Can Mineral Resources be a $40 stock?

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).

Mt Marion

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

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.

Wodgina

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.

Updated Multiples

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

Conclusion

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.

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