While a lot of investors seem to love David-versus-Goliath underdog stories, I think they too often forget a key detail - what makes that story so special is how unlikely the outcome was; normally David gets absolutely pasted and ends up either with a bunch of tubes coming out of him or in a box. In the case of a stock like Thompson Creek (TC), then, I think investors are often too willing to look past the serious operational and macro risks that go capacity expansion stories at small miners.
That grim opening probably suggests that I'm bearish on Thompson Creek Metals. In point of fact, I'm not. I think Thompson Creek is a very interesting speculation at this point. But I do believe it's important for investors considering these shares to appreciate that there are sizable risks here and a happy ending is far from guaranteed.
Decent Q4 Results Aren't A Real Driver
On the whole, Thompson Creek did better than expected in the fourth quarter. Unfortunately, current results aren't all that significant to the long-term value proposition and weak molybdenum prices are an ongoing problem.
Revenue fell 15% from the prior year (but rose one-third sequentially), largely due to substantially (down 16%) lower realized prices. Sales volume declined 3% from the year-ago level (and improved 40% sequentially), while production increased 80% from the year-ago period. Production of 7.7M pounds was below the company's sales volume (8.1M pounds).
Thompson Creek did do considerably better on costs and profits. EBITDA reversed a year-ago and quarter-ago loss and cash costs declined almost 50% from the year-ago level. Unfortunately, this is not due to a sustainable change in the operating model, but rather Thompson's ability to process stockpiled ore.
It's Still Really Tough Out There
The biggest problem for Thompson Creek today is that the molybdenum market is still in pretty miserable shape. Prices have sunk back to around $11/lb due in large part to the weak global steel market (and particularly the weak European market). About 70% of the world's molybdenum is used in some form of steel, and though companies like ArcelorMittal (MT), ThyssenKrupp, and Voestalpine have been sounding a bit more optimistic lately, it's not as though anybody is predicting a sharp recovery in steel (particularly high-end steel) production.
To that end, Thompson Creek lowered its production guidance by about 2 million pounds and increased its cash cost guidance by about $0.25 per lb (to a midpoint of $7/lb). While the problems seem to stem mostly from issues with tailings ponds at Endako, the environment is still difficult enough that it looks probable that the company will not proceed with Phase 8 at the Thompson Creek mine and will essentially put the mine on hiatus after 2014 (though most analysts expect a restart about three years later).
In the meantime, there are enough molybdenum projects around the world to create concerns about pricing in the face of weak demand. Rivals like Freeport McMoRan (FCX), Taseko (TGB), and General Moly (GMO) seem to proceeding responsibly, but the point I'm trying to make is that absent a major demand shift (like, say, India going on a infrastructure spending binge), the price situation is probably not going to get dramatically better soon. Still, prices are close to a point ($10/lb) where the large majority of producers cannot operate on a cash flow positive basis and that may limit further downside.
Mt. Milligan Is The Make-Or-Break Opportunity
Thompson Creek has invested considerable sums of money in bringing its Mt. Milligan mining complex to life. With construction more than 80% complete, this mine should be on target to begin production in the fourth quarter of 2013. Even so, incremental capex costs for the next 12 to 18 months could top $100 million, and the company can ill-afford any delays.
Once open, the Mt. Milligan facility should produce nearly 90 million pounds of copper each year (for the first six years) and over 260,000 ounces of gold (a little more than half of which goes to Royal Gold (RGLD) under a prior agreement). That will substantially re-balance Thompson Creek's market exposures and make the company much less dependent upon molybdenum prices. What's more, Canada is a relatively stable and predictable mining area, meaning that once the company is up and running it is unlikely to have to deal with the same sort of shakedowns that have troubled miners like Freeport and First Quantum Minerals.
But even once Mt. Milligan opens, this is not a sure thing. Cash production costs will probably be north of $3/lb initially and there is a definite risk of cost overruns. For a company like Freeport McMoRan, BHP Billiton (BHP), or Rio Tinto (RIO) that would just be an unfortunate cost of doing business. Given Thompson Creek's liquidity situation and debt covenants, though, overruns or initial problems with Mt. Milligan that might otherwise be considered part of doing business could have outsized importance to investors and the stock price.
To be clear, I think Mt. Milligan will prove to be a very good facility, and a profitable mine for Thompson Creek. I'm simply making the point that the weak state of the molybdenum market and the company's prior capital needs have shrunk the margin of error and upped the need for management to execute with minimal margin of error.
Value Seems To Depend On When And Where You Look
Valuing mining companies is always a bit fuzzy, as free cash flow modeling is difficult at best. That leaves investors with imprecise tools like EV/EBTIDA and NAV to separate the high-potential opportunities from the overpriced traps.
I believe Thompson Creek is meaningfully undervalued, but it's not necessarily a straightforward case. If you look at the company's likely EBITDA for 2013, it's very hard to generate a price target much above $1 per share. Move a year forward to 2014, when Mt. Milligan is up and running for a full year, and the situation changes markedly. Using the average sell-side EBITDA estimate for 2014, fair value would seem to come in at $6 per share or higher. Even using the lowest estimate I could find points to a target around $4 to $4.50, and it's well worth noting that the spread between the low and high 2014 EBITDA estimates is greater than 100% - meaning considerable uncertainty over the company's future.
The Bottom Line
Obviously, there is a lot that could go wrong. The company could see delays in opening Mt. Milligan, lower production volumes, higher cash costs, or higher-than-forecast capex needs, as well as some combination of all of the above. Likewise, prices of molybdenum and/or copper could head meaningfully lower from here if the global economy takes another dive into recession. As I've said before, none of these risks are new to mining or exclusive to Thompson Creek per se, but the company's substantial net debt position makes them a more relevant factor than would be the case for a larger, more liquid, and more established mining company.
Still, I think the potential value here is enticing. Yes, I'm worried about the downside risks here, but I think the market is well aware of them too and has priced the shares accordingly. Were I to be adding exposure to mining/natural resources today, this would be one of the first stocks I'd consider. Risk-averse investors should stay clear of Thompson Creek, but investors looking for a high-risk/high-reward opportunity should seriously consider this name.