Joseph Taylor: Good morning, Lochie. Morningstar recently initiated coverage on IGO (ASX: IGO). Can you explain what the company does?

Lochlan Halloway: Yeah, sure. So, there's a couple of pieces to IGO. One part of the business is their nickel mines. So, there's two nickel mines they have in Western Australia. That's the Nova and Forrestania operations. These are fairly close to the end of their lives, with a couple of years left. That's one part of the business. The really important part for IGO though is lithium. So, they own a 25% stake in the Greenbushes lithium mine. They bought that in 2021 from Tianqi Lithium Corporation (HKG: 09696), the Chinese-based chemicals manufacturer. And they got that before the really big run up in lithium prices in 2022. So, in hindsight, an exceptionally timed acquisition. They've really ridden the wave, so to speak, in lithium since then. Also, another part of the business is lithium hydroxide refinery. Again, they're a joint venture partner with Tianqi in that. They have about half of the lithium hydroxide, which is downstream battery chemical manufacturing facility in Western Australia.

Taylor: Great. So IGO is rare for a resources stock because it has been given a moat rating by Morningstar. What explains that?

Halloway: Yes, I mean, fundamentally, at a very high level, we look at moats for mining companies the same way we look at moats across all sectors. Does this company have a durable source of competitive advantage that's going to allow it to earn returns above its cost of capital for at least the next 10 years? What that looks like in mining usually is a very low-cost, high-quality resource, which we think has a long life ahead of it, and has costs, unit costs, that are quite comfortably below the marginal cost of production. That's Greenbushes there. So, in lithium, in hard rock lithium mining, spodumene mineral mining, Greenbushes sits right at the bottom of the cost curve. They make up probably about a quarter – the bottom quarter of the hard rock lithium cost curve and have a very long life of a little bit over 20 years left. That's where the moat comes from. Based on our demand forecasts, we think that Greenbushes and by association, IGO, are going to earn strong returns on invested capital through the cycle.

Taylor: By through the cycle, you mean that no matter where the lithium price is, to an extent, they can still be profitable?

Halloway: Look, to a degree. I mean, they're right at the bottom of the cost curve. They really are sort of one of the last producers to stay in the market if lithium prices continue to retreat further from where they have. That gives them some sort of protection. Obviously, profitability is going to fluctuate as the price of commodity fluctuates. But you'd think all things considered a very high-quality mine like Greenbushes should be profitable at most lithium prices.

Taylor: So, we mentioned the lithium price there. I think it's fair to say it's been all over the place recently. What's been happening there in the market and where does Morningstar see it going from here?

Halloway: Yeah, sure. So, for a bit of context, lithium really ran very hard in 2022 as the battery electrification revolution kicked off. It was a very significant undersupply environment created by booming demand for EVs in 2022, and prices had sort of seven, eight-fold increases. Fast-forward a little bit to 2023 and that story started to unwind. So, a lot more supply came online. High-cost supply brought the market back into an oversupply condition, and then prices fell something like 80%. And they still remain fairly low at the moment. They haven't really recovered much at all since that 80% sort of peak to trough fall.

That's the context. Going forward, though, we see a recovery on the horizon. So underpinning demand for lithium is the electric vehicle transition. It does seem like it's been a soft patch recently, but we think that it's going to pick up again. We're looking at something like sort of 16% compound growth rates for lithium demand over the next decade as the electrification story continues on. We also think that shorter-term, these supply – oversupply factors like inventory de-stocking from battery chemicals manufacturers and also this high-cost supply should start to come out of the market. And that should also support lithium price. So, we're thinking over the next decade that lithium is probably going to average something like US$25,000 a ton. At the moment, it's trading about US$12,000 a ton. So, we see fairly significant upside from here for lithium.

Taylor: I'd imagine that that's one of the key drivers for the stock. Morningstar's Fair Value estimate is a fair bit higher than the current market price. Why is your view so different than the market?

Halloway: So, I think fundamentally it comes back to that view on lithium, especially given that lithium is so important for IGO. It makes up about 90% – the Greenbushes stake makes up about 90% of our fair value estimate. Typically, the market usually puts something like the spot price through. That's sort of the market sort of you think is about spot currently, about US$12,000 per ton. As I said, though, we think lithium over the next decade roughly looks something like US$25,000 a ton, almost twice what it is today. And so accordingly, the share price we have for IGO and other similar lithium miners is trading significantly below where we see its Fair Value.

Morningstar initiated coverage on IGO recently with a Fair Value estimate of $8.30. To learn more about IGO, read this article about its moat and value drivers.

Terms used in this content

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. 

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