Shareholders in Thompson Creek Metals (TC) must be breathing a sigh of relief, as the company's release of third quarter earnings last week was rather uneventful. The stock has been falling, almost without exception, for nearly two years since hitting highs around $15 per share in early 2011. Back then, the company was seeing substantial optimism about its C$650 million purchase of Terrane Metals and its diversification from a pure play on molybdenum through the addition of Terrane's Mt. Milligan copper and gold project.
That optimism has withered over the past few quarters, as persistent cost overruns at Mt. Milligan and difficulties at the legacy Endako and Thompson Creek moly mines have eroded cash flow and wrecked the company's balance sheet. Capital expenditures at Mt. Milligan alone have soared, from an initial estimate of C$915 million to a current figure of C$1.5 billion, according to the Q3 investor presentation. In response, the company has made multiple transactions with Royal Gold (RGLD), selling off 52.25% of Mt. Milligan's gold production for a total of $781 million USD. (Royal is also obligated to pay $435 per ounce for each ounce delivered.) The company has also made multiple debt offerings, including a $250 million issue of tMEDS, a debt-equity hybrid, and the offering of $350 million in senior secured notes today.
Today's issue, if sold, should, finally, remove any doubts about financing for Mt. Milligan, which is expected to begin commercial operations in the fourth quarter of 2013. In the Q3 presentation, Thompson Creek noted that it was already able to finance remaining capex on both Mt. Milligan and its legacy moly mines:
(click to enlarge)
slide courtesy Thompson Creek Q3 investor presentation
The $350 million looks to give TC plenty of flexibility; as CEO Kevin Loughrey noted on the post-earnings conference call, without additional financing, the company would have been dependent on its revolving line of credit to maintain "a significant, reasonable cash balance." That revolver does have covenants -- including the requirement that TC produce positive quarterly EBITDA -- which may have presented a risk that Loughrey and TC management were unwilling to take.
Granted, it has seemed that the funding gap has been closed before, only for cost inflation to again seep in, causing a rise in capex estimates and a need for new debt or gold stream transactions. But with Mt. Milligan nearing completion, some C$935 million of the C$1.5 billion required has already been spent. Thompson Creek has, despite the cost overruns, kept the project on schedule, and management noted on the conference call that most of the key parts and equipment had been procured. The two risks remaining, according to CEO Loughrey, are a harsh winter -- which could slow certain construction projects -- and the ongoing difficulty in finding labor, notably for TC's contractors. On the conference call, Loughrey called the labor issues "manageable," while saying the company was prepared for even "a somewhat worse than average winter."
In short, it appears that Thompson Creek can finally see the light at the end of the tunnel, with its funding secure, its capex estimates finally looking settled, and Mt. Milligan on pace to commence production within a year. Again, it has looked this way before -- over a year ago, I recommended TC near $8 per share, and earlier this year again made a bullish sum-of-the-parts analysis. But the key parts of Mt. Milligan have been procured, construction targets have been hit, and the company has, at least, managed to keep the project on schedule.
As such, it's worth looking at TC's balance sheet to see where the company will stand when Mt. Milligan begins operations in about a year from now. Assuming the high end of capex guidance -- which includes a $54 million "contingency" for additional unforeseen costs; breakeven free cash flow for the next year -- slightly less than a $9MM projection in the Q3 presentation; and a flat stock price, TC can expect to look something like this:
TC Financial Position, Q4 2013
|Cash On Hand1||$300MM|
1 -- estimated; includes proceeds from $350MM senior notes offering, minus one year's interest costs (not included in FCF guidance) and potential closing costs, as all current cash in hand is spent completed Mt. Milligan project
2 -- at TC's price of $2.89 per share as of 1 pm Eastern 11/13/12
3 -- includes $350MM of senior notes issued Tuesday
That $1.13 billion figure, however, does not include the dilutive impact of the tMEDS sold earlier this year. Those units -- which settle in 2015 -- would require the issuance of between 40.35 and 47.4 million shares of TC stock, according to the prospectus. That would create dilution in the range of 24-28 percent, depending on TC's closing price at that time. Using the high end of that figure, we can estimate that the current enterprise value might account for as little as 72 percent ownership of the company, bringing a more proper figure to about $1.57 billion.
So, once again, TC looks undervalued based on the sum-of-the-parts analysis. As noted, Royal Gold has spent $781 million for just over half of Mt. Milligan's gold stream. That $781 million pays for the profit of the gold, above the expected cash costs of $435 per ounce. At that rate, TC's remaining ownership of the gold from Mt. Milligan alone has a present value of $713 million. Bear in mind that the Royal Gold transactions were made with gold trading lower than its current price over $1,700 per ounce, and with a company that, to say the least, had less-than-optimal negotiating leverage. As such, TC's share of the gold stream should have a present value of about $750 million.
Of course, there is copper in their hills, too, and lots of it. Guidance for years 1 through 6 at Mount Milligan expects gold revenue of about $450 million annually, with copper revenue coming in at about two-thirds of that figure. That should put the copper stream -- in which TC still owns a 100% stake -- at about $1 billion in value (two-thirds of the total gold stream value of about $1.5 billion).
Add it together, and Mt. Milligan looks to have a present value of about $1.75 billion. In its presentation, TC noted the cash flow potential of the mine:
slide courtesy Thompson Creek Q3 investor presentation
With $285 million annually in operating profit from the mine, and perhaps an additional $35 million in SG&A (based on run rates from the existing moly mines, which have roughly similar revenue potential), EBITDA from Mt. Milligan alone might be $250 million a year or so, putting our EV/EBITDA ratio for the property around 7. That is on the low end of valuations for the industry's more senior producers:
Of course, these are the mining industry's leaders, though many of them have had their own share price problems as of late. But the comparison gives some additional evidence that our $1.75 billion valuation for Mt. Milligan is reasonable.
And, of course, that figure, on its own, represents a $180 million cushion over TC's current enterprise value, assuming that remaining capex is on the high end of the projected range and assigning what appears to be a conservative value to Mt. Milligan's profit potential. It excludes TC's existing moly mines and smelting operations in Pennsylvania, which are struggling with moly prices around $11 per pound, but which have in the past generated substantial free cash flow.
That figure, however, also excludes the possibility that capex costs could again rise; that the ongoing labor crunch in the mining industry knocks Mt. Milligan off its timeline; or that a worse-than-expected winter causes delays of its own. Investors -- for good reason -- likely have little faith in TC, and any additional bad news about Mt. Milligan will send the stock tumbling yet again.
If the company can -- finally -- execute and bring Mt. Milligan in at or near its current budget, TC is still a bargain. If the copper-gold mine at Mt. Milligan is worth the $1.75 billion I project, the stock should gain $1 per share -- nearly 35 percent -- based on those profits alone. A rebound in moly prices in conjunction with success at Mt. Milligan could easily cause TC to double, with further gains in gold and copper prices adding another source of upside.
After being burned so many times, it's easy to see why investors should be skeptical of yet another bull case for Thompson Creek. (To be honest, I'm still a little wary of publishing it.) The numbers work, but they have looked good for a long time, with the company's missteps and the general cost inflation changing the picture and damaging the stock. If the company can execute, it's a buy -- but that has been, and remains, a huge 'if.'
One way to play the stock is through the purchase of the aforementioned tMEDS, which are exchange-listed under the symbol TC-T. Currently trading at $16.44, the debt portion of the units is currently yielding nearly 10 percent (quarterly interest payments are 40.625 cents). The units are then convertible into TC stock at settlement in May 2015 (though holders can convert earlier). Should TC trade below $4.64 per share, tMEDS holders receive 5.3879 shares of TC stock. Between $4.64 and $5.45, tMEDS holders receive $25 worth of stock (the original offering price). Beyond $5.45, tMEDS holders receive a fixed sum of 4.5855 shares for each unit they own.
With TC common stock at $2.89, the stock component of the tMEDS alone is worth $15.57. The holder will also receive $3.65 in interest (nine quarterly payments remaining at $0.40625 each), putting the total value of a tMEDS unit right now at about $19.22. Should TC stock stay flat from now through May 2015, the tMEDS would still return about 6.45% annually. Indeed, TC common stock could drop all the way to $2.38 before losses were felt, assuming the company does not default on any interest payments. Investors would lose some upside in the case of a big gain for TC, so in essence the tMEDS act as a hedged play, exchanging some downside protection for limited losses on the upside. But, unlike a covered call or cash-secured put, investors still receive a substantial part of any share price growth beyond $5.45.
Given TC's recent history, a hedged play seems like reasonable advice, and the tMEDS units offer a nice balance between downside protection and upside exposure. There are likely some liquidity concerns -- daily volume is only a few thousand units -- but for long-term investors, tMEDS should definitely be considered.
Overall, beyond the massive decline in the share price, little has changed for Thompson Creek. The numbers still look good; the confidence in execution is still not there. But the company is getting closer to completion of Mt. Milligan; it has cut costs in its legacy moly mines to increase cash flow in the short term, and expressed a willingness to shelve those operations if the price of moly does not rebound. Thompson Creek doesn't have to be perfect for the share price to rise; it just needs to be good enough. With much of the company's struggles (hopefully) in the rear view mirror, investors should consider taking a chance on TC and Mount Milligan. Carefully.
Additional disclosure: I am also considering the purchase of Thompson Creek tMED units, traded under symbol TC-T or TC^T, at some point in the near future. I do not currently own any position or have any exposure to any TC-linked security.