This stock is the "holy grail" of ASX investing

You wouldn't want to bet against this company over the long term, says Katana Asset Management's Romano Sala Tenna. 

After all, as Warren Buffett says, the "holy grail" of investing is identifying those companies that have a high return on investor capital AND a high rate of growth. 

"You have to have both, it's no good having a high return on investor capital if you can't grow the business or vice versa. If you have those two, the stock can become a compounding machine," Sala Tenna says. 

He's talking about Mineral Resources (ASX: MIN), which since listing in 2006, has generated an average compound annual growth rate of about 30%. Over those same 16 years, it's also become the second best performer for total shareholder return within the S&P/ASX 300. 

But with underlying EBITDA down 46% to around $1 billion, and revenues sliding 8% to $3.4 billion, is now a good time to be investing in this stock? Or would investors be best served to wait for a better time to buy? 

In this wire, Sala Tenna shares his thoughts on this diversified miners' latest result, the risks he foresees in the future, as well as why he is more cautious right now than he has been for quite some time.

Mineral Resources Q4 FY22 key results

Note: This interview took place on 29th August 2022. This stock is a top holding in the Katana Australian Equity Fund. To learn more about this fund, click the link below:

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What were the key takeaways from this result? What surprised you the most?

There weren't too many surprises on the operational numbers themselves. They're pretty much in line and I think they've been well telegraphed in terms of a quarterly perspective. So let's look at some of the headline numbers. Obviously, the impact on iron ore left a $1.4 billion hole there, but that was completely expected. That was down over 90%. The flip side though was with lithium. MIN was obviously able to take advantage of much better prices there, but they are also trying to pull forward production there too. 

So between that and of course mining services, which is very much the staple there and is just going from strength to strength as the largest contract crusher globally, the results were pretty much in line with our expectations. 

The thing that surprised us the most was the change in the terms to the Albemarle joint venture. So we hadn't expected to see them increase their stake in Wodgina from 40% to 50%. And at the same time, give up some ownership of Kemerton from 40% down to 15%. 

We understand the strategic rationale behind that, but that's probably the biggest surprise from our end. The second biggest surprise would have been with the Ashburton iron ore project. Agreeing to take on the full debt pile or the full development CapEx, which is in the order of $3 billion in exchange for a bigger piece of the project, took us a little bit by surprise as well. 

On the battery manufacturing announcement, I think this is the sort of visionary leadership we need in Australia, but the realities are a long way from that. I think what Wesfarmers (ASX: WES) is doing with Mt Holland and working on an integrated chemical processing facility to lead into the battery stage is within the realms of what's possible in Australia. We still have some strategic advantages there. But for us to try and compete globally, particularly with the economies of scale at these companies out of Asia, I think would be very difficult. 

That said, it would be unwise to challenge Chris Ellison on his plans for the future because he's achieved so much more than so many people ever thought would be possible. 

What was the market’s reaction to this result? Was this an overreaction, an under-reaction or appropriate?

I would say the market's reaction has been appropriate. The stock rallied very hard into these results, as it often does. It rallied around 40% heading into today's result. And it's done that three or four times over the last six to 12 months. And obviously, there is a bit of a downdraught in today's general market, so that's also had an impact.

Would you buy, hold or sell Mineral Resources on the back of these results?

Rating: HOLD. 

Over the short term, it's a hold. And I think there's probably some profit taking going on at these prices. But if you can lift your time horizon a bit, I think it's a very strong buy over the next few years. 

MIN has added an extraordinary amount of value over the last 16 years since it was listed in 2006. It has averaged about 30% CAGR over that timeframe. 

And I think it's the number two, over that timeframe, for total shareholder return. So that's an incredibly impressive track record. 

Warren Buffett talks about the "holy grail" of investing as being companies with a high return on investor capital and a high rate of growth. You have to have both, it's no good having a high return on investor capital if you can't grow the business or vice versa. If you have those two, the stock can become a compounding machine. 

That's where you get the very exciting returns we're seeing now with Mineral Resources. So you wouldn't want to bet against these guys over the medium to long term, but I think over the short term, we've had a good rally leading into the result and we need to see a period of consolidation here. 

What’s your outlook on Mineral Resources and its sector over FY23?

It's really got four sectors in the company. So let's start with the really good - lithium. So obviously, these prices are completely unsustainable over the medium term, but over the short to medium term, they're very sustainable. In fact, it's what's needed to incentivize new production to come on stream. 

So we think MIN's lithium business is going to be very, very strong and they're expanding and increasing production at the right time there. 

Another good is mining services. That business just goes from strength to strength, and is the largest contract crusher in the world today, with a really nice stable income stream. The Ashburton project is going to add between 35-100 million tonnes to each of their different divisions there, at least - it's probably more, for crushing, mining, transportation etc. So they've got a fantastic integrated model there.

The bad would be the iron ore. We know that iron ore is going to be more challenging from here. People have to remember that they're still making a profit on the mining services side of those divisions, but the EBITDA dropped on iron from around $1.5 billion to $64 million give or take. And we would not expect to see iron ore recover in the next 12 months. 

And then energy's interesting. It's a more recent development. They're not late to the party. And the Perth Basin's offering some really good discoveries. So you are getting that for nothing. But in the short term, lithium and mining services are good, and iron ore is going to be not so good, to put it politely. 

Are there any risks to this company and its sector that investors should be aware of given the current market environment?

I think the risks are on everyone's radars - China, its property sector, every way you look at China, it looks challenged at the moment. And the normal levers they've been pulling more recently are just not having the same impact. 

I think iron ore looks very challenging, that's a real risk, but I think that's well known. It's factored into the price. And I think at the moment you're paying for lithium and probably getting mining services, iron ore and energy for free. 

The other risk that has come into play is inflationary cost risks. And especially with Ashburton, now that you are talking about $3 billion in CapEx. MIN is best in breed at managing inflation, managing costs, but I think they're still going to find it difficult to manage inflation pressures. 

From 1-5, where 1 is cheap and 5 is expensive, how much value are you seeing in the market right now? Are you excited or are you cautious on the market in general?

RATING: 

• Trailing: 2-3
• Forward: 3-4

I think it all depends on whether they're using trailing earnings or forward-looking earnings. On a trailing earnings basis, it's probably about a two to three. On a forward earnings basis, it's more of a three to four. So if you're looking at a trailing earnings base it probably looks cheap(ish). And if you're looking forward, I think it's probably on the more expensive side, particularly based on where we think earnings downgrades will end up. 

This is the problem. We are at the beginning of the cycle for downgrades and we really need to see these roll through. 

We've been surprised this reporting season by how little coverage and research commentary there has been on the lack of outlook statements. So I think we need to go through a period over September and October to get some of these downgrades roll through across the spectrum.

We are more cautious right now than we have been for quite some time. We were obviously very cautious as COVID was unfolding, but we understood that it was a transient event. 

One final thing. The consensus view is that this market rolls over - that by September-October, there will be a big dip and great buying opportunities. The masses are very rarely right. And if the consensus position is that we're going to roll over in September-October, then people have positioned for that eventuality. So they've already done their selling. They're already sitting on the cash. So that does concern us a little bit, but it is possible that the market could be right on mass too. It has been right on mass before.

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