Thompson Creek TC
December 23, 2008 - 5:47pm EST by
highline1040
2008 2009
Price: 3.63 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 445 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

As a value investor, I prefer to explore investment opportunities in areas where others are fearful. The metal commodity sector has clearly been gripped by fear (and rightfully so) as the sector has hit a cyclical downturn and metal prices have begun to trade below the highest cost marginal producers. However, like all cyclical downturns, this too shall pass as first supply will be cut and eventually demand will begin to grow. The obvious reality is that the timing of when this cycle turns is anyone’s guess and therefore I am only interested in investing in stocks that I believe can survive a pro-longed downturn – i.e. – a strong balance sheet and relatively attractive cost position. Surprisingly, there are not many of these examples as quite a few mining companies took advantage of easy credit markets to leverage their balance sheets in the pursuit of growth. What looked at the time for these mining companies to be reasonable debt/ebitda multiples, now appear to be a cause of concern. Thompson Creek is an example of an attractive and undervalued mining company that didn’t follow the leverage trend. As a result of prudent decisions by its well-regarded management team, I believe Thompson Creek is well positioned to not only survive this downturn, but reappear as one of the strong winners on the other side.


Overview of Thompson Creek

Thompson Creek is a molybdenum mining company whose stock has declined 80+% from its high. Yet, the company has close to $225mm ($1.65/share) of cash on its balance sheet, only $18mm of equipment loans, undrawn $35mm revolving bank credit facility, and a medium/low cost structure in comparison to other primary molybdenum producers.

Thompson Creek’s three main mining assets are its 100% owned Thompson Creek molybdenum mine in Idaho, its 75% owned Endako molybdenum mine in British Columbia, Canada and its 100% owned Davidson molybdenum deposit in British Columbia, Canada. The Thompson Creek Mine is an open-pit mine that will produce 16.5mm pounds of molybdenum in 2008 and 25mm pounds of molybdenum in 2009. The mine has over 209mm pounds of 2P reserves, which translates into over a minimum 10 year mine life. According to management in 2009, the Thompson Creek Mine’s cash costs are expected to be $5-6/lb.

The Endako mine is an open-pit mine with over 324mm pounds of 2P reserves, which results in a mine life of over 27 years. In 2009, Thompson Creek’s 75% share of this mine’s production is estimated to be 8.5mm pounds in 2008 and 7-8mm pounds in 2009. In 2009,management expects the Endako Mine’s cash costs to be $8-9/lb.

The Davidson project is a non-operating site that is estimated to contain over 288mm pounds of high-grade molybdenum deposits.


Molybdenum Industry Overview

In 2008, close to 460mm pounds of molybdenum will be mined and produced on a global basis. 50% of the world’s mined molybdenum comes from primary molybdenum mines; the other 50% is a bi-product of producing copper mines. Molybdenum is primarily used as alloying agent in carbon steel to make the steel stronger, lighter and more resistant to corrosion. End demand markets for molybdenum break-down as follows:


Construction steel
- 32% - The energy pipeline industry is a large end user of molybdenum within the construction steel segment as the energy industry needs underwater pipelines that are able to resist rusting as well as be able to handle heavier, more acidic crude grades.


Stainless Steel
– 31% - Molybdenum is only estimated to be used in 10% of the stainless steel market; however many of these markets are believed to represent longer term growth markets: power generation, water desalinization, aerospace, energy, harsh weather structures


Chemicals
– 14% - Primarily used as a catalyst in the desulphurization process for crude oil. Higher usage of molybdenum is required as it relates to heavier and more acidic crudes. 


Super Alloys & Other
– 23% - Molybdenum has multiple other uses where superior strength and resistant to heat and corrosion is needed (aerospace, high tech industrial tools).


Molybdenum Supply (according to TC website)

Top 10 Producers                2007 Output (mm lbs)

Freeport                                 71

Codelco                                             62

Grupo Mexico                                   36

Rio Tinto/Kennecott                       33

China Molybdenum                         30

Jinduicheng                                      29

Antofagasta                             22

Thompson Creek                              19

Antamina                                           14

Collahuasi                                          9



Pricing
Throughout much of 2007 and 2008, molybdenum traded in the $25-32/lb price range. From late September through December, molybdenum prices collapsed, briefly touching $8/lb before settling recently around $10/lb.
 

Investment Highlights

Attractive position on the molybdenum cost curve

With cash costs at its two mines of $5-6 at Thompson Creek and $8-9 at Endako, Thompson Creek sits below the marginal cash cost producer at $10-11 and is generally in the middle of the cost curve among primary molybdenum producers. The lowest quartile of primary molybdenum producers has $4-5 cash costs. Most of the molybdenum mines located in China are considered to be the highest costs mines at $10-11 cash costs. Chinese mines represent 25% of global production. When molybdenum prices dipped below $10 in November, China went from being an exporter of molybdenum to being an importer of molybdenum. While only an anecdotal example, it does support the thesis that $10 represents the marginal producer cost.

Well-regarded management team

CEO, Kevin Loughery, is very well-respected within the mining community and has developed a good reputation for being a strong operator as well as very focused on creating shareholder value. Management’s recent decision to immediately stop the expansion of its Endako mine is a perfect example. Significant amounts of work and money had already been spent to begin expanding the Endako mine. It is easy to see how inertia and sunk cost mentality could have taken over and encouraged management to continue developing the expansion project despite the precipitous fall in molybdenum prices. However, management plans to wind down the expansion in a manner that will allow for a quick restart of the project if/when molybdenum prices rebound.

Molybdenum Supply cuts have begun

Codelco has announced a 10% supply reduction (4mm lbs). Freeport has announced a 25% supply reduction at its Henderson mine (10mm lbs). Freeport has also announced the suspension of its new build Climax mine, expected to produce 20+mm annually. Other new build projects such as General Moly and Moly Mines have been suspended indefinitely due to a lack of financing. Due to the fall in molybdenum prices and the credit freeze on new developments, no new supplies of molybdenum will be coming onto the market for a minimum of 2-3 years. Additionally, due to the fall in copper prices, copper suppliers have begun to cut their production schedules, which will inevitably cut back the supply of molybdenum.

Significant upside upon rebound in molybdenum prices

As the chart below indicates, Thompson Creek is able to remain free cashflow positive above $8 molybdenum prices. At prices of $15 and higher, Thompson Creek generates substantial free cashflow, providing significant upside in the stock. $15 is a key level as it represents the threshold needed for new greenfield projects to break-even. Without prices above $15, it is unlikely new supply will re-enter the market. Even if prices do rise above $15, new supply is a minimum of 2-3 years away from being able to come on-line. The chart below also assumes that Thompson Creek would elect to reduce production (first at its higher cost Endako mine) should molybdenum prices drop below $8/lb. Having open-pit mines is a key and critical element as it allows the Thompson Creek management team the flexibility to be able to react to falling prices and reduce/stop production as well as the ability to restart production rather quickly upon a rise in prices. Underground mines often do not provide the same flexibility as stopping production on an underground mine for a pro-longed period can result in a collapse of the mine structure.
 
 

2009 Estimates

Based on Mgmt Guidance

Low Production

High Production

TCM Volume (mm lbs)

                 24.5

               26.0

Cash Costs

 $              6.00

 $            5.00

Endako Volume (mm lbs)

                   7.0

                 8.0

Cash Costs

 $              9.00

 $            8.00

Moly Prices

 $            10.00

 $          10.00

Gross Profit

               105.0

             146.0

D&A

                 42.0

               42.0

SG&A

                 20.0

               20.0

EBIT

                 43.0

               84.0

Tax Rate

33%

33%

Net Income

                 28.8

               56.3

Sustaining Capex

                (36.0)

              (36.0)

D&A

                 42.0

               42.0

FCF

                 34.8

               62.3

Fully Diluted Shares Outstanding

               135.0

             135.0

CF/Share

 $              0.26

 $            0.46

Current TC Share Price

 $              3.63

 $            3.63

FCF Yield

7%

13%



2009 FCF Yield*

 

 Moly Prices

                    

                         $8.00

 $      9.00

 $      10.00

 $      12.00

 $      15.00

 $      20.00

 $      25.00

 $      30.00

 TC Volume

                            27.0

-2.7%

4.6%

12.0%

23.1%

41.6%

60.0%

78.5%

 (TCM + Endako)

                            29.0

-2.2%

5.7%

13.7%

25.6%

45.4%

65.2%

85.0%

                            31.0

-1.6%

6.8%

15.3%

28.0%

49.2%

70.4%

91.6%

                            33.0

-1.1%

7.9%

16.9%

30.5%

53.0%

75.6%

98.2%

                            35.0

-0.6%

9.0%

18.6%

32.9%

56.9%

80.8%

104.7%

                            37.0

0.0%

10.1%

20.2%

35.4%

60.7%

86.0%

111.3%

 * Higher end of cash costs assumed

Catalyst

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