Which Mining Stocks Beat the Competition?

Economic moats, or sustainable competitive advantages, are extremely difficult to find in the basic materials sector. Analysts reveal which ones have succeeded

Elizabeth Collins, CFA 28 October, 2013 | 9:35AM
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Economic moats, or sustainable competitive advantages, are extremely difficult to find in the basic materials sector. Less than 40% of the companies we cover in this sector carry our narrow or wide moat rating. When we are able to find sustainable competitive advantages in basic materials, the primary reason is a durable cost advantage. Indeed, more than 70% of basic materials companies with an economic moat have a sustainable cost advantage. We think cost advantages can be created or destroyed in eight ways: economies of scale, economies of scope, low transportation costs, natural resources, process, bargaining power with suppliers, access to raw materials, and political regime.

We examined our universe of basic materials companies with narrow or wide economic moats as a result of notable cost advantages and determined through which of the eight ways each company had obtained its sustainable cost advantage. We found that natural resource endowments, transportation cost advantages, and economies of scale are the most common characteristics of basic materials companies that have an economic moat thanks to cost advantage.

Companies with attractive valuations and the rare distinction of an economic moat include mega-miners BHP Billiton (BLT), Rio Tinto (RIO), and Vale (VALE); coal producers Cloud Peak (CLD) and Peabody Energy (BTU); cement producers HeidelbergCement (HEI), Holcim (HOLN), and Lafarge (LG); uranium miner Cameco (CCO); Eldorado Gold (ELD); steel producer Nucor (NUE); and fertilizer giant PotashCorp (POT).

Transportation cost advantages accrue to the likes of BHP Billiton and Rio Tinto, whose mines in Australia are relatively close to commodity-hungry China. BASF (BAS) benefits from grouping many different chemical plants close together and vertically integrating production, which helps the
company save on transportation costs. Fibria’s (FBR) pulp plants are located close to its forests and major truck, rail, and shipping hubs, which gives the firm a cost advantage over other South American pulp producers.

Economies-of-scale cost advantages benefit the Powder River Basin coal producers Cloud Peak and Peabody Energy, as these large operators can open new mines adjacent to current operations using lower incremental capital than would be typically necessary, and the proximity allows the big miners to share resources across the basin, lowering extraction costs. Vale has economies of scale, as its iron
ore mega-mines allow it to use huge trucks and other supersize equipment that deliver cost efficiencies (for example, reduced labour or fuel per ton of ore extracted) over more modest-size machines.

Macroeconomic concerns, in addition to other factors, have caused some of our basic materials companies to trade at meaningful discounts to our estimates of intrinsic value. While commodity markets are uncertain, we think basic materials companies with cost-advantage-based economic moats should generate positive economic profits for a decade or more thanks to the cushion created by higher-cost producers. Companies whose valuations currently look attractive to us and that possess the rare distinction of an economic moat include mega-miners BHP Billiton, Rio Tinto, and Vale; coal producers Cloud Peak and Peabody Energy; cement producers HeidelbergCement, Holcim, and Lafarge; uranium miner Cameco; Eldorado Gold; steel producer Nucor; and fertilizer giant PotashCorp.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Cameco Corp65.26 CAD-0.34
Eldorado Gold Corp22.79 CAD0.97
HeidelbergCement AG101.20 EUR-0.83Rating
Holcim Ltd84.78 CHF-0.52Rating
Nucor Corp161.55 USD-1.10
Nutrien Ltd49.59 USD-1.67Rating
Rio Tinto PLC Registered Shares4,932.50 GBX1.24Rating
Vale SA ADR10.77 USD-1.37Rating

About Author

Elizabeth Collins, CFA  is an associate director of equity research with Morningstar.

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