For the most part, our SELL recommendations indicate a belief that the projects in question will never reach production. In the case of Avalon, we believe that the risk is too high, a combination of technical and financial, for the modest revenues that can be generated to justify spending over $1 billion to build the mine, even at the current market capitalization. Quest is in a similar position, however is something more of a borderline case for us; we admit that our valuation is conservative, but the recent announcement of delays in completing the anticipated PFS, with resulting likely delays in production, have pushed the probability of successfully completing this project to too low a level for our liking.
The one exception to this rule is that of Lynas. Here, the political risk remains substantial and relevant, as the Malaysian government continues to study various issues related to their processing plant, and the opposition movement in Malaysia threatens to close the plant should they gain power in upcoming elections. The current level of risk, coupled to a relatively low level of revenue owing to the elemental distribution within the deposit and a business model that produces nothing more than separated and purified REOs results in a poor return for investors at the current price, one that we cannot support.
Contrast these firms with our targets and recommendations on Molycorp and GWG. Both companies have near-term mining projects that are well underway. Molycorp is mining new material at present, Great Western will commence mining in Q2, according to current plans (although for a mine that only requires annual output of less than 50,000 tonnes of ore, we really don’t care if they start mining in June, July or September). But both companies have internal plans or partners to take them well downstream. And that makes all the difference.
Why? Because revenues are multiplied, as are earnings. A kg of Nd2O3 may sell today for US$150/kg outside of China, and each one of Lynas, Molycorp and GWG will be in a position to garner at least that much in revenue. With costs that we estimate to be $12,000, $5,000 and $4,500 per REO tonne, respectively, each of the companies can make money on selling Nd2O3 (although one needs to bear in mind that our long-term prices for La and Ce oxides are below these costs, so the companies must make enough money on other rare earths to carry the production of low-priced oxides). However, one must then understand that very high quality magnet alloys, to be used to make sintered magnets or those of similar quality, can sell for more than $200 a kg. This may not seem like a generous markup, but bear in mind that a kg of Nd2O3 is the equivalent of 857 grams of Nd metal, or 2.77 kg (or more, depending on Dy content) of magnet alloy. So a US$150 kilogram of Nd2O3 becomes US$550 of magnet alloy. And a kilogram of magnet alloy can become nearly US$1,000 worth of magnet, based on the selling price of good magnets in the market today.
As an example of what can be done, solely on the basis of Nd2O3 production and based on selling their entire inventory of materials at the highest possible prices (which is unlikely for Molycorp, but we will use this as a benchmarking exercise), we offer the following:
Company
Ticker
TREO Prodn (t)
Nd
2O3 Prodn (t)
Potential Revenue (US$M)
Lynas Corporation Ltd.
LYC - ASX
22,000
4,096
$614.4
Great Western Minerals Group Ltd.
GWG - TSXV
10,000
1,667
$916.9
Molycorp, Inc.
MCP - NYSE
43,000
5,031
$5,031.0
Those companies that have credible plans for moving downstream and being able to reap some portion of these revenues are the ones we most enthusiastically support. Further, those revenues and the earnings flowing from them are somewhat protected against sudden decreases in the commodity prices themselves; as engineered materials (alloys with very specific sets of specifications) or highly technical final products (magnets meeting certain industry specifications), downstream products have much higher switching costs than basic materials.
Earnings can become equally impressive. Our analysis on GWG supports comments made by the management team during multiple meetings with investors that we have attended. Management has publicly noted that it believes the all-in cost of their magnet alloys could be less than US$20 per kilogram. 1,667 tonnes of Nd2O3 makes 4,265 tonnes of magnet alloy, so a cost of roughly US$92 million is required to earn revenues of as much as US$917 million. While we anticipate magnet alloy prices dropping further, with decreasing Nd2O3 prices, we do not see margins dropping much below 70% on sintered alloys, at any point in the future.
In addition to the above coverage, we also have two names on our Watchlist. The Watchlist indicates our interest in a name where there is insufficient information at present to draw firm conclusions regarding target price. Our two watchlist names that pertain to the rare earths market are Tantalus Rare Earths AG and Orbite Aluminae Inc. (Interesting to see Orbite in this list) While we have expressed positive sentiment regarding Tantalus, and the exciting potential that its deposit will be shown to be an ionic clay in the mold of the south China HREE clays, we are less enthusiastic with respect to the potential for Orbite to become a meaningful producer of rare earths. However, when additional information emerges, then we will come to a more complete conclusion on both names.
Conclusions and Directions
Rare earths remain a strong industry, one where we believe that the right companies can make investors a lot of money. Making those outsized profits are predicated on a few things.
? Have a strong deposit (high grade and good elemental distribution in a mineral form for which the hydrometallurgy and its costs are well understood; this minimizes mining costs and maximizes potential revenues)
? Have a strong physical concentrate (by improving head grade to the hydrometallurgy plant, the cost of hydrometallurgy per tonne of REO production is optimized)
? Know how to do solvent extraction (claiming it will be developed is all well and good, but based on the experience of Lynas, simply designing a viable facility from scratch can take two years, and design doesn’t help recruit the necessary personnel with experience operating such a plant)
? Know how to make downstream products (there is a great deal of profitability available in possessing the intellectual property as to how to make magnet alloys and magnets themselves, but claiming to be able to develop that from scratch in a short time is also likely to be shown to be specious)
? Find an off-take partner, not just for the good stuff (as we noted, even so-called HREE projects produce a lot of La and Ce, and the world may well be swimming in this stuff by 2015; having someone who will buy it and contribute to cash flow is much preferred to having to put the material in tailings)
Combine all of the above, and we believe that you have a winning formula. Our top picks in the space are GWG and Molycorp, precisely because they are following this path.
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