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Morningstar | Mineral Resources' Strong Fiscal 2018 Cost Performance Sees Earnings Beat Target. No Change to FVE. See Updated Analyst Note from 15 Aug 2018

We make no change to our AUD 12.85 per share fair value estimate. Mineral Resources announced a 35% increase in underlying fiscal 2018 NPAT to AUD 272 million, 22% ahead of our AUD 222 million forecast. However, lower-than-anticipated depreciation, down 30% to AUD 113 million was a key contributor to outperformance versus our forecast. Depreciation fell, but in the context of AUD 65 million of impairments which are excluded from underlying fiscal 2018 earnings, largely in the mining segment. Net operating cash flow was strong, up 68% to AUD 408 million, somewhat flattered by working capital moves including an AUD 108 million build in payables. But the cash result regardless also exceeded expectations, and Mineral Resources' balance sheet remains creditably unleveraged--that's despite a 75% increase in fiscal 2018 development expenditure to AUD 320 million, including on lithium mine developments.

Our unmoved fair value estimate reflects little if any meaningful change to our long-term expectations, in combination with the appearance of near-term headwinds. On the crushing and processing side, Mineral Resources guides for fiscal 2019 tonnage to be slightly less than in fiscal 2018 due to the loss of Mining Area C and reduced volumes at Roy Hill. These hitherto undiscussed contracts are expected to be only partially offset by ramp-up of Wodgina lithium, in addition to two additional new projects during fiscal 2019. Mineral Resources only reports installed crushing capacity, not the portion of that capacity actually utilised. On the commodity exports side, Mineral Resources anticipates a total 11.5 million tonnes to be shipped in fiscal 2019, 12% down on fiscal 2018’s 13.2 million tonnes but at an increased ratio of higher value 6% lithium ore to lower grades including direct shipping ore. Our fiscal 2019 EPS forecast is unchanged at AUD 1.09. Mineral Resources is cutting direct shipping ore exports in preference for later higher grade/value lithium product.

Mineral Resources shares have declined 30% from AUD 21-plus peaks of December 2017, and at AUD 15 are now only at a moderate premium to fair value. A key driver for continued share price depreciation could be commodity price retreat to our less optimistic midcycle forecasts. Benchmark iron ore fines for example have fallen 15% from USD 75 per tonne 2017 highs, but at USD 65 still remain well ahead of our USD 38 midcycle forecast.

Our group fair value estimate equates to a fiscal 2023 EV/EBITDA of 5.8, a P/E of 12, and dividend yield of 4.0%, all discounted at WACC. Versus today's fair value estimate, 2023 P/E and yield are 7.0 and 6.9%, respectively. Our fair value estimate breaks down to 67% for mining services & processing (predominantly crushing), and 33% for mining of which 90% is for lithium products and the 10% balance largely iron ore. We exclude potential for construction of a lithium carbonate plant upgrade at the Wodgina project given its early stage. If approved this plant could produce 50,000 tonnes of 99.5% Li2CO3 with expansion potential of up to 100,000 tonnes, worth in the vicinity of AUD 1.0 billion or AUD 5.30 per share. The market was likely already factoring much of this in, though less so of late with the share price having retreated.

A lack of financial disclosure makes operational and financial analysis difficult in Mineral Resources. And increased reliance on lithium, a commodity with a potentially volatile future, necessitates added shareholder care. Mineral Resources reported an EBIT loss for its iron ore business in second-half fiscal 2018 and is a high cost producer. Lithium is a far less certain market than for iron ore, still in its infancy, and increasing lithium reliance on both the mining and crushing sides of Mineral Resources' business adds to uncertainty. Despite being in good financial health, we continue to rate Mineral Resources as having very-high systematic risk to equity.