Giddy Heights For Mineral Resources

This story features MINERAL RESOURCES LIMITED. For more info SHARE ANALYSIS: MIN

-Increased guidance lifts valuation
-Yet several consider stock fully valued
-Minimal new lithium supply in 2016
-Material catalyst in resource update?
 

By Eva Brocklehurst

The hot potential of lithium has caught up with Mineral Resources ((MIN)), resulting in two brokers downgrading the stock recently. The company has been spirited into the spotlight with the surge of interest in lithium and its use in battery storage. The stock is now seen straining at the leash.

Mineral Resources has announced a forecast of 400,000 tonnes of lithium concentrate per annum is set to be produced at the Mt Marion joint venture, WA, a 40% increase on prior guidance. First shipment is due in October and an aggressive ramp-up is expected.

The company recently exercised an option to increase its stake to 43.1% from 30% in the project and Deutsche Bank now values this stake at $247m, or $1.32 a share. This lifts the stock's valuation by 6% to $8.45. Despite this upgrade, Mineral Resources has rallied hard in recent weeks and the broker downgrades to Hold from Buy.

Mt Marion is expected to generate around $60m in earnings per annum for the company on the broker's US$550-600/t spodumene (lithium containing) price forecasts, with $330/t in unit costs. The project represents 14-20% of the company's earnings. Deutsche Bank forecasts 2016 lithium demand will reach 209,000t of lithium carbonate equivalent in 2016, a 14% increase on 2015.

While demand is growing there is minimal new supply coming on line at present besides the Orocobre ((ORE)) Olaroz project, and Chinese re-starts which the broker concludes are at high cost.

By the end of this year the first shipments from Mt Marion and the Galaxy Resources ((GXY))/General Mining ((GMM)) project at Mt Cattlin will arrive in China. These two assets are hardly expected to impact the market in 2016 but will increase supply by 30% as they ramp up early next year. Deutsche Bank forecasts lithium pricing will then fall from the September quarter 2017.

Macquarie is of a similar view, incorporating Mt Marion into earnings forecasts and lowering its recommendation on Mineral Resources to Underperform from Neutral. The broker believes the excitement surrounding lithium has been a key contributor to the share price performance this year and the market is currently capitalising a long-term lithium price that is too high into the stock.

The broker suspects the project could produce as much as 80% of the current shortfall in the market and values it at $1.10 per share, using a long-term spodumene price of US$600/t.

Yet, Mineral Resources is not all about lithium. Another driver of the share price was the spike in the iron ore price earlier in the year. Macquarie forecasts iron ore costs will fall again to $50/t in FY17, driven by the company's focus on cost and productivity. Using spot FX rates and iron ore prices suggests to the broker cash flow is close to zero.

Meanwhile, the company's mining services business has been proving it can withstand the tough external environment, with the broker noting crushing capacity continues to grow.

Macquarie finds no stock is strictly comparable, given the company's mix of mining services and mining, but compared with both mining services and mining peers it appears expensive on a relative basis. The broker recently raised its target to $8.30 from $5.35 with the inclusion of Mt Marion earnings being offset by lower iron ore price assumptions.

Commodity analysts at Macquarie are of the view that the lithium market will remain tight for 18 months but it does not have a capacity constraint and major producers are likely to be forced to lift output with the threat of new entrants, capping the price rally from late 2017 despite the compelling demand outlook.

Furthermore, as with many specialty metals, the market is relatively small and price mechanisms opaque. There is no exchange for trading the metal, with pricing determined by agreements between suppliers and consumers.

The upcoming resource update could could be a material catalyst, Ord Minnett contends. The broker also believes the company could surprise on the upside at its FY16 results. While headline multiples look full, this broker takes the view that the lithium assets are highly saleable and generate no earnings in FY16. On this basis, Ord Minnett believes there could still be significant upside for the stock.

The broker uses as 50:50 mix of discounted cash flow and enterprise value/earnings multiples to determine its valuation, referencing peer comparisons in mining services, lithium and iron ore. Morgan Stanley, too, likes the potential value accretion from the lithium asset rather than the exposure to the lithium price, retaining mining services and iron ore assets as the larger component in its base case valuation.

FNArena's database has two Buy ratings on Mineral Resources (Ord Minnett, Morgan Stanley), one Hold and one Sell. The consensus target is $9.01, suggesting 8.3% upside to the last share price. Targets range from $8.30 (Macquarie) to $10.33 (Ord Minnett).
 

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