Measuring the Moat of Natural Resource Companies

[3259]

It seems like a miner or Oil E&P that owns a mine or similar access to a useful resource can have a nearly impenetrable moat if the mine or other source places the company at the low end of the cost curve AND the mine has a long life.  However, value investors and, more specifically, those who follow the "Munger" strategy of being a long-term investor in quality companies appear to steer clear of such investments.

 

What are the reasons for this?  High capex?  Depleting resource issues?  Difficulty of getting management to restrain growth to only such low cost opportunities?  Volatility of commodity prices provides too many opportunities for management error in capital allocation decisions?  Difficulty in replacing such low cost reserves?  Anything else?

 

Looking into BHP Billiton is what raised the question for me personally (although I don't have an opinion yet as to whether BHP falls into this category).  Interested in how others view this issue and eager to understand the issue more clearly.  If you follow a Munger-type strategy, would you even consider such companies?  Why or why not?  Please focus your comments on companies that have access to cheap, long-lived resources.

[DavidVY]

There is no moat w/commodities.

 

Each commodity is likely fungible with another. There are some minor differences, but by in large that is the case.

 

What you are describing is being low-cost provider. Munger and Buffet talk about compounding power, consumer pricing power and minimal Capex. These are all factors that mining and E&P don't have.

 

BHP is a great company but it is far from low-cost provider. Its in the middle range for mining cash costs, but w excellent ethical management.

[Guest Dazel]

 

 

royalty companies have moats and as such are incredibly expensive to buy...0 capex..and the ability to grow their cash flow on the back of the miners capex $'s....they do not reach value investors screens because they are moats and out of the price range for most. i.e. Franco Nevada and Royal Gold, Prairie Sky, Silver Wheaton....we see some value guys dipped into Prarie sky on the oil fall and Altius last fall. Altus does not have a moat...but it is closer to getting there after their latest acquisition... for now it is a poor man's royalty company as it trades at a third of the multiples of the above royalties. Once a company reach's critical mass they achieve their moat status as they are able to use their massive multiples to take over the smaller players (this why there is not any competition)..it is in effect an oligopoly as their rich valuation in share price and financial strength allows them a distinct and huge advantage over their competition...their steady cash flow  allow them to trade like a bond investment with ever rising dividends and a built in inflation hedge.

 

Dazel

 

[ItsAValueTrap]

It seems like a miner or Oil E&P that owns a mine or similar access to a useful resource can have a nearly impenetrable moat if the mine or other source places the company at the low end of the cost curve AND the mine has a long life.

 

1- Many of these companies are lying about their cash costs and their reserves.  So just be careful.

 

2- Some of these companies are badly managed.  If the company promises to increase production based on unannounced/TBD acquisitions, I'd stay away.  To meet their promise, they have to acquire reserves at ANY price.

 

3- The returns of the company will depend on commodity prices, which can be affected by overbuilding by their competitors. 

 

4- Commodities tend to be cyclical, so try not to buy at the top of the cycle.

 

5- Mines with high margins (or low costs) and lots of reserves can be good assets to own because the company may own land with lots of exploration potential.  There's a saying: the best place to look for a mine is beside an existing one.  That's because the geology is likely similar and because there's all this infrastructure already in place and paid for.  The dream is to find a high-margin deposit close to existing infrastructure... looking near high-margin deposits with existing infrastructure is a very obvious place to look.

 

6- I don't think that moats are necessarily the right way of looking at commodity companies.  The reason why Buffett and Munger like moats (and moats are rare mind you) is that the company will be able to invest capital at high rates of returns for very long periods of time.  That doesn't really apply to mines and oil/gas reserves (though #5 may apply).

[ItsAValueTrap]

However, value investors and, more specifically, those who follow the "Munger" strategy of being a long-term investor in quality companies appear to steer clear of such investments.

 

Buffett has actually invested in companies like Cliffs Natural Resources (back when it was steel mills + mines) and physical silver, presumably trying to pick cyclical bottoms.  He also invested in Posco, Petrochina, etc.

 

Kevin McArthur of Tahoe (and previously Goldcorp) looks for deposits that may be the "tip of an iceberg".  In a way it's value investing.  He's looking to buy exploration potential really cheap.  Sometimes people underappreciate the value of land beside an existing high-margin deposit.  However, he's a trained mining professional with a technical background in the stuff.  Evaluating mining assets is difficult because you need to know stuff about geology, mine engineering, mine exploration, politics, taxation, etc. etc.  Munger would advocate sticking to your circle of competence.

 

Brian Dalton of Altius is brilliant.  But again... circle of competence.  You do not want to be Nolan Watson, who has been repeatedly scammed in his royalty investments.  As far as I can tell, watson does not have a technical background and didn't hire people with technical backgrounds in mining.

[netnet]

There is no moat w/commodities.

 

Each commodity is likely fungible with another. There are some minor differences, but by in large that is the case.

 

What you are describing is being low-cost provider. Munger and Buffet talk about compounding power, consumer pricing power and minimal Capex. These are all factors that mining and E&P don't have.

 

 

You are wrong on this one.  Remember that all we are talking about here is what are the ways that you defend your business, i.e. what is your competitive advantage. hence the castle/moat analogy.  Being THE low cost provider can by definition be a moat. Buffett has said as much.  If you have something that the market wants and you can produce it cheaper than anyone else, you have a moat.  Now it might not be really deep and wide, but it is a moat.  Unfortunately, to quote Twain, often a "mine is a hole in the ground with a liar on top." But that is another story.

[netnet]

 

Brian Dalton of Altius is brilliant.  But again... circle of competence.  You do not want to be Nolan Watson, who has been repeatedly scammed in his royalty investments.  As far as I can tell, watson does not have a technical background and didn't hire people with technical backgrounds in mining.

 

Can you point me to a discussion of Watson? other than the string on the web.  Or what clued you in??  I looked at Sandstorm awhile ago and I noticed a number of seemingly bad decisions, but that was more gut feel if you will. as in I did not like the repeated equity issuance.  I (correctly) figured that Altius was way way better, but you seem to have it nailed.  Can you elaborate?