Apart from gold, September saw commodity prices generally fall. Worries in China about weakened end-user steel demand saw iron ore and other steelmaking commodities take a hit. Base metal prices also fell on worries over slower economic growth in China among other regions.

Our analysts identified Mineral Resources Limited (“MinRes”) and Iluka Resources Limited (“Iluka”) at a significant discount to fair value estimates.

MinRes’ discount is primarily driven by lower near-term iron ore and lithium prices driving a ~20% discount to our fair value estimate. Going forward we expect the firm’s earnings to rise as lithium prices recover and the sale of their 49% stake in Onslow Iron haul road is realised.

Iluka’s fair value discount can be attributed to soft near-term demand for mineral sands, which we believe will likely recover.

Recent developments

Last week China’s central bank announced a stimulus package to bolster the slowing economy which is predicted to fall short on the 5% per year growth target. The easing of monetary policies focused on helping the property and construction market led the prices of iron ore futures to surge.

Mineral Resources Limited ASX:MIN ★★★★

  • Primary Commodity: Diversified
  • Moat rating: None
  • Share price: $48.80 (as at 27th September 2024)
  • Fair value: $62.00
  • Price to fair value: 0.8 (Undervalued)
  • Uncertainty rating: High

Mining services company MinRes holds a portfolio of mining operations across lithium and iron ore. The business consists of three core pillars: Mining Services, Commodities, and Innovation and Infrastructure.

Whilst MinRes has no economic moat, return on invested capital averaged 16% for the past 10 years which is well above the cost of capital. These returns were bolstered by favourable iron ore prices and more recently driven by high lithium prices.

In respect to Iron Ore, MinRes sits in the highest quartile of the cost curve with margins below industry leaders BHP, Rio Tinto and Vale. To combat this the company is ramping up production from its Onslow iron ore mine which will operate at a considerably lower cost than existing smaller operations.

Mining services makes up around half Morningstar’s fair value estimate with mining accounting for the balance. We prescribe a high uncertainty rating to MinRes due to its earnings dependency on lithium and iron ore prices, both directly via sales and indirectly via the provision of services to lithium and iron ore mining companies.

MinRes is in reasonable financial health despite being highly leveraged with a group debt of $4.2 billion after hefty expenditures on Onslow. Despite no financial maintenance covenants, current debt levels need to be monitored especially in conjunction with the volatility of commodity prices. The present circumstance is unusual given the company has operated with little to no debt for the eight years to fiscal 2018.

MinRes is currently undervalued by ~20% with a FV estimate of $62.00

Iluka Resources Limited ASX:ILU ★★★★

  • Primary commodity: Diversified
  • Moat rating: None
  • Share price: 6.84 (as at 27th September 2024)
  • Fair value: $9.50
  • Price to fair value: 0.7 (Undervalued)
  • Uncertainty rating: High

Iluka is an international critical minerals company with exposure in exploration, project development, mining, processing, marketing and site rehabilitation. The company holds a 20% stake in Deterra Royalites Limited (“Deterra”), the largest ASX-listed resources focused royalty company.

Iluka’s sales volume relies on the overall industry growth in the zircon and titanium minerals markets. The Jacinth-Ambrosia mine has a cost advantage over other zircon-producing competitors due to high grades but its reserve life is less than a decade. Their other project, Cataby mine is a chloride ilmenite-rich mine with a remaining life of five years with the potential of a four year extension.

Iluka is also facing industry wide declining grade profile at its mines, but a constrained outlook for supply should support prices. Iluka shoulders part of the responsibility for balancing industry supply, allowing a flex in production to increase market share or liquidate excess inventory as prices rise.

Commodity producers are generally price takers, therefore need low-cost mines with long lives and low capital base to support excess returns. Neither Jacinth-Ambrosia or Cataby mine are moatworthy due to declining grades and remaining reserve lives of less than a decade.

Iluka retains a strong balance sheet with ~$150 million net cash, but we expect debt to increase materially to help build planned rare-earth refinery, Eneabba. This conservative approach creates the ability to finance inventory build when necessary and provide the flexibility to invest through the cycle.

Iluka is currently undervalued by ~30% with a FV estimate of $9.50

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Terms used in this article

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued. 

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica. 

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.