Perspective

The Sohn Pitch we Never Had the Chance to Make…A Bonus 2019 Conference ‘Mini Pitch’

When asked to pitch a stock at the 2019 Sohn Hearts & Minds Conference, we instantly knew what it would be...
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We could not have been more excited to contribute to the Sohn Hearts and Minds Conference line up.

This was primarily driven by the fact that we feel completely aligned to the mission of the conference – Sohn Hearts and Minds has done a phenomenal job in raising almost $20m for medical research in Australia. We did however have to have overcome the mental hurdle of undoubtedly being judged on a one year performance horizon given that we make portfolio investment decisions based on likely outcomes over a decade, not months. 

Regardless, we knew instantly which business would be TDM’s SOHN pitch…

One of the most unknown, underappreciated, Australian innovation and commercial success stories.

A company that since IPO in 2006 has achieved;

  • EPS growth of 15% per annum
  • Total shareholder return including dividends of 20x (26% per annum)
  • Return on funds employed (pre-tax) averaging approx. 30%
  • EBITDA to cash flow conversion of approx. 100%

A business that currently has:

  • A bulletproof balance sheet with $200m+ of net cash
  • Inside ownership of over 15%

And our view is that it has the potential for EBITDA to grow over 20% p.a over the next 5 years?
and…is trading on FY20 PE (ex-cash) of 7x!

Investment opportunities don’t come any better than this – having owned the business for over 13 years, this was the chance we had always wanted to unveil to the world how we see this incredible business.

The pitch? Mineral Resources (ASX: MRL).

Our longest portfolio company, having first invested at IPO in 2006.

Mineral Resources (ASX:MRL)

Turns out though that great minds do in fact think alike; we heard that the incredible Emma Fisher (nee Goodsell) from Airlie Funds Management was also planning to pitch this stock. She won the coin toss. Having seen Emma in action at the 2018 SOHN Conference in Melbourne we knew she would do a phenomenal job pitching Mineral Resources. We did want to add one little tidbit though to her pitch as we think it is crucial in understanding what has and will continue to drive value for Mineral Resources as a business and ultimately their shareholders.

We call it the Mineral Resources Flywheel. As described by Jim Collins, some of the best businesses in the world exhibit powerful and self-perpetuating flywheels – attributes or forces that build on each other, and in doing so create unstoppable momentum.

MRL is a world-leading mining infrastructure specialist, whose core competitive advantages revolve around engineering and commercial innovation. It is this level of sustained innovation that has allowed them over the last 13 years to consistently deliver best in class mining infrastructure sites 3 times faster and at one-third the cost of all other market players.

A quick history lesson

Turn the clock back all the way to 2006. It was the year the MRL flywheel was getting it’s first big push from Chris Ellison (who in our mind is one of Australia’s greatest entrepreneurs). 2006 is the year MRL proves they do in fact have a structural advantage in cost, capital and speed to market, and start to build the trust with the major miners that this is in fact the case.

A case in point, it is the year Mineral Resources delivers a 12m tonne iron ore crushing project at Nammuldi for Rio Tinto, their largest build, own, operate (“BOO”) project for a major miner, and they deliver it in true MRL fashion – at 1/3 the cost, in 1/3 the time and operate it with 1/3 the staff of what was originally estimated by their competitors. Rio evidently were thrilled with the outcome – 13 years later. MRL still own and operate the plant.

The next big nudge to the flywheel came in 2008; the delivery of Fortescue Metals’ Christmas Creek iron ore expansion that enabled MRL to fully service two plants totalling 60m tonnes of iron ore. This mine still remains one of the largest in the world! At this point in time, MRL is starting to build a reputation as the ‘little engine that could” – a mining services business that delivers world-class sites for world-class miners, and with this a deepening of trust with tier 1 client base.

With the building cash flow generated from a growing list of mining infrastructure services contracts, Chris’ entrepreneurial spirit could start to be harnessed, and no better example exists than the deal with Mount Marion in 2009 – a mine southwest of Kalgoorlie which just so happened at the time to hold the world’s second-largest high-grade lithium reserves. With this investment in a “cornered resource”, MRL would build, own and operate the mining infrastructure on a 30-year contract, as well as owning 30% of the mine itself. This changed recently to a 50/50 JV with Ganfeng, and an upgrade to the mine that is able to produce up to 400k tonnes of spodumene concentrate per year. The flywheel is now spinning hard at this point. We estimate this mining infrastructure contract alone contributes $30m in annuity-style EBITDA p.a and MRL are moving across the mining infrastructure value chain.

And now the for the fun stuff – what to do with all these annuity earnings, having proved out the BOO model and the number of long term contracts mounting? You might need to reuse those tissues you used to wipe your eyes earlier…

Having proved out the BOO model and the number of long term contracts mounting, and with them annuity earnings, Chris has both the capital, strategic vision and a mercurial entrprenurial hunger to what we like to call ‘an ability to pull rabbits out of hats’…

Act II: Wodgina.

There is no way to give this any more colour than the facts;

Step 1: Buy the mine site for an immaterial sum (we estimate $50m), and invest c$600m over three years. Total investment c$650m.

Step 2-4: Build a best in class mine, using proprietary and innovative techniques to deliver this at the lowest possible cost.  Extract $250m in cash flow while building operations from the site. Sign a 30-year mining services agreement we expect to produce $30m in EBITDA per annum.

Step 5: Sell 60% of the mine, three years later, for 35x what you paid ($1.8b) and receive 40% of the product profit which we expect to be between $100-$200m a year for 30 years! Rabbits indeed.

The Flywheel continues to spin

Innovation allows MRL to deliver incredible outcomes on-site, building their annuity income streams, allowing them to invest in cornered resources and services these mines, innovate and so on and so forth the wheel goes.

With a bulletproof balance sheet, the proceeds from Wodgina are expected to fund the port and rail projects that will undoubtedly deliver huge long term earnings growth for Mineral Resources. This will move them again further across the mining infrastructure value chain, further fuelling the flywheel’s velocity.

Why such a mismatch between the market’s view and how we view the business?

Rather than thinking (and valuing) MRL like you would a typical mining services business, with earnings heavily dependent on the mining cycle (and commodity prices) we think you can now start to think of MRL akin to an infrastructure business akin to a Macquarie Group – yes there are undoubtedly market-facing businesses inside MRL whose earnings will rise and fall with commodity prices, but underpinning there earnigns profile, after 13 years of track record, are very strong annuity earnings streams.

In the last five years, MRL have retained 96% of all of its mining services contracts – the other 4% is accounted for via a mine closure that had run its expected life span. 76% of these contracts are for longer than 5 years, and a third is longer than 10 years.

In our mind, MRL’s mining infrastructure earnings – crushing, processing, contract mining, accommodation and potentially in the future roads and ports – are high-quality annuity-style earnings with a high return on funds employed and the commodities (market facing) business can then be viewed as ‘cream on the cake’.

While we didn’t have the opportunity at this year’s Sohn Hearts and Minds Conference to give the insight into our own thinking and appreciation of both Mineral Resources’ track record and unique business model, what we do know is this;

At the moment, the mining infrastructure business and cash/investments alone are worth more than the share price.

We can only hope over time more people come to view the business as we do but don’t expect this to happen overnight. Thankfully we are very patient investors. If it takes another 13 years and 20x later, then so be it.

Sometimes it is best just to let these compounding machines speak for themselves.

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If you want to see the business we did pitch…

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