Mineral Resources: The Case for Airbus and Gentex

The exploitation of the Earth’s vast mineral resources has been central to humankind’s economic progress. Mineral mining and metals refining has enabled countless transformational technologies. Cities lined with skyscrapers, auto and air travel, as well as electronics that power our digitally connected lives, are all made possible by the myriad industrial applications for materials derived from the Earth’s crust.

However, the invasion of Ukraine--which has driven the price of several mineral commodities sky-high--is a stark reminder of the distinct environmental, social, and governance risks that exist as a consequence of our dependence upon the Earth's finite mineral resources for everyday life. This price inflation also presents critical ramifications for investors in the multitude of industries and enterprises that supply goods made from mineral-derived inputs.

Mineral commodities are naturally abundant in some parts of the world and less so (or even entirely absent) in others. Therefore, the potential for souring international relations is an ever-present risk to the orderly and reliable supply of any mineral resources that aren’t naturally ubiquitous. That risk becomes more pronounced when mineral commodities are supplied by a concentrated number of deposit-rich nations. While the trade of commodities in global markets helps overcome this, geopolitical tensions and their potential to hinder international trade are an omnipresent risk for stocks that rely upon mineral resources that cannot be locally sourced.

Palladium, titanium, and nickel are examples of important industrial materials affected by the Russia-Ukraine conflict. Palladium is critical in the manufacturing of catalytic converters for automobiles. Russia is the largest supplier of palladium, accounting for 43% of global supply in 2020, according to U.S. Geological Survey data. With only four other countries supplying the global palladium market, prices have soared since the outbreak of the war, contributing to raw material inflation, margin pressure, and even the possibility for supply disruption for automakers. A similar story exists for titanium, which is important to aerospace, marine, and auto industries. Nickel, which jumped to a record high in March 2022, is an important input in stainless steel, and is also used in batteries, electrical equipment, and coatings.

The risk that Russia’s mineral production poses to the users of commodities is obvious given Russia’s governance challenges. The Sustainalytics Institutional Capital Score, which provides an assessment of the social and institutional infrastructure, civil rights and freedoms, and political and social stability, is a good proxy for country governance and geopolitical-related risks. Even before the war, Russia scored below average for a range of these governance issues, including political rights, civil liberties, and voice and accountability, according to Sustainalytics.

Russia’s Institutional Capital Is Judged as Low, but This Is Also the Case for Many Mineral-Exporting Nations

- source: Sustainalytics.

But Russia is not the only commodity-producing nation that scores poorly on country governance issues. Some 28 countries represent the bottom quartile of commodity producers on governance issues, including Zimbabwe, Belarus, and The Democratic Republic of the Congo. When low-IC-scoring nations contribute significantly to the global supply of a particular commodity, supply risk for that mineral resource increases substantially. In particular, there are six minerals--palladium, gemstones, potash, industrial diamonds, cobalt, and tantalum--where 30% or more of global supply comes from countries in the bottom quartile of IC scores.

Beyond geopolitical flare-ups, other ESG risks are associated with mineral resource use. One stems from the simple fact that minerals extracted from the Earth’s surface are nonrenewable--meaning that they cannot be replaced once they have been consumed. Set against a growing global population, the ongoing rise of living standards in emerging economies, and megatrends like the renewable energy transition (which promises to be highly mineral-intensive)--the Earth’s nonrenewable mineral resources are becoming increasingly scarce.

So, which minerals are likely to come under the most strain from an ever-expanding global economy? One way to answer this question is by comparing the known global reserves of a mineral resource with its current level of annual production. Doing so yields a reserves/production ratio. The lower this ratio, the sooner the global reserves of a given mineral resource are likely to be fully exhausted.

The 10 minerals with the lowest reserves/production ratios--of the approximate 90 industrial minerals reported on by the USGS--are chromium, antimony, silver, lead, tin, gold, cobalt, arsenic, nickel, and industrial diamonds. The application of these minerals is vast--from energy storage, electronics, industrial machinery, to chemicals, construction materials, paints, and coatings to jewelry. Without the development of economically viable substitutes (which would ideally be renewable), market prices for these minerals are at risk of rising materially in coming decades, potentially presenting a significant challenge to the many industries and businesses where they form a critical input of their operation.

Recycling and reuse will become increasingly important since mineral resources aren’t renewable. However, these initiatives wouldn’t entirely offset the finite reserves given an ever-growing global economy. And recycling rates for metals remain generally low, with just six metals globally--lead, palladium, rhodium, nickel, gold, and platinum--boasting a recycling rate of 25% or more.

Achieving a high rate of recycling for a particular material depends upon whether it can be done in a cost-efficient manner. In the case of scrap metals, the collection and separation of most metals from global waste streams faces cost-efficiency challenges, according to the United Nations Environment Programme. The cost to collect and convert many metals back to usable feedstock is high relative to what it costs to simply dig more virgin material out of deposits currently being mined. These act together to suppress metal-recycling rates. Yet raising recycling rates would help to reduce the risk faced by companies and industries that rely on mineral resources. Where recycling rates remain low, greater innovation and investment in recycling technology to drive down the cost of collection needs to take place. The introduction of a price signal--for example, a tax--by policymakers on the use of primary metal could facilitate this investment, driving better metal-recycling outcomes as scrap and primary metal production costs are brought closer to parity with one another.

Investment Opportunities Exist Despite the Challenges Posed by Mineral Resource Reliance

Despite the unique ESG challenges presented by mineral resource use, we see investment opportunities across a number of mineral resource-reliant stocks. One is Airbus AIR. Airbus has a wide Morningstar economic moat and attractive valuation despite its multiple mineral exposures as well as related supply chain concerns presently stemming from sanctions on Russia. Airbus, to our knowledge, gets 50% of its titanium from Russian suppliers, particularly VSMPO-AVISMA, which provide semifinished metal products to the aircraft manufacturer. Titanium is used frequently in aerostructures, and the A350neo, for instance, has 14% titanium content by weight.

While we would not be surprised to see supply chain disruptions interrupt near-term manufacturing, we don’t see much risk of customers turning to other suppliers for aircraft since Airbus’ customers purchase aircraft years in advance. We think the market doesn’t fully appreciate Airbus’ dominance in the high-margin, narrow-body market, and it underestimates the long-term demand drivers for aircraft, namely increasing propensity to fly as emerging-markets nations become wealthier.

Another example is narrow-moat Gentex GNTX, which trades at an attractive discount to fair value. Gentex is one of the world’s top automotive suppliers, responsible for more than 90% of automatic-dimming interior and side mirrors in the world, thanks to its mastering of electrochromic technology.

EC mirrors expose Gentex to rising costs of electronic components, which are highly mineral resource-reliant, and to certain other metals such as zinc, copper, and ruthenium. To maintain its dominant share, Gentex offers automakers annual price reductions of about 2%-3%. Cost improvements are critical, so Gentex constantly works to drive new product innovations as well as to improve manufacturing processes.

Despite these challenges, the growth prospects for EC mirrors look strong. Furthermore, Gentex’s continued investment in technology to reduce costs offers a degree of protection to its operating margin from inflation in the cost base, mineral resource-input-related or otherwise. We estimate an approximate 36% of all light vehicles produced in 2021 had interior auto-dimming mirrors, and exterior auto-dimming mirror penetration is far below interior. Accordingly, growth will come from increased vehicle penetration as more automakers make the safety benefit of auto-dimming technology available, and as Gentex's research leads to new, advanced-feature mirrors that ultimately become standard products.