The miner giving bang for its buck

Vinay Ranjan

Airlie Funds Management

At Airlie we are looking to invest in high-quality businesses, which we would define as businesses that earn high returns on their invested capital. Airlie Australian Share Fund portfolio company Mineral Resources (ASX:MIN) is a wonderful case in point that we explore in more detail below.

“Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for 40 years, you’re not going to make much different than a 6% return – even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with a fine result.”  - Charlie Munger

Mineral Resources is a leading mining services company providing crushing, mineral processing, and a suite of infrastructure services to mines such as haulage and ship-loading. The company listed on the Australian Stock Exchange in 2006 at $0.90/share and reported pre-tax profits of $25.6 million that fiscal year. Today Mineral Resources trades at almost $50/share and in the most recent financial year delivered $1.79 billion of profit before tax. This equates to a total shareholder return (including dividends) of 32% p.a. or almost 70x your money if you invested in the IPO!

Figure 1. Mineral Resources – Share price performance since listing (Total Shareholder Return)

Source: FactSet

We believe this phenomenal growth over the last 15 years is due to the fact the company has deployed capital at extremely high rates of return, earning on average an after-tax return on invested capital of 27% since listing. This is almost three times the average return generated by companies in the ASX 200 industrial index.

Unique business model enables high returns on capital

We believe the reason MIN has been able to consistently generate high returns on capital is due to its unique business model. Unlike traditional mining services companies, Mineral Resources has expanded into acquiring undeveloped resource assets, investing in the mine infrastructure, and bringing them into production. We consider the intention here is not to be a miner and own the underlying commodity, but rather to build a pipeline of work for its mining services arm.

So typically, once the mine has been fully developed and is generating cash flow, MIN will look to sell part of its ownership to a joint venture partner. While MIN may realise a profit from this sale, more importantly as part of the sale agreement the company will typically negotiate to retain a life of mine contract to provide mining services to that mine. Effectively, locking in an annuity income stream from that mine. Meanwhile, the capital released from the asset sale is free to be recycled into a new project, which when developed could result in another annuity mining services contract and so on (see Figure 2 below).

Figure 2. Mineral Resources – Unique business model

Over time, the accumulation of these ‘annuity-style’ mining services contracts has resulted in mining services (ex construction) EBITDA growing at a 23% CAGR since FY15.

Figure 3. Mining services (ex construction) EBITDA

Source: FactSet

Future opportunities to earn high returns on capital

Importantly, we think the company can continue to compound capital at high rates of return over the next few years as it repeats this process of investing in growth projects, which will contribute to earnings over the next three to five years.

We explore two of these major growth opportunities in detail below:

1. Downstream lithium hydroxide conversion

Mineral Resources jointly owns two of the world’s largest hard-rock lithium deposits in Wodgina and Mt Marion. While these assets are currently generating meaningful profits, there is an additional profit pool available if MIN can convert all of its lithium spodumene (the ore itself) into lithium hydroxide (the end product used in lithium batteries). The company is currently in the process of building lithium hydroxide conversion plants leveraging the experience of its joint venture partners Albemarle Corporation (‘ALB’) and Jianxi Ganfeng Lithium Co (‘Ganfeng’). Over the next few years, the company estimates their share of lithium hydroxide production capacity will exceed 100,000 tonnes per annum.

The combination of high lithium prices and increased share of downstream economics in our view has increased the intrinsic value of MIN’s lithium business. Even using conservative prices, we estimate by FY25 MIN’s lithium business could generate in excess of $1 billion in EBITDA. If prices were to remain at current elevated levels (US$70,000/t) it could eclipse the entire market value.

2. Ashburton iron ore hub

MIN has long been viewed as a marginal player in iron ore due to the short reserve life of its operating mines as well as their low-grade, high-cost tonnes. The Ashburton iron ore development, which is due to commence first production in 2024, is a low-cost, long-life operation capable of producing 30mtpa. The project, which has an estimated capital spend of A$2.4-$2.55 billion, will be split into a Mine Co and an Infra Co, with the latter consisting of a private haul road, port infrastructure and transhipper wharfs. Given the low-cost nature of this operation, we believe MIN will be able to generate high returns on this capital spend even at iron ore prices significantly below spot. We also expect there will be opportunities for MIN to realise some value via a partial asset sale of both entities once they are up and running.

Founder-led management team

While rate of return is an important driver of shareholder returns, we think just as important is a well-aligned and disciplined management team. MIN’s founder-led management team led by Chris Ellison (12% shareholder) has been instrumental in the company’s success by ensuring capital is only allocated to projects that generate the highest rates of return. We believe even a high-quality business can be turned into a poor investment if run by management that misallocates capital, as this can disrupt the compounding effect and dilute shareholder returns. Chris is an entrepreneurial founder who is constantly identifying new investment opportunities and only pursues those opportunities when he thinks he can generate high returns for shareholders (himself included).

Over the long term, we believe MIN’s founder-led management team and high-performance culture will ensure shareholder capital is deployed at high rates of return for many years to come.

Access more insights from Airlie's latest InReview

This year’s collection of investment perspectives features our experienced and proven team of portfolio managers and analysts. We share our advice on investing in today’s ‘extreme’ market conditions, explain why most owner-managed businesses succeed in the long term, and unpack a number of companies that we believe are strongly positioned for the year ahead. Learn more here.

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Vinay Ranjan
Equities Analyst
Airlie Funds Management

Vinay Ranjan joined Airlie as an Equities Analyst in 2020. Prior to joining Airlie, Vinay was an investment analyst at Hayberry Global Fund, a long-short global equities fund focused on special situations. At Hayberry, Vinay was part of a small...

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