Optimism about increased China stimulus sees most commodity prices higher on last quarter. Exchange-traded fund flows from Western investors and central bank purchases are driving stronger gold prices. Bauxite has materially increased on supply issues in Guinea, in turn propelling alumina prices.

Why it matters: We roll forward our assumed midcycle prices to 2029 from 2028. China continues to announce various monetary and fiscal stimulus aimed at boosting its economy and stabilizing its ailing residential property sector.

We are skeptical that stimulus will overcome longer-term structural headwinds in the country. Challenges include China's transition to a less commodity-intensive, consumption-based economy, slowing urbanization, diminishing returns on infrastructure investments, and a declining population.

Iluka ILU

Iluka is a global mineral sands miner. Major mines are Jacinth-Ambrosia in South Australia and Cataby in Western Australia. Relatively low operating costs for zircon are supported by Jacinth-Ambrosia, but its reserve life is less than a decade. Like the industry, Iluka is facing a declining grade profile at its mines, but a constrained outlook for supply should support prices.

Mineral sands prices and volumes are the primary drivers of our fair value estimate of $9.20. The shares are currently trading at a 44% discount to our fair value.

 Iluka's focus is on managing volumes and the resulting impact on prices. Efforts to maintain margins and prices mean sales volumes can fall in periods of weak demand as Iluka shoulders part of the responsibility for balancing industry supply, but the company can also flex production to increase market share or liquidate excess inventory as prices rise. Primary products are split between zircon (used in tiles and ceramics, refractories, chemicals, and so on) and titanium dioxide feedstocks rutile and synthetic rutile (used for pigments in paints, coatings, plastics, and paper).

Iluka is building a rare-earth refinery at Eneabba that will utilize its existing monazite stockpile as initial feedstock. The refinery will also be able to process feedstock from third parties as well as from Iluka's West Balranald development and its potential Wimmera project.

Maintenance capital expenditure is relatively modest, but expansions and reinvestment to prolong life are generally pursued when Iluka sees a need for new demand and the potential for reasonable returns on investment.

The balance sheet is relatively strong with net cash of around $150 million as at the end of June 2024, but debt will increase materially to help build the rare-earth refinery. Iluka maintains a conservative balance sheet with no net debt on average through the cycle. This should provide the capacity to finance inventory build when necessary and invest through the cycle. Management values returns to shareholders, primarily through dividends, but will flex depending on investment needs.

Whitehaven WHC

We raised our fair value on Whitehaven 3% to $9.60. The shares are currently trading at a 31% discount to our fair value.

Whitehaven Coal offers exposure to global energy and steel demand via thermal and metallurgical coal production. Its mines are in New South Wales, Australia. Salable coal production expanded from 10 million metric tons in fiscal 2014 to about 14 million metric tons in fiscal 2022, largely due to the ramp-up of Maules Creek and the expansion of the Narrabri mine. It purchased Blackwater and Daunia metallurgical coal mines in Queensland from BHP and Mitsubishi in April 2024, but has agreed to sell a 30% stake in Blackwater to two Japanese steelmakers, likely effective early 2025. Equity output is expected to grow to 32 million metric tons by fiscal 2029, split roughly between 60% coking coal and 40% thermal coal.

Favorable coal prices are critical to generating excess long-term returns, but on this front we're circumspect. Poor coal prices in response to the global recession caused by the coronavirus along with production difficulties at Narrabri saw the firm's balance sheet quickly deteriorate. However, from losses in fiscal 2021, elevated coal prices in the wake of the Russia-Ukraine war saw the company quickly repay debt and move into a net cash position.

Whitehaven is a price-taker, meaning maintainable competitive advantage requires low capital and operating costs and long-life mines. It's early mines had relatively high operating costs and produced mainly thermal coal. Narrabri and Maules Creek in particular have reduced group cash costs and increased semisoft metallurgical coal production. However, coal mining is a capital-intensive business and some assets were acquired through relatively expensive acquisitions, the cost partly assuaged through the use of overvalued shares.

Elevated coal prices mean near-term adjusted return on invested capital is forecast to be materially above its weighted average cost of capital. However, we forecast ROIC to return to high single digits by fiscal 2029 with midcycle returns below its WACC. This is driven by prices moderating to our long-term or midcycle assumptions of about USD 155 per metric ton for coking coal and about USD 105 for thermal coal.

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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.