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Thompson Creek Metals (NYSE:TC) is about to start commercial production at its Mount Milligan copper and gold mine. This mine is expected to produce the majority of Thompson Creek's revenue and cash flow in the future, and development cost overruns had significantly affected Thompson Creek's stock price in the past. Those problems are over now, and its stock price has gone up 25% since the last quarterly report in early August as a result. However, Thompson Creek also produces 30 million pounds of molybdenum per year, and expected molybdenum oversupply for the next five years may serve to limit Thompson Creek's upside.

The Molybdenum Market - History and Future

Since averaging near $30 per pound in 2007 and 2008, Molybdenum prices have fallen drastically. Throughout 2012 and 2013, prices have averaged below $13 per pound, sinking to $9.52 per pound in July 2013.

Period

Price Per lb.

2007

$30.00

2008

$28.94

2009

$11.08

2010

$15.72

2011

$15.49

2012

$12.74

Q1 2013

$11.35

Q2 2013

$10.87

July 2013

$9.52

Source: Platts Metal Week

The molybdenum market is expected to have a slight surplus in 2013 and 2014, maintaining prices around present levels. However, from 2015 to 2017, there is going to be a significant amount of additional supply entering the market from China and as a byproduct from several copper mines.

To put the potential supply increase in perspective, worldwide molybdenum production was 529.8 million pounds in 2012, which was an all time high. The Sierra Gorda copper mine in Chile alone is expected to produce 54 million pounds of molybdenum per year over its first three years after it starts producing in mid-2014. This is a 10% increase in supply just from that product. Molybdenum consumption was 520.9 million pounds in 2012, down slightly from 522.1 million pounds in 2011.

It is expected that some of the higher cost mines will suspend production to reduce the supply imbalance. However the copper mines with molybdenum as a byproduct will keep producing as long as copper prices stay reasonably high. Hence there is the potential for molybdenum prices to remain depressed for an extended period of time.

Thompson Creek's Molybdenum Mines

Thompson Creek has two molybdenum mines: the Endako mine and the Thompson Creek mine. Thompson Creek's 75% share of the Endako mine is approximately 10 million pounds of molybdenum per year. Endako's production cash cost is expected to be $9 to $10.50 per pound in 2014. At current prices, Endako will have zero gross margin.

The Thompson Creek mine produces around 20 million pounds of molybdenum per year. Its production cash cost is expected to be $5 to $6 per pound in 2014. At current prices, the Thompson Creek mine will contribute approximately $80 million in gross margin in 2014. However, the Thompson Creek mine will be placed in maintenance mode after 2014 unless Phase 8 stripping is restarted. Phase 8 stripping was suspended in October 2012 due to low molybdenum prices, and the mine plan indicated that this phase contributes positive economics if molybdenum prices are between $10.75 to $12.00 per pound. With molybdenum prices below that level, the mine will likely be idled indefinitely. Even if prices rise above that level, the decision would depend on whether the rebound appeared sustainable. A $14 per pound price for molybdenum would make it an easy call though.

Completing stripping activities will take around eighteen months (if production is still ongoing) or twelve months (after 2014 when current production concludes). Production cannot continue beyond 2014 at Thompson Creek mine without completing these stripping activities. Therefore, even if molybdenum prices suddenly rose and stripping activities were to begin immediately, it is likely that there would be some interruption to production in the first few months of 2015.

With additional supply from new mines like Sierra Gorda keeping the price of molybdenum down, production at the Thompson Creek mine may be halted for a significant amount of time.

Molybdenum Mine Idling Effect On EBITDA

At current copper and gold prices, Mount Milligan is expected to contribute $509.9 million in annual revenue during its first six years of operation. Assuming that SG&A is 6% of revenues, and that the annual mine operating cost remains at $280 million, Mount Milligan's gross margin will be $199.3 million.

Metal

Annual Production

Price Per Unit

Revenue ($ Million)

Copper (Pounds)

89,000,000

$3.19

$283.91

Gold (Ounces excl. Royal Gold's share)

125,153

$1330.00

$166.45

Gold (Ounces - Royal Gold's Share)

136,947

$435

$59.57

Total Revenue

$509.93

Gross Margins For Mount Milligan

Total Revenue ($ Million)

$509.93

Cost of Mine Operations ($ Million)

$280.00

Additional SG&A ($ Million)

$30.60

Gross Margin ($ Million)

$199.33

If we assume that molybdenum prices recover somewhat to $11 per pound, then the Endako mine will contribute approximately $12.5 million to the bottom line. However, it is unlikely that the Phase 8 stripping will happen at Thompson Creek mine at those molybdenum prices, so that mine will be idled. There may be some savings on operating expenses if that mine is closed, so we'll reduce operating expenses from its current $40 million to $30 million. EBITDA will therefore be around $181.8 million in FY 2015 under these conditions.

FY 2015

Mt. Milligan Gross Margin ($ Million)

$199.33

Molybdenum Mines Gross Margin ($ Million)

$12.50

Operating Expenses ($ Million)

$30.00

EBITDA ($ Million)

$181.83

Thompson Creek does have around $90 million per year in interest expenses and $60 million per year in capital expenditures, but it should be able to cover those expenses and still generate positive cash flow even with very minimal molybdenum related income. However, this does put Thompson Creek's current valuation at a fairly high 7.0x EV/FY 2015 EBITDA. An increase in gold to $1450 per ounce and copper to $3.50 per pound For Thompson Creek would reduce EV/FY 2015 to 5.7x at its current share price.

Conclusion

Thompson Creek has successfully diversified itself and greatly increased cash flow through the completion of its Mount Milligan mine. However, low molybdenum prices may mean that the value of the Mount Milligan mine is already captured in the recent share price increases.

Those low molybdenum prices have caused Thompson Creek postpone the Phase 8 stripping needed for it to continue production at its Thompson Creek mine beyond 2014. As it may take up to 18 months to finish Phase 8 stripping, 2015 production is already being threatened. Even if gross margin was only $3 per pound, the Thompson Creek mine would produce $60 million in gross margin per year.

Large amounts of molybdenum supply being added over the next few years means that prices may be stuck near current levels without significant production curtailments at existing mines. If conditions improve enough for Thompson Creek to restart Phase 8 stripping though, that will be a catalyst for Thompson Creek's shares to resume their advance.

Source: Thompson Creek: Low Molybdenum Prices Limit Upside And Affect 2015 Production