You wouldn’t want to bet against this company long-term, says Romano Sala Tenna of Katana Asset Management.
After all, as Warren Buffett says, the “holy grail” of investing is to identify those companies that have a high return on investors’ capital AND a high rate of growth.
“You have to have both, it’s not good to have a high return on investors’ capital if you can’t grow the business or vice versa. If you have those two, stocks can become a capitalization machine,” says Sala Tenna.
He is talking Mineral Resources (ASX: MIN), which since its listing in 2006 has generated an average compound annual growth rate of around 30%. During those same 16 years, he has also become the second-best performer in total shareholder return in the S&P/ASX 300.
But with underlying EBITDA down 46% to around $1 billion and revenue down 8% to $3.4 billion, is now a good time to invest in this stock? Or would investors be better off waiting for a better time to buy?
In this cable, Sala Tenna shares his thoughts on the latest result from this diversified miner, the risks he sees ahead, and why he’s more cautious right now than he has been for quite some time.
Mineral Resources Q4 FY22 key results
- Revenue fell 8% to $3.4 billion
- Underlying NPAT down 64% to $400 million
- EBITDA down 46% to $1 billion
- Net debt of $698 million
- Capital expenditures (CapEx) of $800 million
- End of year dividend of $1.00, 43% less
Note: This interview took place on August 29, 2022. This stock is a major holding in the Katana Australian Equity Fund. For more information on this fund, click on the following link:
Katana Australian Equity Fund
What were the key points of this result? What surprised you the most?
There weren’t too many surprises in the operating numbers themselves. They’re pretty much in line and I think they’ve been well telegraphed in terms of a quarterly outlook. So let’s take a look at some of the headline numbers. Obviously the impact on iron ore left a $1.4 billion hole in there, but that was entirely expected. That was more than 90%. However, the other side of the coin was lithium. MIN was obviously able to take advantage of the much better prices there, but they are also trying to boost production there.
So between that and of course mining services, which is very much the staple there and going from strength to strength as the world’s largest contract crusher, the results were pretty much in line with our expectations.
What surprised us most was the change in the terms of the Albemarle joint venture. Therefore, we did not expect to see them increase their stake in Wodgina from 40% to 50%. And at the same time, give up part of the Kemerton property from 40% to 15%.
We understand the strategic rationale behind that, but that’s probably the biggest surprise on our end. The second biggest surprise would have been with the Ashburton iron ore project. Agreeing to take on all of the debt or full development CapEx, which is on the order of $3 billion in exchange for a larger part of the project, also caught us a bit by surprise.
As for the battery manufacturing announcement, I think this is the kind of visionary leadership we need in Australia, but the reality is far from that. I believe that Wesfarmers (ASX: WES) is doing with Mt Holland and working on an integrated chemical processing facility to lead to the battery stage is well within the limits of what is possible in Australia. We still have some strategic advantages there. But for us to try to compete globally, particularly with the economies of scale in these companies outside of Asia, I think that would be very difficult.
With that said, it would be unwise to question Chris Ellison about his plans for the future because he has achieved so much more than many people thought possible.
What was the market’s reaction to this result? Was it an overreaction, an underreaction, or an appropriate one?
I would say that the market reaction has been appropriate. The stock rallied very strongly in these results, as it often does. He recovered about 40% heading into today’s result. And he has done it three or four times in the last six to 12 months. And obviously there’s a bit of a downdraft in the overall market right now, so that had an impact as well.
Would you buy, hold or sell mineral resources based on these results?
In the short term, it is a wait. And I think there is probably some profit taking at these prices. But if he can extend his time horizon a bit, I think he’s a very strong buy for years to come.
MIN has added an extraordinary amount of value in the last 16 years since it was listed in 2006. It has averaged around 30% CAGR over that time period.
And I think it’s number two, over that time period, for total shareholder return. So that’s an incredibly impressive track record.
Warren Buffett talks about the “holy grail” of investing as companies with a high return on investors’ capital and a high growth rate. You have to have both, it’s not good to have a high return on investors’ 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 exciting returns that we’re seeing right now with Mineral Resources. So you wouldn’t want to bet against these guys in the medium to long term, but I think in the short term we’ve had a good rally before the result and we need to see a period of consolidation here.
What is your outlook on mineral resources and your sector during FY23?
You really have four sectors in the company. So, let’s start with the really good stuff: lithium. Obviously, these prices are completely unsustainable in the medium term, but in the short to medium term, they are very sustainable. In fact, it is what is needed to encourage the start-up of new production.
So we think MIN’s lithium business is going to be very, very strong and they are expanding and increasing production at the right time there.
Another good is mining services. That business is going from strength to strength and it is the largest contract crusher in the world today with a very stable revenue stream. The Ashburton project will add between 35 and 100 million tons to each of its different divisions there, at least; probably more, for crushing, mining, transportation, etc. So they have a fantastic model built in there.
The bad would be the iron ore. We know iron ore will be more challenging from here. People have to remember that they are still making a profit on the mining services side of those divisions, but EBITDA fell by iron from around $1.5 billion to $64 million or so. And we would not expect to see a recovery in iron ore in the next 12 months.
And then the energy is interesting. It is a more recent development. They are not late for the party. And the Perth Basin is offering some really good discoveries. So you’re getting that for nothing. But in the short term, mining and lithium services are good, and iron ore won’t be as good, to put it politely.
Are there risks to this company and its industry that investors should be aware of given the current market environment?
I think the risks are on everyone’s radar: China, its real estate sector, whichever way you look at China, seems challenged right now. And the normal levers they’ve been pulling more recently just aren’t 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 included in the price. And I think right now you’re paying for lithium and probably getting free mining, iron ore and energy services.
The other risk that has come into play is the risk of inflationary costs. And especially with Ashburton, now that you’re talking about $3 billion in CapEx. MIN is best in class at managing inflation, managing costs, but I think they’re still going to have a hard time managing inflationary pressures.
From 1 to 5, where 1 is cheap and 5 is expensive, how much value do you see in the market right now? Are you excited or cautious about the market in general?
- Behind: 2-3
- Forward: 3-4
I think it all depends on whether they are using trailing earnings or prospective earnings. Based on final earnings, it’s probably two to three. Based on future earnings, it’s more than three to four. So if you’re looking for a bottom line profit base, it probably looks cheap (kind of). And if you’re looking ahead, I think it’s probably going to be more expensive, particularly based on where we think the earnings downgrades will end.
This is the problem. We are at the beginning of the sales cycle and we really need to see how they play out.
We have been surprised this reporting season by how little investigative coverage and commentary there has been on the lack of outlook statements. So I think we have to go through a period between September and October for some of these downgrades to apply across the spectrum.
We are more cautious right now than we have been for quite some time. Obviously, we were very cautious as COVID unfolded, but we understood that it was a transient event.
One last thing. The consensus view is that this market is turning around, that for September-October there will be a big drop and big buying opportunities. The masses are rarely right. And if the consensus position is that we are going to turn around in September-October, then people have positioned themselves for that eventuality. So they have already made their sale. They’re already sitting on the cash. That worries us a bit, but it is possible that the market is also in mass. He’s been right in mass before.
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