why we think iluka has a moat

this report comes from Morningstar
( a moat rating is what morningstar gives to companies like BHP,WOW,MTS,WES,WBC,NAB,ANZ,CBA ans so on.)

We believe Iluka has a narrow moat due to its low cost mining assets, primarily in the Murray and Eucla Basins – particularly Jacinth/Ambrosia. Those high grade deposits underpin the company’s position as the leading global mineral sands miner but in time will need to be replenished as reserves deplete.


The primary source of competitive advantage for a miner is low cost production. Iluka’s margins are strong relative to the industry due to high grade deposits weighted to higher value products – zircon and rutile. Reserve life is shorter than we would like at around 10 years, but the resource base is significantly larger and sufficient to satisfy 30-40 years of operations. The company has a history of converting resources to reserves by drilling out, advancing and developing new deposits close to existing processing infrastructure. We expect this track record to continue.


Lower grade resources are likely to become economic over time as the industry mines the best deposits and average grades fall. A sufficiently favourable interaction between price and industry costs would incentivise investment in the next generation of lower grade deposits, of which Iluka holds significant exposure in first world locales. Many of those lower grade deposits are located close to existing mining infrastructure. A royalty over BHP’s Mining Area C, while only a small component of our fair value estimate, is an impressive adjunct. Mining Area C is a key source of BHP’s future iron ore growth. This expansion requires no capital contribution from Iluka so returns are enviable. The Mining Area C royalty could be a wide moat asset if separately listed but within Iluka only comprises about 10% of our fair value estimate.


Major growth capital expenditure is behind Iluka and maintenance capital expenditure relatively modest. The company has numerous expansion projects to enhance life and to a lesser degree output. Conversion of resources to reserves is an obvious path to life extensions though future returns while still sufficient to support the narrow moat are unlikely to be as lucrative as grades will be lower and costs higher. This, along with the relatively short reserve life, will mean Iluka will need to work hard to maintain its narrow moat rating as high grade deposits deplete. If no meaningful new high grade reserves are found in the next five years, it is likely Iluka will lose its narrow moat rating.


Margins are likely to moderate significantly once high grade reserves in the Murray and Eucla Basins exhaust. But peripheral resources and likely new discoveries in producing basins can leverage off processing infrastructure. This sunk capital, which will be significantly depreciated, enhances returns on brownfields developments versus stand alone new greenfields mines. We think declining grades and consequent higher costs will regardless ultimately drive weaker group profitability. Prices for mineral sands in the decade prior to 2011 were unattractive and discouraged investment in new capacity. The more than doubling in zircon, rutile and synthetic rutile prices since 2009 will incentivise investment in exploration and competition from new mines. The time lag between new discoveries and the development of mines means Iluka is positioned to earn excess returns for a number of years before new supply from competitors could potentially dilute returns.


A significant new discovery for Iluka may widen the moat but the Eucla and Murray Basin reserves are better than industry average grade with a greater weighting to high value zircon and rutile. It is difficult to imagine higher quality deposits of sufficient size will be found to meaningfully widen the moat. Iluka will do well to extend life and maintain its current cost advantage relative to the industry as high grade reserves deplete.


Undeveloped deposits are generally lower grade than operating mines. Discovery of a new large, high grade deposit by a competitor is a key risk to prices and returns. Iluka has a reasonable chance of making that discovery with dominant acreage in major basins and free cash flow to support an exploration push. Regardless, significantly higher prices for key products are likely to drive increased investment and competition over time and industry returns should moderate from very attractive levels.