Chart of the Week: The only miner with a wide moat
Our Mining Outlook shows that moats are rare in the mining sector. Here’s what it takes to earn one.
Mentioned: Deterra Royalties Ltd Ordinary Shares (DRR)
It doesn’t take long to come across the term moat when consuming investing content. For many investors the term can seem nebulous. Moats are the mythical creature of investing. We are told they exist. Some investors see signs of them everywhere. But for most investors—try as we might—identifying a moat seems just out of reach.
The term is generally attributed to Warren Buffett. If Buffett cares about moats than perhaps, we should too. At Morningstar we certainly care about moats. For each of the roughly 1600 shares we cover globally our analysts opine on the existence or lack of existence of a moat. We have a moat committee to add rigor. Former analysts even wrote a book on moats with the self-explanatory title Moats Matter.
A moat is a sustainable competitive advantage. The imagery of moat as a body of water to protect a castle is apt as a moat protects a company from competition. To offer effective protection the moat must be sustainable. A company may benefit from a first mover advantage but without the protection of a moat those advantages will be eroded over time by competitors eager to get a piece of an attractive opportunity. A company that our analysts believe will sustain a competitive advantage for 10 years receives a narrow moat rating. A wide moat rating denotes am expected 20-year sustainable advantage.
When it comes to mining, moats are rare. Durable competitive advantages are hard to create and hold onto in mining.
Miners produce commodities and are generally price takers. Hence, the primary source of a potential economic moat, if there is one, is cost advantage. Broadly speaking, this means durably producing at a cost below the industry average. Examples of moatworthy assets are BHP’s and Rio Tinto’s iron ore operations in Western Australia. However, we don’t think these miners are moatworthy, given other highercost assets and the substantial invested capital bases, which stymie overall returns on invested capital.
Wide-moat Deterra Royalties DRR is an exception. Our wide moat for Deterra Royalties reflects its royalty on BHP’s Mining Area C (MAC) iron ore operations. This is a rare asset, based on cost advantage and intangible assets.
The cost advantage stems from both the low cost to acquire the MAC royalty area and the low-cost iron ore production which underpins the royalty. The certainty of the cash flows that arise from the low-cost nature of MAC iron ore production, which in our view means production is highly likely to continue even in a cyclical downturn in iron ore prices, underpins the value of the intangible asset that is the MAC Royalty Agreement.
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