A mine of opportunity
By Manuel Greenland, Senior Portfolio Manager, Australia
01 November, 2016
We like investing in companies with sustainable competitive advantages, or "economic moats". Moats allow a company to earn higher profits in good times, and avoid financial distress when conditions are difficult. Companies with moats can usually determine their own destinies, rather than having their performance dictated by things outside their control.
In the short term, the fortunes of mining companies are tied to changes in the prices of the metals they dig up and sell. So can a mining company have a moat? We think it sometimes can. Those miners with the lowest production costs earn higher profits in the good times, and remain viable when metals prices are weak. Analysing cost advantage is key for the moat investor looking to invest in a mining company.
Size is important. The cost of a mine does not change much with its size, so larger mines produce more for a given cost. The amount of metal per tonne of rock dug up is called the "grade". Higher grades offer greater sales potential. The ease with which miners can extract valuable metals from rocks is referred to as the metallurgy. Simple metallurgy means lower production costs. Finally, having mines close to customers reduces transport costs. The best miners are large, work high grade deposits with simple metallurgy, and are close to key customers.
Australia has a large mining sector, but only a few of the miners meet our quality criteria. During September we added Rio Tinto to our portfolio. The business has among the lowest production costs in the copper and iron ore markets, and has been a great profit generator over the long term. Changes in the global economy have improved the prospects of an upturn in demand for metals going forward, creating an attractive earnings outlook for the best quality miners.