Jon Hykawy: Our absolute top pick in the space would be Saskatoon-based Great Western Minerals Group. This is a company that is still overlooked by a large portion of the investors interested in the rare earths space. It is a downstream manufacturer of advanced rare earth alloys, rather than a simple miner. The only reason that the company is reopening a mine in South Africa is because of uncertainty with respect to getting the supply of materials that they need to make magnet alloys. Without being able to reliably get neodymium and dysprosium from the Chinese – an issue that they saw years ago – the least expensive way for GWG to reliably get those materials was to reopen a mine.
But what people don’t really appreciate is the leverage that’s given to anybody participating in this downstream space. A company making good magnet alloys, which are necessary to make really high-quality rare earth magnets, can expect to sell those alloys for up to US$300/kg. This is an alloy that only contains about 30% neodymium. The rest of the material is relatively cheap iron and boron. So, even at the peak of neodymium pricing, these magnets contained about US$100 of neodymium. That means you’re selling US$100 of neodymium for US$300. That’s not bad leverage. But when Steenkampskraal reaches production, my estimates for Great Western would suggest that this sort of US$300/kg alloy could be produced by GWG for probably less than US$15/kg or US$20/kg.
And in no circumstance do we see the price for high-quality magnet alloys dropping below US$100/kg. So, if you’re looking at an $80 or $85 margin on one kilogram of magnet alloy, you’re not doing too badly. The cash flow that a company like GWG can generate is fairly robust.
SmallCapPower.com: What’s your 12-month target on GWG?
Jon Hykawy: Currently it’s $3.40, which looks a little extravagant compared to the trading range that it’s in but, frankly, it still only represents a $1 billion to $1.5 billion market cap, and this is a company that we believe, when it’s in full production, will generate cash flow of $300 - $400 million a year.
SmallCapPower.com: And your second pick?
Jon Hykawy: Our second pick actually is one that we’ve had a “sell” on for a long time, but the market has chosen to drive the stock down to the point where we actually believe there’s considerable value in it, and that’s Molycorp.
Molycorp, too, is a downstream producer. And, again, we think that is very important because if you follow the pricing through, what we see is that magnet-making is a very good multiplier for revenue. Molycorp just recently signed a joint-venture agreement with two Japanese companies that will see the partners take the lanthanum and cerium output from Molycorp’s Mountain Pass mine in California and sell that to partners interested in taking that material and putting it into the catalyst space.
But once Molycorp starts producing neodymium, it will then take that through its supply chain all the way to building magnets, adding value at each level. We could see Molycorp cash flowing at US$500 million a year once it’s in Phase Two of production. And that easily supports the target that we have on them, which is $40 at this point.
SmallCapPower.com: And your third pick?
Jon Hykawy: The third name we like is Matamec Explorations Inc. (TSX.V:MAT). It has been criticized lately for the deal that it did with Toyota Tsusho. But it is a very interesting name to us because of the very simple metallurgy that’s associated with their deposits. The deposits that comprise Matamec’s Kipawa project are relatively low-grade but have a high percentage of heavy rare earths. Once Matamec is in production, it will produce a larger volume of heavy rare earths than either Great Western Minerals Group or Molycorp. But Matamec likely won’t be in full production of finished concentrates until sometime in 2015.
But this pick is really about the metallurgy, which is very straightforward. All Matamec is doing is using a magnetic separation technique to upgrade their milled ore. They then take the rare earth concentrate and put it in sulphuric acid at room temperature for a couple of hours. The acid consumption is very low, and there’s no heat involved. That means the cost of their hydrometallurgy is very low. And so Matamec should eventually reap the advantages of selling valuable heavy rare earths with very low processing costs.
SmallCapPower.com: Do you believe that Matamec President Andre Gauthier secured enough in return for what he gave up to Toyota Tsusho?
Jon Hykawy: I’ve had discussions with him about that. I think it’s fair to say we believe that they could have received more. On the other hand, the argument that we’ve been given and one that we have to agree with is that the rare earths space includes about 400 names that are all trying to come to market and the rare earths industry can’t support 400 new projects. To reach production, a rare earths mine has to have four things: a tractable deposit; an economic deposit; a customer for its end-product, and the financing to build it. Without all of those, you don’t have a mine. What Matamec gained in signing its agreement with Toyota Tsusho – and doing the best deal that they believed they could do at the time – is access to financing and access to the customer. And that means that Kipawa is fully on track to become a mine. Not too many other companies in this space can say that. And you can’t quibble with the fact that you’ve still got a good investment return for shareholders. Our target on the company is $0.95 and carry a “buy” recommendation on it because, frankly, that’s what their portion of this project is worth.
