Why Mathan's sweet on this record-breaking ASX nickel play

For all the talk of soaring lithium prices, it’s another battery metal that has caught the attention of Mathan Somasundaram. He doesn’t currently own the nickel mining company we discuss below - which on Thursday reported a record $457 million in before-tax profit – having exited earlier this year “when nickel prices went nuts”. 

But Somasundaram, the founder of Deep Data Analytics, is watching closely for his next opportunity to buy back in.

Lithium dominates most discussions of the red-hot electric vehicle and decarbonisation themes. As proof, you only need to look at the FY22 results posted by the likes of Pilbara Minerals ASX: PLS and Allkem Limited ASX: AKE last week, whose FY22 earnings also broke new records.

“But there isn’t a lot of competition in nickel, and they’ve become a dominant player,” Somasundaram says, referring to IGO Limited ASX: IGO.

Indeed, he regards the lithium sleeve IGO added more recently as the predominant risk. The $1.3 billion acquisition of West Australian lithium miner Western Areas was finally consummated in June, after a long-running courtship that started last August. It also bought a 49% stake in Tianqi Lithium Corporation 12 months earlier.

In the following interview, Somasundaram discusses IGO’s FY22 results and the market’s reaction. He also explains why he regards the miners’ management team as one of the best in the business and his outlook for IGO and the broader commodities sector over the next 12 months.

IGO ASX: IGO key results

• Revenues up 34% to $903 million
• NPAT down 40% to $331 million
• Underlying EBITDA up 51% to $717 million
• Dividend of 10 cents a share, in line with FY21

Note: This interview took place on 30 August 2022. This stock is not currently held in any of the Deep Data Analytics model portfolios.

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

Today’s result was pre-announced so there weren’t any real surprises. We’re in a part of the cycle where everything related to energy is doing well. So, EV led the cycle and then you’ve got coal and uranium following and now oil is bouncing as well. And IGO will benefit from this too because if you want nickel exposure, you don’t have a lot of choices – and its lithium is the extra kicker.

Today’s result doesn’t change too much on the investment thematic. In the context of where we are in the market, the macro views will likely take over in the next six to 12 months. Rising recession risk will have something to do with it, but we’re in a reflation cycle. Inflation will pick up again, which should be positive for commodities.

The dividend was probably a bit lower than the market was expecting, but management’s guidance is maintained. And I think everyone, from retailers to miners, is playing an offensive game. I think IGO is probably lowballing its guidance and will beat that quite comfortably.

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

I think the market reaction was in line with expectations. 

Because miners report their production results quarterly and given where commodity prices are right now, it’s hard for these companies to shock the market in a negative way. 

The only thing most people will be a little scared about with the miners is where their costs are, but again at these commodity price levels, that’s not a huge issue now.

If you look at most EV stocks and other commodity stocks, they’ve mostly traded in a similar trend.

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

I’d say Hold. The beauty of it is, looking at how it’s traded over the last couple of years, you can see how stable the stock has been. We sold the stock from our model portfolios earlier this year when nickel prices went nuts. We’re still looking at and want it to have a decent pull-back in price before getting back in.

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

All of these stocks have had a pretty good run – including South32 (ASX: S32) and Mineral Resources (ASX:MIN). But economic news is pretty weak and while China's stimulus is kicking in, it's not really delivering any upside.

In the short term, we think there is a risk in the commodity cycle and especially in Growth metals. I'd expect some of these valuations to come off, and when that happens, that's the opportunity to get back in. 

In the medium- to long-term, I think commodities will have a decent cycle for the next couple of years. There is obviously a supply-demand dynamic that's out of sync. I don't see anyone suddenly increasing supply when you have these recession pressures, which means it's probably going to get even tighter.

Are there any risks for IGO and the mining sector - particularly in battery metals - that investors should be aware of given the current market environment?

Whenever you have these cycles, the recession isn’t the first cycle that hits you. It’s the second one, and that’s because your ability to respond is much weaker the second time around. I have a feeling we will have another inflation cycle, another commodities cycle – and they tend to be aligned. So, I suspect we’re going to see higher commodities and higher inflation in 2022.

The risk is that if energy prices remain high through this year and into next year, that will mean high inflation, which will mean commodity prices remain elevated.

And specifically, for IGO, nobody cares about costs when commodity prices are doing well. But there is a risk we get a lot more lithium coming into the market, which would bring that side of the business under pressure. But the nickel side of the business is the strong point, that will hold the company’s valuation.

From 1-5, where 1 is cheap and 5 is expensive, how much value are you seeing in the market right now?

Rating: 4 to 5

Looking over the next six months, I'd say the market is expensive – I’d probably rate it a four or a five. But over a 12-month timeframe, it's probably a three.

But in saying that, it varies across different segments of the market. There are some sectors that have been seriously beaten up and others that are way overvalued, such as the banks.

On the other side, retail is cheap – but there's a reason it's cheap. 

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