it's time to go long

After putting a lot of time recently into a review of past statements and commentary from Lynas ahead of the next quarterly report, I’ve come to the conclusion that the company has been underplaying their progress whilst they ramp up operations. I.e. that the next 6 months to the March quarterly report will surprise to the upside and transform market perceptions of Lynas.

I've set up a long position this week but nevertheless thought I'd post my analysis here to test my thinking with the forum.

I’ve tried to piece together the bits of information from various public releases (e.g. Operations Update 30/09/13, Coy Presentation dated 01/08/13) and company comments (e.g. Eric’s June quarterly teleconference, Malaysian MD Datuk Mashal Ahmad’s reported speech of 26/9/13) to revise my view. Pulling strands of information together as a whole looks better than individual announcements, which is why I’m thinking there could be a deliberate strategy of Lynas to quietly get their house in order and then deliver positive surprises to try and turn the share price.

Below is my interpretation of the company’s potential cashflow for this financial year and the model I’m working to. It’s based on plant repairs and modifications being made, concentrate fed and 45days throughput having already occurred to generate first of the volume product on 26th September 2013. The LAMP running at 30% capacity through October and ramping to full production by end of December.

ASSSUMED PRODUCTION VOLUMES & CASHFLOW FY13/14
(Note that 11,000tonnes p.a. /12mths = 917tonnes produced/month)

Sept Qtr 300t x $30/kg = $9,000,000 Gross Revenue

Oct 13 30% 275t x $30/kg = $8,250,000

Nov 13 50% 459t x $30/kg = $13,770,000

Dec 13 80% 734t x $30/kg = $22,020,000

Jan 14 100% 917t x $30/kg =$27,510,000

Feb 14 100% 917t x $30/kg =$27,510,000

Mar 14 100% 917t x $35/kg =$32,095,000

Apr 14 100% 917t x $35/kg =$32,095,000

May 14 100% 917t x $40/kg =$36,680,000

June 14: (Allow for shipping and documentation. Cash received FY15)

Estimated Cash received this Financial Year = $208,930,000 FY13/14

Tonnes produced and delivered this Financial Year = 6,353 tonnes

Cost of Production $18/kg = $114,354,000 Operating Cost

Margin on CASH RECEIPTS to June 2014 = $94,576,000 Gross margin

That is, approximately 6,000t delivered with cash received, generating around $90million gross operating margin this financial year, less corporate costs.


ASSUMPTIONS

SOLTJIZ: need 333t @$30/kg average price for their $10m debt repayment due Jan 19, will be covered easily by product delivery. Soljitz to take 3,000t by March 14 meaning they take nearly all production for next 5 months up until February . Financing deal with Soljitz presumably renegotiated with production schedule known.

CUSTOMER DEMAND: All 11,000t can be sold, with small amount on spot market if needed. Lynas have told us this and that they have contracts in place. They haven’t advised otherwise so this remains their public position. I’ve listened to the arguments on HC as well as Lynas and taken the view there is no permanent demand destruction. An on-going market is there for the Lynas suite, including Phase 1 Cerium being sold to Rhodia.

COST OF PRODUCTION. Lynas have stated cash costs of production of $14-15/kg for 22,000t, so presumably for 11,000t it’s higher and also higher during ramp-up. Eric has given guidance of high-teen’s so I’ve gone with $18/kg. However, with WA shutdown/go slow and ore and concentrate stored from previous years, initial COP could surprise to the low side. Note that June quarter “on-going operational, production and administration costs” reported as $37.8m, which is $151.2m annualised or $13.75/kg.

LAMP PHASE II: Being commissioned now and possibly complete and operating. Lynas to produce 11,000t using both Phase I and II facilities to diversify suite and give flexibility to optimise margins around highest-value sales and lowest cost of production. i.e. produce more higher margin product, tailored to current demand profile.

BASKET PRICE: Initially $30/kg assumed, rising to $40/kg before end of financial year based on optimising suite produced and rising prices. Nd/Pr Oxide from LAMP Phase II will be key focus. Profit is not an issue with the tax losses generated to date and cashflow should come through strongly to the bottom line.

CAPITAL POSITION: It appears Lynas could achieve self-sustaining cashflow in either the March or June quarters. Cash in hand by my rough calc’s would last somewhere about 1st quarter 2014, hard to be precise. Unless you’re the company CFO, it’s simply too difficult as an outsider to figure out whether their cash will run out before self-sustaining cash in-flow occurs. However , on the above model, I’m thinking it’s more of a bridging finance problem and hence whether they need a temporary working capital debt facility which won’t dilute the share price, rather than a capital raising which would.

MOLYCORP: Recent HC posts (thanks Ausheds) suggest Moly is a failing organisation and possibly headed for insolvency. Ongoing poor headlines for RE industry could have a negative SP impact. However for the underlying Lynas business, Moly's troubles are a positive. Who's going enter into a long-term supply contract with Molymess in their current state? A stronger competitor might emerge down the track if they're broken up, but we can worry about that in a couple of years time.

STRATEGY:

I'm comfortable buying this on a fundamental basis at this point as all the evidence needed for success or not for this business should emerge over the next 6months, so I’d rather be set.

From January 2014 at full ramp-up, if monthly gross revenue is $27.51m and operating costs $18/kg, then annualised operating margin for 11,000 tonnes would be $132.12m. Take off some corporate overhead and debt interest @ $22.12m (just a guess), no tax for a while due to accumulated losses, gives a very rough earnings per share of $0.06. Say easily PE 12x for a growth company, probably should be a lot higher, gives rough valuation in the new year of $0.72 share. You can add your own growth or PE expansion from there.

I also might put up a chart sometime, but technically LYC's rate of previous rises from it's lows (price/time) for a hypothetical upturn here would provide a price of $1 in the first 2 weeks of May i.e. just after the March quarterly announcement. So a SP of $1 early May is a reasonable assumption both fundamentally and technically, if my analysis is in the ball park.

My strategy therefore has been to buy this week around $0.37, go and do other things to wrap up the year, get some sand under my toes over Xmas and as the new-year gets underway the SP should be nudging $1. Fair risk/reward. As long as Nick and Eric play nice.

CONCLUSION:

Putting together known information and interpreting the gaps suggests to me the period from now until the March 14 quarterly will transform market perceptions of this company. I think they’ll finally make it. The only outstanding risk is a capital raising which is too close to call observing from outside the company, but I’m now leaning to a temporary debt facility only if needed and no CR.

After analysis, I’ve found myself surprisingly impressed by the quiet way Lynas are steadily building their business under the radar and not hyping their potential. I’ve decided to put my trust in management one last time and back them by opening a long position, which I’ll add to as progress is confirmed.

But if Curtis let’s me down again this time, I’ll ....well, go all Nursery-like and haunt him on this forum for the rest of my days.