Undervalued ASX miner joins select club with only 5 members

Joseph Taylor | Morningstar 

Until recently, only four mining industry companies with full Morningstar coverage – anywhere in the world – had anything other than a No Moat rating. That changed at the start of July when Morningstar Australia’s Esther Holloway initiated coverage on IGO Ltd.

Why do so few miners have moats?

At Morningstar we define a moat as a structural advantage that allows a company to earn excess returns on its investments for a long period of time. Most miners, almost by definition, have no durable competitive advantage protecting their profits.

This is because miners are commodity producers selling products with little or no differentiation to those sold by peers. They are price takers, not price makers. The profitability of a miner in any one year is mostly due to factors – like commodity prices – that it has little control over.

Most moats in the mining industry stem from a cost advantage. This is where the unique characteristics of a mine allow the owner to produce the commodity for far less than most, if not all, other producers. This, in theory, gives the miner more of a chance to make profits even if commodity prices are low.

You can see a list of the four other moated mining industry companies below.

• Lithium Americas (Argentina) Group: Narrow Moat, Cost Advantages
• Tianqi Lithium: Narrow Moat, Cost Advantages
• Compass Minerals International: Narrow Moat, Cost Advantages
• Deterra Royalties: Wide Moat, Cost Advantages + Intangibles

Except for Deterra Royalties, all of the moats above stem purely from cost advantages. Deterra Royalties is different because it is a mining royalties company. It doesn’t drill holes. It just collects royalties from those that do.

What gives IGO a moat?

Like the other moated miners, our analysts think IGO Ltd benefits from a cost advantage. This stems from IGO’s 25% non-controlling interest in the Greenbushes lithium mine, which was purchased from Tianqi Lithium in 2020.

Morningstar’s Esther Holloway explains in her research report that Greenbushes is the highest-quality hard rock lithium operation in the world. The mine produces spodumene concentrate, the feedstock for the battery compound lithium hydroxide. Greenbushes’ cash cost of around USD 200 per metric ton in 2023 sits comfortably below our long-run price forecast for spodumene concentrate of USD 1,200 per metric ton and places the mine at the bottom of the hard rock lithium cost curve.

With around 20 years left on current reserve estimates, Holloway thinks Greenbushes has enough remaining life to support a moat. She expects returns on invested capital, or ROIC, for the asset to average more than 50% over her 10-year explicit forecast period.

As the Greenbushes stake comprises around 90% of Holloway’s Fair Value estimate for IGO, she feels this warrants a Narrow Moat rating for the company as a whole.

What makes up the rest of IGO?

Through its joint venture with Tianqi Lithium, IGO also has a 49% economic interest in the Kwinana lithium hydroxide refinery. Tianqi’s share of spodumene from Greenbushes is preferentially processed at the Kwinana refinery, with surplus concentrate exported to Tianqi refineries in China.

By contrast to Greenbushes, the Kwinana refinery is not cost-advantaged. A big reason for this is that competitors based in China have lower capital intensity and benefit from lower operating costs due to factors including cheaper labour. As estimates peg China’s share of global lithium production at around 60%, Holloway thinks Kwinana sits in the top half of the lithium hydroxide production cost curve.

Holloway thinks the Kwinana refinery comprises around 5% of IGO’s total value, with the remaining 10% besides Greenbushes coming from its legacy nickel mines.

How much could IGO be worth?

IGO currently trades at a significant discount to Holloway’s fair value estimate of $8.30 per share.

Holloway thinks the main valuation driver for IGO is the lithium price.

Lithium prices have remained soft in 2024 and averaged around USD 14,000 per metric ton in the June quarter. This represented a further fall from the all-time highs of around USD 80,000 per metric ton seen in 2022. Holloway thinks a recovery from current levels seems likely. This is because she expects long-term prices to remain above her forecast for lithium’s marginal cost of production, which she thinks will average USD $20,000 over the next several years.

Good value but high Uncertainty

Turning to potential downside risks, Holloway expects electric vehicle (EV) batteries to account for nearly 70% of lithium demand by 2030, up from around 50% in 2023. This leaves the lithium industry increasingly tied to the progression of EV adoption. If EV demand grows more slowly than expected, lithium prices may not recover to the levels Holloway expects.

In addition to this, there is a chance that new battery technologies like sodium-ion could overtake lithium as the preferred energy storage resource. Other threats to lithium prices could come from oversupply and lower production costs due to technological breakthroughs. Asides from volatile lithium prices, Holloway always sees elements of execution risk for the Kwinana refinery. But seeing as this only makes up 5% of her Fair Value estimate, they aren’t overly material.

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