Seeking Alpha
Long/short equity
Profile| Send Message| ()  

Thompson Creek Metals (TC) is a molybdenum mining company that is in the process of diversifying by developing a copper and gold mine called Mount Milligan in British Columbia, Canada. The cost of developing Mount Milligan went up from $915 million to $1.5 billion, leading Thompson Creek to take on substantial amounts of debt and sell part of the gold stream from Mount Milligan to Royal Gold (RGLD).

The construction on the Mount Milligan mine has appeared to make it past the winter season on track to begin operations in the latter half of 2013, with full production starting in 2014. Therefore, this seems to be a good time to evaluate what a fully operational Mount Milligan means for Thompson Creek's value.

Mount Milligan: Copper Becomes More Important Than Gold

Mount Milligan is expected to produce 89 million pounds of copper and 262,100 ounces of gold per year for the first six years of operation, with a decrease to 81 million pounds of copper and 194,500 ounces of gold per year for the remaining 16 years of mine life after that.

One consequence of selling 52.25% of their gold production to Royal Gold at $435 per ounce (or market price, whatever is lower) is that the price of copper becomes more important to Thompson Creek than the price of gold, as long as gold stays above $435 per ounce. In the below table we can see that a 1% change in the price of copper has a 60% greater impact on revenues than a 1% change in the price of gold.

Metal

Annual Production

Current Price Per Unit

(May 3)

Change in Revenue From 1% Change in Price

Copper (Pounds)

89,000,000

$3.3135

$2,949,015

Gold (Ounces excl. Royal Gold's share)

125,153

$1470.70

$1,840,625

Sources: Copper pricing and gold pricing

Baseline Scenario For Mount Milligan

This scenario reflects gold and copper prices as of May 3, and assumes similar levels in the future. The additional SG&A expenses created by Mount Milligan is estimated at 6% of revenues. This is in addition to the current SG&A expenses for the rest of Thompson Creek's operations, which will be discussed later. Mine operating expenses are pegged at $280 million per year according to Thompson Creek's management.

Under this scenario, Mount Milligan will generate $538.53 million in revenue per year, with gross margins of $226.22 million per year after the cost of mine operations and additional SG&A are subtracted.

Metal

Annual Production

Price Per Unit

Revenue ($ Million)

Copper (Pounds)

89,000,000

$3.3135

$294.90

Gold (Ounces excl. Royal Gold's share)

125,153

$1470.70

$184.06

Gold (Ounces - Royal Gold's Share)

136,947

$435.00

$59.57

Total Revenue

$538.53

Gross Margins For Mount Milligan Under Baseline Scenario

Total Revenue ($ Million)

$538.53

Cost of Mine Operations ($ Million)

$280.00

Additional SG&A ($ Million)

$32.31

Gross Margin ($ Million)

$226.22

Optimistic Scenario For Mount Milligan

This scenario reflects gold and copper prices rising to the most bullish forecast levels from analysts mentioned in this article. Bank of America forecasts gold to average $1,838 per ounce in 2014, while ABN Amro forecasts copper to average $8,300 per tonne ($3.7648 per pound) in 2014.

Under this scenario, Mount Milligan will generate $624.67 million in revenue per year, with gross margins of $307.19 million per year after the cost of mine operations and additional SG&A are subtracted.

Metal

Annual Production

Price Per Unit

Revenue ($ Million)

Copper (Pounds)

89,000,000

$3.7648

$335.07

Gold (Ounces excl. Royal Gold's share)

125,153

$1838.00

$230.03

Gold (Ounces - Royal Gold's Share)

136,947

$435

$59.57

Total Revenue

$624.67

Gross Margins For Mount Milligan Under Optimistic Scenario

Total Revenue ($ Million)

$624.67

Cost of Mine Operations ($ Million)

$280.00

Additional SG&A ($ Million)

$37.48

Gross Margin ($ Million)

$307.19

Pessimistic Scenario For Mount Milligan

This scenario reflects gold and copper prices declining to the most pessimistic forecast levels from analysts mentioned in this article. ABN Amro forecasts gold to average $1,150 per ounce in 2014, while Goldman Sachs forecasts copper to average $6,925 per tonne ($3.1411 per pound) in 2014.

Under this scenario, Mount Milligan will generate $483.06 million in revenue per year, with gross margins of $174.10 million per year after the cost of mine operations and additional SG&A are subtracted.

Metal

Annual Production

Price Per Unit

Revenue ($ Million)

Copper (Pounds)

89,000,000

$3.1411

$279.56

Gold (Ounces excl. Royal Gold's share)

125,153

$1150.00

$143.93

Gold (Ounces - Royal Gold's Share)

136,947

$435

$59.57

Total Revenue

$483.06

Gross Margins For Mount Milligan Under Pessimistic Scenario

Total Revenue ($ Million)

$483.06

Cost of Mine Operations ($ Million)

$280.00

Additional SG&A ($ Million)

$28.98

Gross Margin ($ Million)

$174.10

Value of Molybdenum Mines

Thompson Creek's molybdenum mines have been hampered by falling molybdenum prices. As a result, there have been extended shutdowns of actual mining activity at the mines in order to reduce costs. The Endako Mine had a shutdown where mining activity ceased, and the focus was on processing existing stockpiles. The Thompson Creek mine suspended stripping activity. This stripping activity would allow mining to continue beyond 2014, but would add significantly ($5 per pound) to the cost of producing molybdenum from that mine during one year. If the stripping wasn't completed, the mine would need to be put on a care and maintenance program.

In a pessimistic scenario, molybdenum prices fail to recover or go down further. In such a case, the molybdenum mines will prove to be an unreliable source of revenue, and can be described as having limited value - just enough to cover current operating expenses at $40 million per year.

In the baseline scenario, molybdenum prices increase slightly from current levels (from $11 to $12 per pound), allowing for continued mining operations delivering approximately 30 million pounds per year long-term at a cost of $8.50 per pound. This allows the mines to generate $105 million in gross margins per year.

In an optimistic scenario, molybdenum prices increase to $15 per pound as forecast by the Chilean copper commission Cochilco. Assuming the same 30 million pounds per year in production results in the molybdenum mines generating $195 million in gross margins per year.

Scenario

Annual Production (Pounds)

Price Per Pound

Cost of Sales Per Pound

Gross Margin ($ Million)

Baseline

30,000,000

$12.00

$8.50

$105.00

Optimistic

30,000,000

$15.00

$8.50

$195.00

Pessimistic

$40.00

EBITDA Under The Three Scenarios

The table below illustrates EBITDA under the three scenarios. EBITDA would be $174.10 million for a pessimistic scenario involving frequent shutdowns of the molybdenum mines, gold prices falling to $1,150 per ounce, and copper prices falling to $3.14 per pound. A baseline scenario with current copper and gold prices, and slightly improved molybdenum prices, results in $291.22 million in EBITDA. An optimistic scenario with $15 per pound molybdenum prices, gold rising to $1,838 per ounce, and copper rising to $3.76 per pound results in an EBITDA of $462.19.

Operating expenses have been pegged at $40 million per year, and includes SG&A as well as a small amount for exploration. It does not include expenses that are included in the cost of sales.

Baseline Scenario

Optimistic Scenario

Pessimistic Scenario

Mt. Milligan Gross Margin ($ Million)

$226.22

$307.19

$174.10

Molybdenum Mines Gross Margin ($ Million)

$105.00

$195.00

$40.00

Current Operating Expenses ($ Million)

$40.00

$40.00

$40.00

EBITDA ($ Million)

$291.22

$462.19

$174.10

Valuation Based On EBITDA

Thompson Creek will have approximately $921.8 million in debt by 2014 if there is no additional borrowing. Counterbalancing that is $526.8 million in current cash, plus $111.9 million in future payments from Royal Gold, and expected $18 million in net cash flow before Mount Milligan enters production. There are also $480 million in capital expenditures for 2013. The result of all this is that Thompson Creek's net debt should be around $745.1 million before Mount Milligan starts contributing significant revenues.

There are currently 168.4 million shares outstanding. However, Thompson Creek has tMEDS that will result in dilution as they convert into shares in 2015. The estimated effect of these tMEDS is listed below as well.

Using the EBITDA figures under each scenario and a target enterprise value/EBITDA ratio of 6.0 gives us a target enterprise value of $1.75 billion in the baseline scenario, $2.77 billion in the optimistic scenario, and $1.04 billion in the pessimistic scenario.

Since Thompson Creek has a significant amount of debt, the variance in enterprise value in each scenario leads to a greater variance in projected market capitalization and the target price per share. This target price per share varies from $1.39 under the pessimistic scenario to $4.65 under the baseline scenario, and $9.72 under the optimistic scenario.

Baseline Scenario

Optimistic Scenario

Pessimistic Scenario

EBITDA ($ Million)

$291.22

$462.19

$174.10

EV/EBITDA Multiple @6.0 ($ Million)

$1747.32

$2773.14

$1044.60

Net Debt ($ Million)

$745.10

$745.10

$745.10

Market Capitalization ($ Million)

$1002.22

$2028.04

$299.50

Current Outstanding Shares (Million)

168.40

168.40

168.40

Dilution from tMEDS (Million)

47.31

40.35

47.41

Total Shares (Million)

215.71

208.75

215.81

Target Price Per Share

$4.65

$9.72

$1.39

Conclusion

Thompson Creek is currently undervalued if you believe that copper and gold prices will remain at current levels, while molybdenum prices make a slight recovery. In such a scenario, Thompson Creek should be worth $4.65 per share. In an optimistic scenario with strong increases in metal prices, Thompson Creek could be worth as much as $9.72 per share. Copper prices are the most important factor in Thompson Creek's future value, so the future prospects for copper prices should be a key consideration for an investment in Thompson Creek.

The downside with Thompson Creek is that the company's value varies greatly depending on the prices of the metals that they mine. In a pessimistic scenario with long-term weaker metal prices, they could be worth only $1.39 per share due to debt making up much of the enterprise value. As long as Mount Milligan is operational though, they should be able to manage their heavy debt load. In such a scenario, there is very significant vulnerability to any issues with Mount Milligan though.

An alternative way to play Thompson Creek is via their tMEDS, which are discussed further here. They offer some interest payments in exchange for sacrificing a bit of upside. At current prices (as of May 3), the tMEDS should outperform the common stock for rate of return if Thompson Creek's common stock price is approximately $5.20 or less per share on May 15, 2015. The market for the tMEDS is less liquid though, and these calculations don't account for taxation differences between interest and capital gains.

Source: Thompson Creek: Undervalued As Mount Milligan Approaches Completion