ML probably doubles within 2 years if current copper (Cu)
and molybdenum (moly) prices hold for foreseeable future. If ML converted to a
Master Limited Partnership (MLP), valuations of similar MLPs or trusts suggest a C$40/share ML price.
If assume current Cu futures prices and half current moly
price, ML’s value is C$10/share +/- 10% within same period. ($=US$,
ML is fully-funded to expand production 10x to ~130MM Cu
equivalent lbs, 60% of revs from moly and 40% from Cu assuming spot prices. ML
will finish phase I expansion to 25,000 tons per day within 1 year and phase II
to 50,000 tons per day within 2 years. Refer to Dec 29, 2006 news release on
ML’s website for details re this expansion. The section detailing economics
begins on p.180 of the report. P.184 shows annual payable production. The first
5 years at full capacity average 60MM lbs Cu, 11MM lbs moly, and 700koz silver
annually. Assuming all warrants/options exercised, ML’s net debt post start-up capex will be $60MM +/- 10%.
Reasons behind ML’s upside:
1. As ML transitions from development to production, it
should trade in-line with comps
2. ML can convert to a tax efficient, yield vehicle such as
an MLP or LLC
3. ML’s moly grades may be up to 25% higher than in
4. ML will probably run at 10% higher throughput than in
Cu is $3.30/lb, moly $32/lb, and silver $12/oz. At these
prices, in 2009, ML would generate revs of $558MM. In this scenario, total
costs should average $130MM (over first 5 years), suggesting EBITDA of $428MM.
Per the “Cash Flow Financial Analysis” on p.192, cash taxes as % of EBITDA
approximate 33%, suggesting free cash flow (FCF) of $288MM, (C$300MM) or
C$3.50/share assuming 85MM shares fully diluted. Comps trade at 3-4x (2009 EV)/(2009
unlevered FCF), implying C$10-$14/share price.
At half of today’s spot prices, in 2009, ML would generate
revs of $280MM. In this scenario, total costs should average $115MM (over first
5 years), suggesting EBITDA of $164MM. Assuming 33% of EBITDA goes to taxes,
free cash flow to equity should be $110MM, (C$115MM), or C$1.35/fully diluted
share. ML trades at 4.5x such FCF.
Using the “half of today’s prices” scenario to value ML is
excessively conservative, however, because Cu on the London Metal Exchange can
be “locked-in” via shorting at $2.90/lb for 2009, $2.67/lb for 2010, $2.44/lb for
2011, and $2.21/lb for 2012. ML’s NPV discounted at 10% using such curve and
$2.00/lb LT, $12/oz silver price, and $32/lb moly in 2008, $24/lb in 2009, and
$16/lb in 2010 and LT, is C$10/share +/-10% assuming NO upside from reasons 2-4
Moreover, moly prices could be tight for the foreseeable
future. See report entitled “Structural changes in molybdenum demand” by Denis
Battrum available at http://www.thompsoncreekmetals.com/s/Home.asp
and his August 2007 monthly molybdenum commentary available at http://sprottmoly.com/home.html
Molybdenum Participation Corporation, a new public company intent on
capitalizing on moly’s future, comments on recent moly developments in MD&A
of its June quarterly:
significant development in the molybdenum industry in the period ended June 30,
2007 was the imposition of export quotas in China. In late May 2007, the
Chinese government established a list of qualified exporters of molybdenum
consisting of 32 companies. In late June 2007, foreign trade bureaus informed
traders that export quotas would come into effect on July 1, 2007. The total
quota for the second half of 2007…represents a 50% reduction to last year’s
levels. Such a reduction in Chinese exports is expected to have a significant
impact on the world supply, and, therefore, molybdenum prices.
In addition, the Chinese government
has announced it will eliminate or reduce VAT tax rebates on certain molybdenum
products effect July 1, 2007…This change highlights the robust demand growth in
China and the country’s desire to reduce exports in energy intensive
China is not the only country
demonstrating concern about the supply of strategic resources. Resource-poor Japan is aiming
to increase its molybdenum inventory to 60 days of consumption [from] 21 days’
REASONS BEHIND ML’s UPSIDE:
As ML transitions from development to
production, it should trade in-line with comparable producers’ free cash flow
multiples, which range from 3x-4x (2009 EV)/(2009 unlevered FCF)
Comparable copper producers include: Quadra Mining (TSX:
QUA), Frontera Copper (TSX: FCC), Taseko Mining (TSX: TKO), and Sherwood Copper
Comparable moly producers: Thompson Creek Metals (TSX: TCM)
TCM, a pure moly producer, seems like ML’s closest comp
because 60% of ML’s revenue stems from moly (assuming spot). ML is about half
the size of TCM on a moly-equivalent basis, i.e. converting Cu to moly using
ratio of prices, with similar costs. With Cu at $3.30 and moly at $32, about 10
Cu lbs equal 1 moly lb.
In a rosy scenario for TCM re production/costs and assuming
$32/lb moly holds through 2009, TCM, at $17/share, trades at 3x (2009 EV)/(2009
unlevered FCF). Such ratio implies an $11 ML share price.
Reason #2: ML
could convert to an MLP or LLC
Master Limited Partnership (MLP) is a limited partnership
that combines the tax benefits of a limited partnership with the liquidity of a
publicly traded security. MLPs trade at yields of 6-12%, implying FCF multiples
An MLP has a partnership structure but issues investment
units that trade on an exchange
like common stock. The modern form of MLPs was
defined by the Tax Reform
Act of 1986
and the Revenue Act of 1987, which outline how companies
can structure their operations to realize certain tax benefits and define which
companies are eligible. In order to qualify, a firm must earn 90% of its income
through activities or interest and dividend payments relating to natural
resources, commodities or real estate.
Tax implications for MLPs differ significantly from
corporations for both the company and its investors. Like other limited
partnerships, there is no tax at the company level. This effectively lowers an
MLP's cost of
, as it does not suffer the problem of double taxation on
dividends. Companies that are eligible to become MLPs have a strong incentive
to do so because it means a cost advantage over their incorporated peers.
In an MLP, instead of paying a corporate income tax, the tax liability of the
entity is passed on to its unitholders. Once a year, each investor receives a
K-1 statement (similar to a 1099-DIV form
detailing his or her share of the partnership's net income
which is then taxed at the investor's individual tax rate.
One important distinction must be made here: While the MLP's income is passed
through to its investors for tax purposes, the actual cash distributions made
to unitholders have little to do with the firm's income. Instead, cash
distributions are based on the MLP's distributable
(DCF), similar to FCF. Unlike dividends, these
distributions are not taxed when they are received; instead, they are
considered reductions in the investment's cost basis
and defer tax liability until the MLP is sold.
Fortunately for investors, MLPs generally have much higher distributable cash flow
than they have taxable income. This is a result of
and other tax deductions. Investors then receive higher cash payments than the
amount upon which they are taxed, creating an efficient means of tax deferral.
According to a report by Wachovia Securities, titled "Master Limited
Partnerships: A Primer" (2003), the taxable income passed on to investors
often is only 10-20% of the cash distribution, while the other 80-90% is deemed
a return of capital and subtracted from the original cost basis of the initial
If ML, once debt-free, converts to an MLP (or LLC) its
EBITDA would become FCF.
If prices hold, ML operates at 50kptd (using feasibility
moly grades), and ML as an MLP trades at 8x FCF multiple, it would have a $3BN
market cap, implying C$40/share price.
Coal mining MLPs exist, but there aren’t any copper
producing MLPs. The valuations of Fording Canadian Coal Trust (NYSE: FDG) and
Southern Peru Copper (NYSE: PCU), however, suggest that a 10% yield is
appropriate for ML as an MLP.
Fording is a Canadian royalty trust producing metallurgical
coal and trades at 7.5% yield. Metallurgical coal’s market is opaque like
moly’s. PCU is a Mexican/Peruvian producer of copper, moly, zinc and silver,
with 90% of revs coming from copper and moly for foreseeable future. Its
dividend yield is 10% and it dividends most of earnings.
Reason #3: ML could
run at 10% higher throughput than in feasibility
A 10% increase in throughput would likely increase costs by
10%, equal to $11-13MM, for additional power, consumables, etc but would add
6MM lbs of Cu and 1.5MM lbs of moly annually (on avg) within first 5
Reason #4: ML’s
real moly grades could be 0.05%, 34% higher than in feasibility
Management says that actual moly grades mined by previous
operator, Duval Corp, over 17 years were between 0.04% and 0.05% rather than
0.038%, which feasibility assumes.
Such higher grades imply proportionally higher payable
metal output, i.e. 11.6-15MM lbs at 50ktpd, adding 0.6-4MM lbs of production
annually versus feasibility.