Company Reports

Commodity prices diverged in the quarter. Despite solid China steel production, iron ore and metallurgical coal prices are down, while copper rose on supply issues and hopes of faster global growth. However, prices are elevated compared with history and cost-curve support.

Iron ore prices are lower on concerns over China steel demand due to its struggling property market and weak infrastructure spending. However, gold prices are up on optimism over peak interest rates, driving a 2% rise in our estimate for no-moat Newmont, to USD 51. It remains the cheapest miner we cover, trading 27% below fair value.

Deterra Royalties aims to grow into a diversified royalty company with multiple cash flows. New royalties are likely to be added in time, but we believe disciplined investment is likely, given the managing director's background at Iluka Resources and the discipline shown since Deterra listed on the Australian Securities Exchange.

Demand growth from China has been the main driver of rising commodity prices in the past two decades. More recently, though, most commodity prices have fallen from highs set with Russia’s invasion of Ukraine, the subsequent sanctions on Russia, and the rerouting of supply chains. Prices, nevertheless, are generally elevated versus the 20-year average, as well as relative to cost support.

We retain our fair value estimate of AUD 4.40 per share for wide-moat Deterra Royalties with first-half fiscal 2024 earnings broadly in line with expectations. Adjusted EBITDA of about AUD 113 million was 24% higher than last year, driven by stronger average iron ore prices offsetting modestly lower sales volumes from Mining Area C, or MAC. Net profit after tax of AUD 79 million or AUD 0.15 per share, also rose 24%. The fully franked interim dividend of AUD 14.89 cents per share to be paid in March represents a 100% payout ratio consistent with its policy. We forecast a similar payout for fiscal 2024 for a fully franked yield of about 7%. With no debt as of the end of December 2023, Deterra’s balance sheet is pristine.

The royalty over BHP Mining Area C provides cash flow without exposure to capital or operating costs. The low historical cost for the royalty means returns are enviable. BHP is expanding output from 60 million metric tons of iron ore in 2019 to about 145 million metric tons by 2024 through the development of its South Flank mine. This benefits Deterra through a proportionally increased royalty. Deterra receives 1.232% of the Australian dollar value of iron ore sales revenue from the royalty area, free on-board price ex-Port Hedland. Deterra also receives AUD 1 million capacity payments for each 1 million metric tons annualized increase in production above the high-water mark.

Near-term iron ore prices are higher on strong China steel production. Gold prices are up on optimism over peak interest rates, driving a 2% rise in our estimate for no-moat Newmont, to USD 54. It is the cheapest we cover, trading 30% below fair value.

The royalty over BHP Mining Area C provides cash flow without exposure to capital or operating costs. The low historical cost for the royalty means returns are enviable. BHP is expanding output from 60 million metric tons of iron ore in 2019 to about 145 million metric tons by 2024 through the development of its South Flank mine. This benefits Deterra through a proportionally increased royalty. Iluka receives 1.232% of the Australian dollar value of iron ore sales revenue from the royalty area, free on-board price ex-Port Hedland. Deterra also receives AUD 1 million capacity payments for each 1 million metric tons annualized increase in production above the high-water mark.

Commodity prices diverged in the quarter with strong China steel production driving iron ore and metallurgical coal prices up, while base metals prices dropped on worries of a Western recession. Even so, prices are elevated versus history and cost-curve support.

Strong China steel production is supporting prices for steel inputs despite recession concerns. Otherwise, changes to our commodity price assumptions are mixed, led by higher near-term iron ore prices and lower near-term thermal coal prices. We think thermal coal miner Whitehaven Coal and minerals sands miner Iluka are the cheapest we cover. Both trade at 29% discounts to our AUD 9.50 and AUD 10.50 per share fair value estimates, respectively, with Whitehaven’s down 3% on lower near-term thermal coal prices, partially offset by a weaker Australian dollar. Peer New Hope is also down 3% to AUD 6.10 per share. Iluka’s estimate is unchanged, with a weaker Australian dollar offsetting lower synthetic rutile prices.

The royalty over BHP Mining Area C provides cash flow without exposure to capital or operating costs. The low historical cost for the royalty means returns are enviable. BHP is expanding output from 60 million metric tons of iron ore in 2019 to about 145 million metric tons by 2024 through the development of its South Flank mine. This benefits Deterra through a proportionally increased royalty. Iluka receives 1.232% of the Australian dollar value of iron ore sales revenue from the royalty area, free on-board price ex-Port Hedland. Deterra also receives AUD 1 million capacity payments for each 1 million metric tons annualized increase in production above the high-water mark.

Commodity prices have generally stabilized after falling on concerns that China’s reopening would underwhelm, along with worries over a recession in the West. Even so, they remain elevated versus history and cost-curve support. The Russian invasion of Ukraine and subsequent sanctions on Russia support energy prices and reinforce the importance of energy security.

Wide-moat Deterra Royalties’ fiscal 2023 result met our expectations. Net profit after tax was roughly AUD 150 million or AUD 0.29 per share, 15% below fiscal 2022. Adjusted EBITDA of about AUD 220 million was also 15% lower, driven by lower capacity payments from BHP. The benefit of higher sales volumes from Mining Area C, or MAC, offset the lower average iron ore price. Deterra will pay a fully franked final dividend of AUD 16.85 cents per share in September, bringing fiscal 2023 dividend to AUD 28.85 cents fully franked, down 15% on last year given lower earnings, but with the 100% payout ratio retained. We forecast a similar payout for fiscal 2024 for a fully franked yield of about 6.3%. The balance sheet is pristine, with no net debt at end-June 2023.

Wide-moat Deterra’s first-half fiscal 2023 was strong, driven by increased iron ore sales volumes at BHP’s Mining Area C, or MAC, and a weaker AUD/USD rate, partially offset by a lower average iron ore price. Net profit after tax was AUD 64 million, or AUD 0.12 per share, up nearly 3% on first-half fiscal 2022. Adjusted EBITDA was around AUD 92 million, also up about 3%. MAC production of about 63 million metric tons was up 27% for the half as BHP’s new South Flank mine continues to ramp up to full capacity of about 80 million metric tons per year, likely in 2024. Production more than offset the 19% fall in average realised iron ore prices to around AUD 133 per metric ton, down from around AUD 164. Under the terms of its MAC royalty, Deterra receives AUD 1 million for every 1 million metric ton increase in annual production at MAC. This is determined every fiscal year and so Deterra didn’t receive any one-off capacity payments from BHP in the half. However, we expect about AUD 30 million in additional capacity payments once South Flank ramps to full capacity. Capacity payments are nonrecurring and stop once production plateaus.

Commodity prices have generally fallen over the second quarter of 2022 as central banks try to regain control of inflation, raising interest rates faster than many investors expected. This has led to fears of recession and lower demand for many commodities, with China’s attempts to contain COVID-19 also a drag. After updating our commodity price assumptions, the fair value estimates for most miners on our coverage fall. We think gold miner Newcrest remains cheapest, trading at around a 40% discount to our unchanged fair value of AUD 33 per share.

We reduce our fair value estimate for wide-moat Deterra Royalties to AUD 3.80 per share from AUD 4.00 previously following transition of coverage to a new analyst. The reduction reflects lower assumed near-term iron ore prices, which more than offset the ramp-up of BHP’s South Flank mine in Mining Area C that is proceeding ahead of schedule.

The outbreak of war in Ukraine, and the subsequent sanctions levied on Russia, has sent shockwaves through commodity markets. As we saw with Vale’s tailings dam failure in 2019, supply shocks can materially affect the outlook for prices and valuations. But the impact of supply shocks is not always intuitive. There’s one major difference between the current largely sanctions-driven supply disruptions and Vale’s tragedy. The supply capacity being disrupted is still intact in Russia. An outbreak of peace and a political agreement could see Russian commodity supplies return to the global market relatively quickly. Given that, there is considerable uncertainty as to how long any potential supply disruption will last.

BHP, which owns and operates the Mining Area C, or MAC, iron ore mines on which wide-moat Deterra Royalties earns its main royalty, reported stronger MAC production during the second quarter than we had expected. Despite border restrictions leading to temporary labour constraints, MAC produced 27.0 million tonnes of iron ore during the second quarter of fiscal 2022, 21% above the previous quarter. BHP’s South Flank mine within MAC remains on track to expand its annual production capacity by an additional 80 million tonnes over the three-year period to fiscal 2024. If achieved, this will raise MAC production to around 145 million tonnes per year from about 60 million tonnes.

We still see general overvaluation among our listed mining coverage with the average price/fair value estimate sitting at a 9% premium, versus 10% in April. But some of the recent commodity price moves are yet to be factored into the share prices and we rate seven stocks as undervalued. Thermal coal miners New Hope and Whitehaven remain the cheapest of our coverage. Along with Glencore and South32, the firms trade in 4-star territory. Alumina Limited, Newcrest, and Teck Resources are also at modest fair value discounts.

Mining stocks largely traded sideways in the first quarter of 2021 with the S&P/ASX200 resources index adding just 0.2% versus 3.1% for the broader ASX 200 index. Our coverage moves from an average 25% premium to our fair value estimates in our last quarterly update to a 10% premium now. The change primarily reflects fair value increases given ongoing near-term commodity price strength, especially for iron ore and copper. Only thermal coal-exposed firms New Hope and Whitehaven are still trading in 4-star territory although Glencore, Iluka Resources, Newcrest and South32 are at modest discounts. Undervaluation from COVID-19 is a distant memory, thanks to Chinese government stimulus and lending. Iron ore and copper have benefited most.