we have assumed corporate costs revert to a more normalised level ~AUD30m p.a. in FY20 vs 1H FY19 which included three material corporate transactions, including Wodgina sell-down.

Conclusion

MIN for us remains undervalued on a sum of the parts basis, with a margin of safety in earnings vs consensus even if Wodgina earnings in FY20 are immaterial (our projections imply ~3.5x EV/EBITDA in FY20).

DISCLAIMER
Past performance is not a reliable indicator of future performance. Positive returns, which the Chester High Conviction Fund (the Fund) is designed to provide, are different regarding risk and investment profile to index returns. This document is for general information purposes only and does not take into account the specific investment objectives, financial situation or particular needs of any specific individual. As such, before acting on any information contained in this document, individuals should consider whether the information is suitable for their needs. This may involve seeking advice from a qualified financial adviser. Copia Investment Partners Ltd (AFSL 229316, ABN 22 092 872 056) (Copia) is the issuer of the Chester High Conviction Fund. A current PDS is available from Copia located at Level 25, 360 Collins Street, Melbourne Vic 3000, by visiting vertium.com.au or by calling 1800 442 129 (free call). A person should consider the PDS before deciding whether to acquire or continue to hold an interest in the Fund. Any opinions or recommendations contained in this document are subject to change without notice and Copia is under no obligation to update or keep any information contained in this document current