Ask the analyst: What to make of cash gushing Deterra?
Deterra owns a unique and world-class asset but is only suitable for investors who know what they are signing up for.
Mentioned: Deterra Royalties Ltd (DRR)
Welcome to the latest edition of Ask the analyst, where I put questions from myself and readers about ASX200 companies and industries to our analysts. If you have a question, please email it to [email protected]. It may appear in a future article.
Today’s question came from your author. I have always found mineral royalty companies interesting and own shares in several US and Canada-listed firms of this kind. As a result, I have been following the developments at ASX-listed Deterra Royalties (DRR) for some time.
My questions for our mining analyst Jon Mills centered on what Deterra’s long-awaited first acquisition and what, judging by its 17% decline in share price over the past year, investors appear to be so worried about. Is it the capital allocation or just the iron ore price?
As always, let’s start with a quick description of how Deterra Royalties makes money.
A quick look at Deterra and the royalty business
Deterra Royalties was spun-off by Iluka Resources in 2020. It owns a portfolio of royalty and mining offtake assets dominated by the royalty it holds over BHP’s Mining Area C asset in the Pilbara, Western Australia. The economics of royalty and streaming companies are very different to miners.
Miners have to foot the costs of exploring, constructing and operating a mine to extract materials. They will then sell the mined and processed material in the hope of making a profit. If commodity prices rise but costs rise more, they will make less money than they did before.
Royalty and streaming companies are not involved in production. In most cases, they provide up-front capital to mining companies, often when a potentially economic deposit is still being drilled up or a new mine is being constructed. As such, they are an alternative source of finance for miners and would be miners to equity and debt markets.
In return, they receive pre-agreed payments in cash or a percentage of a mine’s production once it begins operating.
A royalty company will get a pre-agreed cut of revenue or a payment per metric ton of iron ore (for example) in cash. By contrast, the owner of a streaming agreement takes delivery of the produced material (or exchange credits for the material in question) at a pre-agreed price. This will usually be below market prices, so they can sell at a profit.
While some royalty and streaming companies get involved in exploration to source new royalty assets that way, most of them are essentially financing and accounts receivable businesses.
Those with established and significant assets, like Deterra, can be highly cash generative with very high margins. For example, Deterra generated $241 million of revenue in FY2024 on operating costs of $13 million and reported a pre-tax profit of over $221 million.
This was almost entirely thanks to Deterra's Mining Area C royalty, which our analyst Jon Mills likens to “a toll-road with leverage to the iron-ore price”.
Big Mac
Iluka inherited the royalty on Mining Area C (MAC) from Consolidated Gold Fields (CGF), one of the companies that merged to form Iluka in 1998. The royalty was allocated to Consolidated Gold Fields in lieu of payments owed by BHP to CGF regarding the purchase of the area.
The royalty gives Deterra the right to just over 1.2% of revenue generated from specific regions of the MAC royalty area plus extra payments in any year where annual production tops the previous annual high. Given the nature of Mining Area C, this is a highly valuable asset.
I say that because MAC is not your average iron ore province. For one, consider its size – once BHP scales up annual production to 145 million tons per year, MAC will be the biggest iron ore hub in the world. It is also one of the world’s lowest cost operations, as shown by the chart below.
The slide, which Deterra sourced from a Wood Mackenzie report and used in a recent investor presentation, estimate that BHP’s North and South Flank mines comfortably put Mining Area C in the bottom half of the worldwide cost-curve:
Figure 1: North and South Flank position on cost curve. Source: Deterra, Wood Mackenzie
In short, Mining Area C is 1) one of the biggest and best iron ore assets in the world 2) it is operated by one of the biggest and best mining companies in the world and 3) is cheap enough to mine that production would likely continue in almost any conceivable iron ore price environment.
Not so simple anymore?
For the first few years of its life post-IPO, Deterra was rather simple: it existed purely to collect royalty payments from Iluka’s old royalties, mostly from MAC, and distribute them to shareholders.
This also made for a simple (but not easy) equation in terms of predicting the company’s earnings and what it might mean for the stock. Deterra’s earnings and dividend outlook rested on a combination of 1) BHP’s annual production in Mining Area C and 2) what iron ore prices could be expected.
Relying purely on MAC was never the long-term plan for Deterra, though. And the company’s broader strategy – to grow and diversify by buying royalty assets beyond Mining Area C – finally got going in June 2024 with the purchase of Trident Royalties for roughly AUD 250 million.
Investors can’t really have been surprised that Deterra announced an acquisition. After all, its desire to do deals like this had been telegraphed since before the spin-off in 2020. Investors did appear to be surprised, though, by what Deterra bought and what it meant for the dividend.
Deterra’s board had long flagged the possibility of a dividend cut to fund growth projects and acquisitions. But the magnitude of June’s cut – down from a 100% payout ratio to a target minimum 50% payout of net profits after tax may have caught investors off guard.
While Deterra drifted down with the iron ore price for much of the past year, you can see a marked fall in June following the announcement.
Figure 2: Deterra share price 12M to 15/1/2025. Source: Morningstar.
While we’re on the topic of the dividend, don’t forget to factor this in before taking Deterra’s headline dividend yield of 7%+ as gospel.
Jon’s forecast for 2025 predicts a $0.14 per share payout, which represented around a 3.5% yield at recent share prices. Jon assumes a 2025 payout ratio of 50% but notes that the actual payout could be higher than that.
What did Deterra get in the Trident deal?
Here is a list of the royalty assets and offtake agreements that Deterra got with the Trident deal:
Figure 3: Trident Royalties assets. Source: Trident's 2023 Annual Report.
And here is how Trident’s portfolio of assets was split up (based on the amount of money they spent on acquiring each asset in the first place):
Figure 4: Trident portfolio by commodity. Source: Trident Annual Report.
As you may have gathered, a big chunk of the acquired Trident assets relate to gold. This may have stumped some investors, given that previous communications on Deterra’s growth strategy put pretty much everything except precious metals to the fore.
Take this slide from Deterra’s H1 2024 results presentation, for example, made only a few months before the Trident deal was announced:
Figure 5: Deterra acquisition strategy as of H1 2024. Source: Deterra Royalties
The reality is that Trident may never have been about the gold offtake agreements, though. After all, there is more than likely a market for these if Deterra wants to sell them, even more so amid a very strong period for gold prices.
Instead, it has been framed more as a play on lithium. Given that lithium was still coming through a vicious downcycle, that wasn’t going to be the easiest sell either. But our mining analyst Jon didn’t hate the deal.
“I like how DRR bought Trident when lithium prices are depressed” he says. “It was a countercyclical investment with opportunities to monetise the gold offtakes, which we think the company should consider”.
It also isn’t that big a deal in the grand scheme of things for Deterra, with Jon still attributing roughly 90% of the company’s value to the core MAC royalty asset. “If Trident is a bust, then DRR doesn’t lose that much.”
If lithium can recover, though, as our analysts expect, Deterra could come out of the deal rather nicely.
Iron ore with a free option on lithium?
Perhaps the most alluring asset Deterra got with Trident is a royalty on the Thacker Pass lithium project in the United States owned by Lithium Americas.
As Jon notes “it is the type of royalty that Deterra should be considering. Namely, a royalty on a relatively low cost, large, long-life project with expansion options. It is currently the largest lithium resource in the world”.
Once you adjust for the likely scenario that Lithium Americas will exercise its right to buy back part of Trident’s royalty for around AUD 20 million, Deterra will be left with a 1.05% gross revenue royalty on what could become a major resource.
Thacker Pass is likely a couple of years away from production but is backed by co-owner General Motors and a multi-billion dollar US government loan. Lithium Americas recently shared a four-phase plan to reach annual production capacity of 160,000 metric tons in the 2030s.
If that kind of production materialises and lithium prices recover to nearer our mid-cycle estimates, Thacker Pass alone could deliver Deterra a $20m+ annual boost within a few years.
That doesn’t sound bad versus a purchase price of $275m, especially if a big chunk of that outlay is recouped by selling the gold offtakes.
Even though the Trident deal faced a rather harsh reckoning in the media and the stock market, Jon has maintained the firm’s Capital Allocation rating of Exemplary. As for Lithium Americas, shares currently trade at around a 60% discount to our fair value estimate of USD 8 per share.
Still all about MAC for now
More acquisitions could one day further reduce MAC’s weighting in Deterra’s portfolio and potentially also lead us to reconsider its Exemplary Capital Allocation rating. But until when and if this occurs, it will likely remain the cornerstone asset.
This could be something of a double edged sword.
In one sense, there aren’t many higher quality royalty assets in the world than the one Deterra has over MAC. So even if its large weighting does bring a lot of volatility when iron ore prices move, it could be trade-off worth taking. Most royalties added to Deterra’s portfolio to increase its diversification would dilute its overall quality, while those that didn’t dilute the quality would likely cost an awful lot.
With MAC and iron ore playing such a big role, there is no getting away from the likelihood that Deterra’s share price will be highly volatile. And potential investors need to consider whether they can stomach the trade-off of volatility for quality.
Indeed, this kind of exposure to changing iron ore prices hasn’t been much of a positive for Deterra over the past twelve months. Iron ore prices started 2024 at around $130 per metric ton. As I write this at the start of 2025, this has dipped to around $90.
Jon’s current forecast from 2025 to 2027 is for iron prices to average about USD 95 per metric ton. Over the medium-term, he sees the iron ore price drifting lower to a mid-cycle level of around $72 as demand from China slows and global supply rises, led by Simandou and iron ore major Vale.
Nonetheless, Jon sees Deterra offering better than average value at a recent share price of around $4 per share. As we discussed earlier, this company may only be suitable for investors who know what they have signed up for.
Deterra Royalties (DRR)
- Moat rating: Wide
- Uncertainty: Medium
- Fair Value estimate: $4.24 per share
- Share price January 15: $4.05 per share
- Star Rating: 4 stars
Individual investments should only be considered as part of a broader investing strategy. For a step-by-step guide on how to create an investing strategy, read this article by my colleague Mark LaMonica.
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Today’s question came from your author. I have always found mineral royalty companies interesting and own shares in several US and Canada-listed firms of this kind. As a result, I have been following the developments at ASX-listed Deterra Royalties (which I do not own) for some time.
My questions for our mining analyst Jon Mills centered on what Deterra’s long-awaited first acquisition and what, judging by its 17% decline in share price over the past year, investors appear to be so worried about.[JM1] Is it the capital allocation or just the iron ore price?
As always, let’s start with a quick description of how Deterra Royalties makes money.
A quick look at Deterra
Deterra Royalties was spun-off by Iluka Resources in 2020. It owns a portfolio of royalty and mining offtake assets dominated by the royalty it holds over BHP’s Mining Area C asset in the Pilbara, Western Australia. The economics of royalty and streaming companies are very different to miners.
Miners have to foot the costs of exploring, constructing and operating a mine to extract materials. They will then sell the mined and processed material in the hope of making a profit. If commodity prices rise but costs rise more, they will make less money than they did before.
Royalty and streaming companies are not involved in production. In most cases, they provide up-front capital to mining companies, often when a potentially economic deposit is still being drilled up or a new mine is being constructed.
As such, they are an alternative source of finance for miners and would be miners to equity and debt markets. In return, they receive pre-agreed payments in cash or a percentage of a mine’s production once it begins operating.
A royalty company will get a pre-agreed cut of revenue or a payment per metric ton of iron ore (for example) in cash. By contrast, the owner of a streaming agreement takes delivery of the produced material (or exchange credits for the material in question) at a pre-agreed price. This will usually be below market prices, so they can sell at a profit.
While some royalty and streaming companies get involved in exploration to source new royalty assets that way, most of them are essentially financing and accounts receivable businesses. Those with established and significant assets, like Deterra, can be highly cash generative with very high margins.
As an example, Deterra generated $241 million of revenue in FY2024 on operating costs of $13 million, generating a pre-tax profit of over $221 million. This was almost entirely thanks to its Mining Area C royalty, which our analyst Jon Mills likens to “a toll-road with leverage to the iron-ore price”.
Big Mac
Iluka inherited the royalty on Mining Area C (MAC) from Consolidated Gold Fields (CGF), one of the companies that merged to form Iluka in 1998. The royalty was allocated to Consolidated Gold Fields in lieu of payments owed by BHP to CGF regarding the purchase of the area.
The royalty gives Deterra the right to just over 1.2% of revenue generated from specific regions of the MAC royalty area plus extra payments in any year where annual production tops the previous annual high. Given the nature of Mining Area C, this is a highly valuable asset.
I say that because MAC is not your average iron ore province. For one, consider its size – once BHP scales up annual production to 145 million tons per year, MAC will be the biggest iron ore hub in the world. It is also one of the world’s lowest cost operations, as shown by the chart below.
The slide, which Deterra sourced from a Wood Mackenzie report and used in a recent investor presentation, estimate that BHP’s North and South Flank mines comfortably put Mining Area C in the bottom half of the worldwide cost-curve:
In short, Mining Area C is 1) one of the biggest and best iron ore assets in the world 2) it is operated by one of the biggest and best mining companies in the world and 3) is cheap enough to mine that production would likely continue in almost any conceivable iron ore price environment.
Not so simple anymore?
For the first few years of its life post-IPO, Deterra was rather simple: it existed purely to collect royalty payments from Iluka’s old royalties, mostly from MAC, and distribute them to shareholders.
This also made for a simple (but not easy) equation in terms of predicting the company’s earnings and what it might mean for the stock. Deterra’s earnings and dividend outlook rested on a combination of 1) BHP’s annual production in Mining Area C and 2) what iron ore prices could be expected.
Relying purely on MAC was never the long-term plan for Deterra, though. And the company’s broader strategy – to grow and diversify by buying royalty assets beyond Mining Area C – finally got going in June 2024 with the purchase of Trident Royalties for roughly AUD 250 million.
Investors can’t really have been surprised that Deterra announced an acquisition. After all, its desire to do deals like this had been telegraphed since before the spin-off in 2020. Investors did appear to be surprised, though, by what Deterra bought and what it meant for the dividend.
Deterra’s board had long flagged the possibility of a dividend cut to fund growth projects and acquisitions. But the magnitude of June’s cut – down from a 100% payout ratio to a target minimum 50% payout of net profits after tax may have caught investors off guard.
While we’re on the topic of the dividend, don’t forget to factor this in before taking Deterra’s headline dividend yield of 7%+ as gospel. Jon’s forecast for 2025 predicts a $0.14 per share payout, which represented around a 3.5% yield at recent share prices. Jon assumes a 2025 payout ratio of 50% but notes that the actual payout could be higher than that.
What did Deterra get in the Trident deal?
Here is a list of the royalty assets and offtake agreements that Deterra got with the Trident deal:
And here is how Trident’s portfolio of assets was split up (based on the amount of money they spent on acquiring each asset in the first place):
As you may have gathered, a big chunk of the acquired Trident assets relate to gold. This may have stumped some investors, given that previous communications on Deterra’s growth strategy put pretty much everything except precious metals to the fore.
Take this slide from Deterra’s H1 2024 results presentation, for example, made only a few months before the Trident deal was announced:
The reality is that Trident may never have been about the gold offtake agreements, though. After all, there is more than likely a market for these if Deterra wants to sell them, even more so amid a very strong period for gold prices. Instead, it has been framed more as a play on lithium.
Given that lithium was still coming through a vicious downcycle, that wasn’t going to be the easiest sell either. But our mining analyst Jon didn’t hate the deal.
“I like how DRR bought Trident when lithium prices are depressed” he says. “It was a countercyclical investment with opportunities to monetise the gold offtakes, which we think the company should consider”.
It also isn’t that big a deal in the grand scheme of things for Deterra, with Jon still attributing roughly 90% of the company’s value to the core MAC royalty asset. “If Trident is a bust, then DRR doesn’t lose that much.”
If lithium can recover, though, as we expect, Deterra could come out of the deal rather nicely.
Iron ore with a free option on lithium?
Perhaps the most alluring asset they got with Trident is a royalty on the Thacker Pass lithium project in the United States owned by Lithium Americas. As Jon notes “it is the type of royalty that Deterra should be considering. Namely, a royalty on a relatively low cost, large, long-life project with expansion options. It is currently the largest lithium resource in the world”.
Once you adjust for the likely scenario that Lithium Americas will exercise its right to buy back part of Trident’s royalty for around AUD 20 million, Deterra will be left with a 1.05% gross revenue royalty on what could become a major resource.
Thacker Pass is likely a couple of years away from production but is backed by co-owner General Motors and a multi-billion dollar US government loan. Lithium Americas recently shared a four-phase plan to reach annual production capacity of 160,000 metric tons in the 2030s.
If that kind of production materialises and lithium prices recover to nearer our mid-cycle estimates, Thacker Pass alone could deliver Deterra a $20m+ annual boost within a few year. That doesn’t sound bad versus a purchase price of $275m, especially if a big chunk of that outlay is recouped by selling the gold offtakes. Even though the Trident deal faced a rather harsh reckoning in the media and the stock market, Jon has maintained the firm’s Capital Allocation rating of Exemplary[JM2] .
As for Lithium Americas, shares currently trade at around a 60% discount to our fair value estimate of USD 8 per share for those interested in foreign stocks.
Still all about MAC for now
More acquisitions could one day further reduce MAC’s weighting in Deterra’s portfolio and potentially also lead us to reconsider its Exemplary Capital Allocation rating. But until when and if this occurs, it will likely remain the cornerstone asset.
This could be something of a double edged sword. In one sense, there aren’t many higher quality royalty assets in the world than the one Deterra has over MAC. So even if its large weighting does bring a lot of volatility when iron ore prices move, it could be trade-off worth taking.
Most royalties added to Deterra’s portfolio to increase its diversification would dilute its overall quality, while those that didn’t dilute the quality would likely cost an awful lot.
With MAC and iron ore playing such a big role, there is no getting away from the likelihood that Deterra’s share price will be highly volatile. And potential investors need to consider whether they can stomach the trade-off of volatility for quality.
Indeed, this kind of exposure to changing iron ore prices hasn’t been much of a positive for Deterra over the past twelve months. Iron ore prices started 2024 at around $130 per metric ton. As I write this at the start of 2025, this has dipped to around $90.
Jon’s current forecast from 2025 to 2027 is for iron prices to average about USD 95 per metric ton. Over the medium-term, he sees the iron ore price drifting lower to a mid-cycle level of around $72 as demand from China slows and global supply rises, led by Simandou and iron ore major Vale.
Nonetheless, Jon sees Deterra offering better than average value at a recent share price of around $4 per share. As we discussed earlier, this company may only be suitable for investors who know what they have signed up for.
