Mineral Resources: Unearthing Value – Business Breakdowns, EP.172



Mineral Resources 1-Page Guide

Matt (01:45): 

Fraser, I am excited to have you here. We’re going abroad again on Business Breakdowns to your local lands and covering Mineral Resources. This is a business that I knew nothing about. There’s something to be learned just from the name of it, but I’m hoping you can give us just a 90-second introduction to who Mineral Resources is and what they do.

Fraser (02:09):

Yes, sure. Thanks, Matt. Really appreciate your time. I’m a huge fan of the show, so I’m really excited to be here. I’m also a huge fan of your episodes of lesser known businesses I know nothing about. And so we thought we’d come on the show and share one of our absolute favorites down here from Australia.

So Mineral Resources is a founder-led diversified infrastructure and mining business. Now before I scare off your listeners by using the word mining, there are two things I would share. The first is Mineral Resources has been one of the best performing stocks of any business listed anywhere over the last 18 years.

Since IPO, it’s been able to deliver a total shareholder return of 28% per year compounded. The second thing I would add is that Chris Ellison, the founder and still CEO today, is adamant on earnings calls that they are just getting started. And while they may have a $12 billion market cap today, they can grow to many, many multiples of their current size.

In terms of specifically what the business does, I think it’s best if we divide the business into two segments. This is slightly different to how they report it, but I think best for this conversation. The first segment is the infrastructure business. We can refer to it as InfraCo and InfraCo is the heartbeat of Mineral Resources.

This is where the business was founded. InfraCo builds, owns and operates infrastructure for the mining part of the business, but also for third-party major miners like BHP and Rio Tinto. The InfraCo business is charging a fixed fee on volumes, and so it’s not in any way exposed to commodity prices. It’s very long-life, high-value earnings with high-90s gross retention. I would argue it is as good, if not better, than the enterprise software business as investors covet today.

The second part of the business is the mining business. We’ll refer to this as Mining Co. This is probably the higher profile part of mineral resource, but its core purpose is to own stakes between 50% and 100% in a range of mining assets that are then operated by InfraCo. It currently operates in lithium, iron ore and natural gas.

Matt (04:17): 

I like that you’re coming out hot in terms of the quality of that InfraCo. I appreciate that in terms of giving us a sense of the crown jewel here of this business. I want to touch on Chris Ellison, the founder first. You mentioned it’s still owned and operated by Chris. I did do some digging just in terms of his background, and he has quite an entrepreneurial story. Can you share just a bit about how you would categorize him as part of this business, his own journey and how his DNA is basically injected into what MinRes does?

Fraser (04:51):

Absolutely. And Chris and MinRes are kind of one and the same, and he permeates the culture of the business. For any of your listeners that are bored with listening to regular earnings calls with corporate executives, I would strongly encourage them to go listen to any of the historical earnings calls with Chris.

He is a true entrepreneur at heart and he’s extremely passionate about his business. Chris grew up in New Zealand and dropped out of high school at 15 to go work on a farm. And his dream was to one day own a farm that he worked on, but he knew he couldn’t make enough money in just working on a farm in New Zealand to achieve this dream.

And he heard over in Australia, you could make good money in mining. He wasn’t even 20 yet. Him and a mate jumped on a plane over to Sydney and road-tripped up and down the East Coast, trying to find work. Obviously, they had no qualifications, but he eventually ended up as a crane operator, and many years later, founded Mineral Resources in 1992 with $10,000 in a bank account and a $50,000 undrawn credit card.

From those very humble beginnings, Chris has transformed Mineral Resources into the $12 billion market cap business it is today, and he still owns about 12% of the company. And I would say there’s been a very long journey of the business and its quality over that time. So initially, Chris would convince miners to let him crush and process waste iron ore essentially on their mines in very small tonnages.

So 1 million, 2 million tons of iron ore at a time. Today, Mineral Resources processes hundreds of millions of tons of the best rock for some of the biggest miners in the world and has these very long-term contracts in place. So a stat is that over 75% of their contracts will be over five years in lengths within the next couple of years.

And those contracts typically renew at 95% plus retention rates. So Chris, is this incredible founder that has taken a very, very small, humble start and transformed it into one of Australia’s biggest businesses.

Matt (06:57): 

Yes. It was clear in the research that I did, he had this entrepreneurial spirit that got him in the door in ways that you would never expect, literally barging his way into the back door and that seems to have continued on. And then this risk-taking DNA in the sense that he was willing to go out in his own and find a way and figure it out, getting into what he has built from a business sense, can you give some sense of the market overview?

I think for the U.S., we’re far away from some of the mining operations or what’s going on. Mining here is a lot different than what’s going on with mining in Australia. So to the extent that you can cover what is happening with the mining operations, any type of market overview and how that plays into their business would be a useful way to paint the picture.

Fraser (07:46):

I’ll sort of maybe dive into both parts of the business because there’s a very symbiotic relationship between the two. But Mining Co will deliver about $2 billion in annual EBITDA within the next few years, and it covers mining assets across lithium, iron ore and energy, and it’s all based in Western Australia.

In terms of the lithium business, MinRes operates three of the largest and low-cost lithium hard rock mines in the world. All of the output is essentially sent up to China into the battery supply chain. And those assets are owned some in partnership with other major miners such as Albemarle and Ganfeng.

In terms of the iron ore business, this has historically been a very small high-cost mining business that represents, call it, 2% of Australia’s iron ore output, but the iron ore assets within MinRes are undergoing a large transformation to now become a very large low-cost mine, and we can talk a little bit more about that transformation later.

MinRes also has this fledgling energy business and are one of the largest onshore oil and gas acreage holders in Western Australia, and they’re in the process of getting the government approvals in place to build a sizable natural gas business.

In terms of the InfraCo side, the InfraCo business will deliver about a $1 billion of annual EBITDA within the next few years, and it covers all of the large-scale infrastructure that you would need on a mine site and to get ore to port and export it into global markets, so think things like ports, airports, roads and crushing and handling infrastructure.

The key of InfraCo might actually surprise your listeners. InfraCo has a construction capability. So all the infrastructure is designed and built in-house. The construction business doesn’t generate any revenue directly, but it accounts for over 1/3 of MinRes employees because there’s no one-off revenue in the business, the construction capabilities are only to build this infrastructure on mining co-sites and on third-party sites that they can then charge recurring fees on over many, many years. And this internal capability, this construction capability allows MinRes to deliver projects at half the time and 1/3 of the capital intensity versus peers that need to outsource design and construction to third parties.

So you can kind of say that the idea of Mining Co is to go own stakes in mines that it can then pass these construction projects over to InfraCo to then build infrastructure that they can clip the ticket on all the volumes over many, many years going forward.

Matt (10:22): 

That paints a really helpful picture in terms of how they would work with a single site and potentially get all of the business units involved. Just to put a bow on the commodities themselves, lithium, iron ore and natural gas, again, coming from the U.S., oftentimes, I think of commodities as having these very cyclical tendencies.

You’re mentioning that there’s long duration and there’s no one-off revenue payments, which is going to look very different than the oil or natural gas sector would look here with some of the services provided. Can you just get into a little bit more about how much cyclicality there actually is in those industries and how they’re able to presumably not see that cyclicality in their actual financial results?

Fraser (11:05):

To be clear, on the InfraCo side, there’s no cyclicality in the earnings. It’s all fixed dollars on volume. So that is the piece that is very high quality and typically trades at very high infrastructure like multiples. The Mining Co side is absolutely exposed to commodity prices.

And so how we think about these commodity businesses is for each individual commodity there is a cost curve, and it’s important to understand where you sit on that cost curve. And so for all three of Mining Co’s core asset classes of lithium iron ore and energy, they are in the lower end of the cost curve, which means, yes, the overall commodity price will fluctuate, but it would have to be at record lows and wiping out significant parts of other mining businesses, supply or production for it to materially impact the ongoing operations of Mining Co.

If I maybe dive a little deeper, you’ve got something like lithium, which is obviously exposed to the rapid growth in battery consumption, particularly for electric vehicles, and hard rock lithium mining as a category is on the very low cost, and relative to the other ways, you can mine and produce lithium.

On the iron ore side, iron ore is part of the steelmaking process, so you need iron ore to make steel. Australia is by far and away the lucky country when it comes to the fact that we produce a lot of the iron ore that is sent on to global seaborne markets. And so Australian iron ore miners and now MinRes are the lowest cost in the world, in part helped by our proximity geographically to China.

And then on the natural gas side, Australia is well known as being one of the largest gas exporters in the world due to our low-cost gas supplies. So I think we’re kind of up there with the U.S. and Qatar in terms of the quality of our resources. So you can see that while, yes, earnings can be volatile in a commodities business.

If you are on the low cost end of the cost curve, they’re typically very high through the cycle return on invested capital businesses and we can dive into this. But one of our key lessons as non-commodities investors, we typically are more kind of software growth investors, is that through the cycle return on capital is very important to focus on not just predictability of earnings.

Matt (13:26): 

In terms of what these projects look like, particularly from the commodity side of the equation, whether it’s a mining site, however you would categorize that side of the business, how do those look from a life cycle standpoint, just general economics, and how you would think on a project-by-project basis, how MinRes approaches this?

Fraser (13:51):

It’s probably worth doing a little case study on the current iron ore project that’s ramping up and is the big, high profile part of the business currently. I would firstly say that MinRes is very agnostic to mineral type. So they essentially are constantly running a beauty parade as to what projects should get up next, and it’s all about return on invested capital. Secondarily, what type of earnings strength can it pass over to InfraCo.

And so if we look at this new iron ore project, which is the Onslow Iron ore Project I’ll refer to. If we just break apart the Mining Co earnings stream and the InfraCo earnings stream, Mining Co for Onslow will require about $800 million of capital investment of CapEx and an iron ore price lower than what it is currently today at spot rates will deliver about $1 billion of EBITDA. So that’s annually.

So that’s over a 100% return on invested capital because, one is, it’s a very low cost source of iron ore. And the second thing is that CapEx number is very low because MinRes has this internal construction capability that I mentioned. So it’s not having to outsource to EPC contractors. It’s built iron ore mines before.

And so it can deliver these projects, again, half the time 1/3 of the cost of a competitor, which means they can take on these projects that have otherwise been considered very hard to do for other miners and turn them into very profitable projects.

Matt (15:16): 

Just on the time line for that in terms of breaking ground, when you see these mining projects, they’re truly magnificent in terms of the size of what they’re doing. What does that look like in terms of time line from breaking the ground, spending that $800 million in CapEx to hitting that $1 billion of annual EBITDA?

Fraser (15:36):

For a normal project, it would normally be, let’s call it, four to seven years at best once construction starts. MinRes had all of their approvals done less than a year ago. They’ve already delivered first door and are expected to ramp to nameplate capacity by this time next year. So let’s call it two years from shovel hitting to nameplate capacity.

Matt (16:01): 

That run rate EBITDA, I know some of these have very long life cycles, is there a general ballpark for how long these will produce that level of, let’s call it, $1 billion of EBITDA?

Fraser: (00:16:16): Chris would talk about this iron ore mine lasting 50-plus years and having billions of tons of reserves sitting in the region. If we look to a sort of analogous mining businesses in the area of BHP and Rio Tinto, their iron ore businesses have been hugely cash-generative for decades and will continue to be for decades.

These types of mines, it’s all about scale economies going into these regions with huge deposits. Most miners would have to spend tens of billions of dollars in CapEx in rail and port and all the mining infrastructure, and that then gives you these very long life earnings streams.

So we’ve talked about the Mining Co returns for the Onslow project. If we talk about InfraCo, if we think about the capital investment required, it’s about $1.7 billion of CapEx to result in about $560 million of EBITDA, which is about a 30% plus ROIC, which is obviously still extremely attractive for an infrastructure asset. However, and this is the magic of Chris Ellison as a capital allocator, he recently sold $140 million of the $560 million of EBITDA for post-tax proceeds of about $1.2 billion.

Now all of a sudden, the economics are, you’ve only got $500 million of net CapEx to translate into $420 million of EBITDA. And so now all of a sudden, you’ve got a plus 80% return on invested capital on an infrastructure asset that has a multi-decade life and is just clipping the ticket on volumes being processed.

You can sort of now see the magic of the projects that Chris goes after and I would say it’s not about any one project making this business. He is being able to do this consistently over a very long period of time. So even if we pick on some other projects, Chris bought a lithium mine out of administration and receivership late last year. He’s been very cagey about exactly what price he paid.

But generally, the market is of the belief that he will generate the purchase price in EBITDA every year going forward, obviously, depending on the lithium price. There’s many examples of this through history. So he is the capital allocation muscle combined with the operational expertise to actually build mining projects is the secret sauce and the competitive advantage of this business.

Matt (18:36): 

And do those InfraCo projects have similar life cycles to the mining because they are associated with those mines, you can assume similar duration of the cash flows?

Fraser (18:47):

That’s exactly right. So if you imagine, Chris has literally built a highway of 150 kilometers or 100 miles, I guess, from the mine to the port and then built a new port ready to export all this volume of iron ore. And the infrastructure that has been built for this project is not only long life associated with this particular mine, but could also be used by other third parties further increasing the volumes processed on the infrastructure over the time.

Matt (19:17): 

On the sale of the stake massively derisking the project, but as a shareholder, you can kind of back out the multiple that was associated with that sale. And is there some point where they no longer need to do those sales because the balance sheet are so strong? Or do you just generally view that as a net positive from a derisking standpoint?

Fraser (19:39):

I think we’re probably of the view that the business is of sufficient size, scale, strength that maybe they don’t need to do those sorts of derisking sales going forward. But I would say it goes to the discipline of this management team that if they can take a project from a 30% ROIC to an 80% ROIC, they’re going to do it every single day, and as I would say, they will then reinvest those proceeds into other very high return on capital projects, accelerating the flywheel and the earnings growth of the business.

Obviously, over time, though, the InfraCo side of the business is more like a 10x to 15x EBITDA multiple business, so the earnings on that side of the business are far more valuable than the 4x to 6x EBITDA earnings on the Mining Co side. And so there’s this tug of war between releasing cash and being able to reinvest into growth versus holding on dearly to your highest value earning streams.

Matt (20:35): 

Yes. It’s very interesting, I think, when I was first considering this business in those two segments, I thought to myself, there’s one here that’s really high quality and there’s another one here that it can be very high quality, but they’re different just in terms of the visibility and the cyclicality. But to your point, it does seem like that commodity business or that mining business is a feeder to InfraCo and I want to get into that a little bit more.

Just you mentioned they can offer some capacity to third parties. How much of InfraCo’s revenues, or in the future, how much do you think will be generated from projects not associated with their mining division? Is that a key priority? How much can that just be a stand-alone business without the mining strategic dynamics working?

Fraser (21:24):

The external or third-party business is still very, very valuable to MinRes. Again, it’s the combined earnings, whether it’s with Mining Co or third party is not really a distinction and that InfraCo business learns and innovates with both sets of customers, and so it’s very important to competitive advantage and evolution over time.

The third parties will deliver about 1/3 of that $1 billion of EBITDA, I mentioned earlier to InfraCo. And you’re working on some of the biggest, best mining assets in the world at scale that helps Mins learn to then take those learnings into the Mining Co side of the business. I would also say that there are only more opportunities coming for the third-party side of InfraCo.

What makes me say that? Well, when MinRes was smaller, it wasn’t necessarily considered as highly executing projects internally for say a BHP or a Rio. But now that MinRes is of such a scale and size and strength and is clearly showing an ability to build projects faster and cheaper than anybody else in an industry that is plagued by cost blowouts and timing overruns, the BHPs and the Rios of the world, I think are more seriously considering long-term partnerships with MinRes to help them grow and drive earnings into their own mining businesses, which have been lower growth over the last few years.

Matt (22:55): 

And is the competitive landscape today with BHP and Rio that they’re currently doing their own version of InfraCo internally, and it’s just not having the same success that MinRes is having with regards to that specific division and the capabilities?

Fraser (23:11):

I think that’s probably a fair way of phrasing it. So if you take a BHP or a Rio, they will have some sites where a lot of crushing and processing is done by Mineral Resources already. But you can imagine for these types of businesses, they still feel it’s important to have internal capability, and they’ve obviously invested tens of billions of dollars in their own infrastructure in rail, ports, processing and handling.

So they’re kind of a hybrid model of using someone like Min’s and their own internal capability. But as I mentioned, no one is debating any longer who was the more efficient operator. The BHPs and Rios would readily recognize and admit that MinRes is far more efficient, not only on the capital and construction side, but also on the operating side.

I think Chris recently mentioned that MinRes is kind of in the order of 30% more efficient on a 12-hour shift than their peers. So there’s a steady march if you want to lower your costs and drive more profitability to potentially use a partner such as MinRes. And MinRes doesn’t really have any competition, particularly in the crushing side of their infrastructure, which is the key service they offer to third parties.

Matt (24:23): 

When you think about that dynamic where the larger incumbents are more inefficient, I can think about the U.S. shale evolution and where we had examples like Exxon buying a shale business and the cost profile went up because their safety checklist and the standards that they would have in terms of administrative work, that all went into the production just was so much more inefficient than what these smaller shale players were doing at the time.

Are there dynamics like that? Or would you point to anything else beyond that? Because traditionally, you think of large-scale players are certainly having economies of scale when it comes to things like this. So what would you say is driving that difference in efficiency and productivity?

Fraser (25:06):

It more comes down to the internal capability. So if you imagine these major resources companies, there’s a lot of outsourcing. They’re outsourcing a lot of the labor, they’re outsourcing a lot of the design and construction. There’s a lot of committees to approve capital plans.

There’s massive head offices in huge skyscrapers all around the country. Mineral Resources is all about internal capability and delivering high performance outcomes. And I would say it’s not so much on things like cutting corners on safety or compliance or anything like that. I think if you listen to Chris, he is very, very focused on his people and delivering the best environment for his people of any mining business anywhere in the world.

We can dive into some of these innovations that don’t necessarily seem obvious like some of his more infrastructure type innovations, but he is leading the charge in the global mining and resources industries.

Matt (26:05): 

Yes. No, I would love to hear more. I can remember him telling the story of working on a site all day. And then when he was finished, he had the crane operator teach him how to operate a crane for another four hours. And they didn’t have certain restrictions so he could work these shifts that were going on 20-plus hours for certain periods of time.

So he seems to have that interest in knowing how every little piece works and I can imagine that’s tying into the innovation, but would love to hear about some of the things that they’re doing. I am sure that, that is equally a driver just in terms of the efficiency and productivity.

Fraser (26:38):

Yes, absolutely. And it goes to their ability to attract great talent and corner the talent market in Western Australia. I mean some examples. Historically, the accommodation on site for mines were little temporary basic accommodation facilities. I think Chris would use stronger words to describe just how basic they were.

At Onslow, he is now creating essentially a resort with queen-size beds, kitchens, laundry facilities, large TVs, where couples can now come and stay together and work on site. There’s Olympic swimming pools and tennis courts and Michelin star chefs that he now flies out to then cook à la carte menus on these mine sites.

Chris has started his own airline. So he was not happy with the incumbents in Australia, and he realized he could optimize the flight schedules to ensure his employees were spending the maximum amount of time they could with families in their two weeks off before then flying to spend two weeks on mine sites.

And because he had his own airline, he was then able to schedule flights to both the East Coast of Australia and the West Coast of Australia, thereby tapping another labor pool for talent. At head office, he bought out the next door neighbor’s property and he’s building a childcare facility.

So instead of people spending $200 a day on childcare here in Australia, the price will be set at $20. He built a gym that now has 1,500 members that looks like something you’d see at an NFL team’s facility. They have a medical center on site at head office with everything from GPs through the psychological, mental health support.

His safety stats, he likes to joke probably better than the WA mining regulator, which is actually just desk office job people. So even though they’re operating in one of the most dangerous industries in the world, they’re very focused on safety.

And so you kind of get a sense of the innovation in the business, not only on the building big infrastructure, do it cheaper and faster than other people, but let’s build an amazing environment that attracts the best talent from around the industry and around the world.

Matt (28:50): 

It was a great list there. The one thing I want to follow up on is the airline. I have heard of the businesses that have airplanes. Is he actually operating some type of airline? I would love to hear more about head dynamics.

Fraser (29:03):

Yes, I must say we’re a little shocked sitting at our desk when that announcement came across. But in a world where everyone is scrambling to secure a, particularly Airbus planes, Chris somehow walks out and manages to snag a couple and get them delivered immediately.

Currently, he’s not allowed to say he has an airline because there’s regulations around that, but he has created MinRes Air for internal purposes to fly staff from key hubs like Perth and Brisbane directly onto his mine sites. Given everything else in his business eventually becomes an external-facing offering, you could probably see a world where one day, he’s offering flights to BHP and Rio and other miners in the region.

But I think it’s a great example where he’s constantly thinking about his people and how to offer a better service. And as he would say, you do it for those right reasons, and inevitably, there are financial benefits. As an example, he can build fewer rooms now at Onslow because he can optimize the shift changeover so that you don’t have to have redundancy in case the flights don’t turn up on time.

Matt (30:13): 

Now the benefits and taking care of the employees is all great, but the capitalist investor would say, “Well, that is going to destroy my cost profile, my margins are going to get squeezed. It’s not sustainable. So let’s just use that as the setting to dive into the financial model of the business.” You’ve talked a lot about the top line buckets.

There is some volatility with the mining business, lesser extent with InfraCo. But when you package it all together, how do you think about the financial model, whether it’s from a margin standpoint, from an earnings or free cash flow standpoint, how do you frame it?

Fraser (30:48):

So most sell-side analysts are mining analysts, and I would say as a very detailed-oriented investor, as I’m sure many of your listeners are, when you initially look at this business, you can’t help but model every mine, line by line, figuring out cost line items and how much is the crushing, how much is the haulage to port, what’s the port cost, how much royalties do I have to pay to government.

And you can go down this vortex, that we could go down and spend hours and hours talking about. But I think what I have learned over time is that you miss the forest from the trees if you go too deep trying to understand the business exactly as it exists today because it evolves so quickly when Chris is doing deals and building new projects and shutting other things down.

It’s kind of impossible to ever have a firm grasp on exactly what’s happening at any given time, as we’ve just discussed, occasionally, he decides to build an airline out of nowhere. And so what I would say is the InfraCo side, as you mentioned, is far easier to predict and model and will deliver about $1 billion of EBITDA within the next few years.

We would think about that as dollars per volume processed of EBITDA rather than a margin that’s less important because the dollars, EBITDA dollars per ton are very consistent. That business, if you then look at other infrastructure businesses, as we mentioned, would probably trade somewhere between 10x to 15x of stand-alone, if you look at U.S. railroad, say, as an example through the cycle.

Now I would flag that this business is still growing very fast, so they should probably trade at a premium to something like U.S. railroad, but we’ll park that argument for the moment. The Mining Co side, you absolutely have to think about tons in terms of lithium iron ore and then obviously, volume, but slightly different metrics on the gas side.

And if you think about what is in MinRes control, it’s about growing those volumes over time. So they can be very clear about what they want those sort of subsegments of Mining Co to look like over time, and they are very open with their long-term plans. But then ultimately, you have to apply a price to those commodities and kind of have a stab at what you think they will deliver.

I would say, you don’t have to believe anything heroic typically with MinRes on the commodity price side. We’ve always been able to assume prices well below forecast consensus and still get comfortable with owning the stock. So you’ve then got the revenue side of the Mining Co business.

The cost side, again, is easier to predict on a long-term basis, I should say, and the business gives very good guidance as to kind of what they’re targeting for each of the key mines within each division.

Now it is lumpy. So as an example, the lithium business has had high operating costs more recently because there’s a bunch of stuff happening to change and expand the volumes at the mines, but the long-term costs should stay reasonably unchanged year-to-year. And so that will then spit out an EBITDA number on the Mining Co side.

And as I mentioned earlier, we think that’s in excess of $2 billion of EBITDA within a few years once Onslow is ramped up. Now I would say, as you mentioned, this is more of a 4x to 6x EBITDA business if you look at BHP, Rio, Fortescue and other mining and oil and gas businesses through the cycle.

Lithium has historically traded higher. So you could maybe argue that you can add a premium for the lithium business. And again, this is a growing mining business, which should also attract a premium compared to the mature guys. But again, we’ll park that. So that’s kind of the overall model of the business.

For those keen listeners that have been doing some fast maths in their head, they’ve probably clued on to the fact that the business currently has a $12 billion market cap, but they’ve got an infrastructure business that could be worth $12 billion stand-alone. I would say there have been various moments in time where you could own this business just on the valuation of InfraCo and get Mining Co for free.

Are we in one of those moments right now? I’ll leave up to everyone else, but that has been a core part of our thesis, is that InfraCo is undervalued by the market, and it goes back to that comment I made earlier that sell-side analysts, the investors we speak to are mining people and so they think about the mining business and that it should be valued at 5x EBITDA and they kind of just roll that out across the broader operations.

Matt (35:16): 

Yes. I’m waiting for the activist campaign, see, push to split and unlock the value by letting that trade on its own multiple. It rings true just in terms of the project-by-project modeling. I think the way that you framed it was very helpful just in terms of you have this InfraCo business, which is fairly straightforward to understand and then you can think about whether it’s a free option that you get the mining business or however you want to frame it, it’s very useful.

On the growth side of the equation and getting back into the EBITDA metrics you mentioned, how much of EBITDA is actually converting into free cash flow when you factor in the CapEx spend? Is this a business where you see them spending a lot and reinvesting back into the business right now? And how long would you expect that to take just in terms of an investment period?

Fraser (36:05):

These businesses at maturity throw off a lot of free cash flow. The maintenance CapEx is perhaps not as high as people would think. So if you think about a BHP or Rio, I think about 15% of EBITDA in any given year is used for maintenance CapEx and about 85% of EBITDA then dropped through to your pretax free cash flow number.

So this is perhaps not as capital intensive at maturity as people would think. In terms of where Min’s is at today, they are in compounding reinvestment mode. And so while they do pay a small dividend, they are looking for ways to reinvest every cent that they generate into new projects. They have a publicly stated ROIC target of 25% plus. But as we’ve seen in some of the examples, they have a long track record and history of beating that.

And that’s what ultimately has driven close to 30% total shareholder returns of close to 20 years is their ability to reinvest that cash flow time and time again into really attractive projects. So just to reiterate, this isn’t a kind of a one-hit wonder type business. Chris is a capital allocator on par with anybody else you can kind of think of anywhere in the world, and that is part of the superpower of this business.

And so Chris recently said at risk of scaring shareholders, they’re currently assessing over $10 billion worth of projects in their ongoing beauty parade as to what’s next in terms of their major project development pipeline.

Matt (37:44): 

Going back to the beginning of the conversation, it makes sense then with derisking some of the other projects that you could then deploy them into that CapEx spend opportunity. So I think that certainly ties together and can make some sense when there’s that type of investment horizon.

Fraser (37:39):

Yes, absolutely. And I think just quickly on the split, I think it’s a real conundrum because from a valuation perspective, you can clearly see how much value would be created by having these two businesses sitting side-by-side in separate entities. But I would say that there is so much synergy between the two and Mining Co is successful and delivers high ROIC because InfraCo can build the projects on time and on budget, which seems to allude almost every other miner.

And InfraCo secures these large, very long-term multi-decade contracts because they have such a close relationship with Mining Co. And so I suspect if you tried to pull them apart, you really risk losing that magic, which has driven the compounding over time. And so the way, I guess, we think about it is, we still want to play for the compounding.

We’re not at maturity yet, but we feel really nice that we don’t have to pay for the mining business and that the mining business is going to throw off billions of dollars of cash flow to keep accelerating the compounding over time.

Matt (39:02): 

Everything you’ve mentioned here just in terms of how the business is valued, what they’re doing, everything going on. Is it referenced as an M&A target for the majors? Is that something that comes up often.

Fraser (39:14):

It’s a really good question because historically, it hasn’t. And I’d say that is part of the journey of MinRes. So I mentioned earlier in our discussion that they sort of came from a place of opportunistically buying higher costs, particularly iron ore mines. So they pay a $1 at the bottom of the cycle to buy a mine that was in the marginal supply category.

And then as iron ore prices came back, the mine would then print hundreds of millions of dollars of EBITDA and again, small scale. So we’re talking, let’s say, 10 million to 20 million tons a year, let’s call it, 2% of Australia’s total production. It just wasn’t meaningful for the major miners.

I mean this is quite a topical conversation because at the time of recording last night, MinRes just announced, it was wrapping up or closing one of its higher costs, older iron ore mines, which is immaterial to the value of the business, but is a real milestone for the growing up of this business from, let’s call it, teenager to adults, whereby the business now has low-cost, long-life iron ore assets, lithium assets and soon to be natural gas assets.

And so I think there’s a world where at some point, it probably does become a more interesting opportunity for the major miners. Obviously, Chris owns 12% of the business, and there’s absolutely no way we would want to sell the business to anyone at this point, and there’s no way he would want to sell the business to anyone at this point. But I think the problem with becoming bigger and better and stronger is you naturally attract more interest. One of those dynamics that seems to be ever so common in that space, in particular.

Matt (40:57): 

On some of the risk side of the equation, we’ve touched on commodity prices a lot. Is there any hedging that goes on from MinRes just to reduce some exposure certainly from a cost profile standpoint, there’s not seems like much case for them to ever shut down mines absent what happened recently.

But just from stabilizing the revenue, is that something that’s common either here or even with a BHP or Rio I don’t know how common it is in this space.

Fraser (41:22):

I think this is one of those areas that if we had any Western Australian mining analysts, it would be a very hot controversial topic and everyone has a religious ask opinion. But in terms of MinRes more specifically, they do not hedge. They sell at spot prices to their export customers.

There’s lots of theories as to why you would or wouldn’t do it, but it’s worked for Chris over time to have maximum flexibility at any given moment in terms of where the ore goes to and pricing that he takes. So there’s typically no offtake, particularly on the lithium side, and it’s all priced at spot.

So as an example, there are other lithium mines that will work which, say, an auto OEM or with a battery maker and guarantee that all their volumes will be allocated to that entity. But Chris would much prefer to play the market at any given moment in time and make sure he’s getting maximum value from the incremental buyer of volume at any given moment?

Matt (42:22): 

In terms of other risks that you would tie into this business, what keeps you up at night to the extent that there’s anything, what do you think are the main risks that stand out here?

Fraser (42:32):

The risks are perhaps different than what most people would think. The obvious answer is well, commodity prices is a risk. I guess we’ve sort of referenced that the quality of the InfraCo business is such that at different points in time, you sort of don’t actually have to worry too much about the commodity price cycle.

Obviously, the only threat would be that if commodity prices got so low that these mines had to turn off or mothball for a period of time then InfraCo would have a hole in its earnings. But I would, again, just kind of refer to, if you think about Mining Co’s assets, the BHP and Rio Tinto’s assets, these are the lowest cost assets in the world.

And if you look at the GFC, Min’s didn’t lose a single contract during either that stage or the 2015 commodity bear market. I’m talking on the InfraCo side. So we feel really good that commodity prices are less of an issue than many would think.

The big issues are really around Chris, so a bit like with other exceptional leaders in capital allocators of some of these bigger complex businesses, Chris is a lot of the capital allocation magic. And so if he were to decide it’s time to go retire and live on an island somewhere, the compounding and the project selection magic just isn’t as strong as it has been historically.

Now Chris is a very passionate guy and has said he’s still got another decade at least in the business. So we feel really good that we’ve still got a lot of runway here. More broadly on people, there’s a lot of IP in that construction part of InfraCo. There are people that have been in the business 20, 30 years and those people on that internal IP is why Min’s can deliver projects with the amazing economics that they do.

And so it’s important to retain and keep those people happy. So if you ever had an exodus of talent, I think that would be a real concern. The other criticism that or risk that investors would highlight is that it’s harder to generate higher return on capital as you get larger. We’ve sort of talked about it, but interestingly, returns only seems to be getting better as the business becomes more high profile.

And as other miners see Min’s as a partner of choice to develop mines. So Onslow we spoke about has amazing return on invested capital and is a multibillion dollar CapEx project. And so if Min’s can keep doing those kinds of projects, there’s still a very long runway for this business to generate great returns.

The other thing that sell side have been getting a little bit nervous about lately is just the balance sheet. So Chris does use high-yield bonds from the U.S. to finance some elements of the business at a corporate level. He’s always had a very conservative balance sheet, but you can imagine at this particular moment in time where you’re spending all this CapEx on the Onslow project and then waiting for the earnings to come through, this is the peak moment of leverage before it rapidly deleverages.

I think we would say that, well, if InfraCo is delivering about $1 billion of EBITDA, and there’s about $4 billion of debt on the balance sheet, we feel very comfortable that InfraCo alone could support that level of leverage. But as you can imagine, for mining analysts, it’s quite unusual for a mining business to have that kind of leverage because of the volatility in the earnings due to the commodity price cycle.

So there’s been a lot of debate there, but we feel very comfortable that Chris has managed the balance sheet for decades and is one of the best capital allocators on the planet, and I don’t think would risk blowing up his business over something silly as overleveraging.

Matt (46:12): 

Yes. It feels like it’s necessary to talk about balance sheets with any type of mining or commodities-related business. So I’m glad that we got that in there and addressed the topic. This has been a fascinating conversation, very interesting entrepreneur, very interesting player who feels niche, but at the same time, working with a lot of the major players and an interesting inflection point here. What would you say are the key lessons that stand out to you when you’re looking at this business?

As you mentioned, you invest in a lot of the software names, technology-related names. So this is outside of your traditional spectrum perhaps. What stands out to you in terms of lessons that you can pull away from MinRes?

Fraser (46:53):

There’s so many lessons in this business. I mean, first, the kind of the obvious one, just the power of founders that care about shareholder value creation and return on invested capital. Chris has taken what is a business that most people would not think particularly highly of in terms of quality in comparison to, say, a software business, but has delivered returns better than I suspect almost every software business other than a couple of the other major compounders like a constellation.

So just the power of those founders that really understand how to drive shareholder value. The second thing is this idea of and this is a trap I certainly fall into of getting too detailed into understanding the particular mechanics of the business and the mines in this instance and missing the importance of the broader vision and the broader competitive advantage, which is in MinRes ability to operate mines cheaper than everybody else and build mines cheaper than everybody else and then allocate capital accordingly.

And so while my model is very complex and changes very frequently, I have learned not to get too wedded to the kind of share price number that model spits out at the end of all that analysis. Maybe the third thing is that like in software, what I’ll call a technical founder or CEO, can kind of rally the people and culture of a business better typically than a more corporate executive, Chris has operated all of the machines on site.

He can talk the language to his 7,500 employees. And he understands the little changes he can make to make their lives better on-site where the real money is made. And then in terms of maybe a couple of other minor ones, but few are I said, would you like to invest in a construction business, I think we would both turn up our nose and explain all the reasons why construction is really bad business.

But as a capability, having internal construction is part of the magic of this business, and it took me a very long time to be convinced of that factor. Now I am a resounding advocate. And the final thing is just that investors in this space are overly worried about picking commodity price cycles rather than thinking about through the cycle pricing and through the cycle return on invested capital.

And so while many of us are focused on the predictability of earnings and only investing in software businesses that are really easy to model in Excel, this is a business that has very, very high through the cycle return on invested capital. And so from a quality perspective, is actually far higher than people give it on first class.

Matt (49:35): 

This has been a pleasure, Fraser, and it’s a pleasure to hear about the personal learnings that you’ve gotten out of this and the evolution of the maturity of the investing process. I admire that just in terms of approaching businesses differently and seeming to appreciate longer duration dynamics. So I love hearing those lessons, the broader, the more personal. It’s all excellent. Thank you very much for sharing the knowledge.

Fraser (49:58):

No, it’s been a lot of fun. Thanks, Matt. Appreciate it.

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