Why Rare Earths May Have Room to Run

by: Matthew Smith
With the recent gains in rare earths pushing gains up into the five bagger territory, we were forced to revisit some of our past write-ups and look at the industry as a whole. It is at times such as these that taking a step back and reevaluating the playing field does wonders for one, and one’s portfolio. In volatile, quickly changing sectors of the market, this is a practice one must continually do.
As we looked around at the landscape it was hard to disagree with the thesis we have been using for over the past year. Lynas (OTCPK:LYSCF) and Molycorp (MCP) will be first to production and our first to production strategy has paid off pretty nicely for readers and subscribers. Lynas and Molycorp will be the first Western suppliers of rare earth elements to come online in the next 2-3 years. Light Rare Earth Elements (LREEs), will dominate the market. The Heavy Rare Earth Elements (HREE) market is up for grabs, but our readers know where we stand on the HREEs. Stans Energy (OTC:STZYF) and Quest Rare Minerals are our favorites, with both returning over 500% since we profiled them.
What we found interesting during our reevaluation of the industry is that although many feel that these stocks are overvalued, going forward they could be quite cheap. Based on the expected output of the companies’ mines along with the current prices of REEs, both Lynas and Molycorp continue to appear to us as long-term buys.
We have analyzed the deposits of both Molycorp and Lynas and, feeling that in-situ value is a horrible way to value a company, decided that projected revenues would be the best measure of these companies’ potential fair value. We had to double check the numbers, as we were pretty blown away by the spreadsheet compiled for our database via information available from the companies themselves and other reputable sources. When more than one source was used, we defaulted to the individual company’s data and used the other reference material to confirm the numbers.
Let us first go over the data within the tables below. The production numbers are those which have been publicly announced by the companies, in both cases they have two production levels which represent the two phases they have planned. The REO prices are those supplied via asianmetal.com prices (as of this past weekend). If one wanted to confirm these prices simply go to pelemountain.com and click on the ‘Asian Metal Prices’ link on their page (located at the bottom right of the page).

The revenues are broken down according to total revenue per element at the mine, and the total revenue figure is yearly as it is based on the annual production (per the companies). Now both have contracts, and in some cases firm sales prices via floors and ceilings, on forward production but this would be their ‘base case’ bringing production online today at current prices and with only selling the oxides (not further ‘refining’ the product as MCP will do). Due to the lack of information on breakdown of the ’Other REEs’ we have simply used a sales price of zero for these materials.

Here are the current prices we used in our analysis:

Product Current Price
Cerium Oxide (USD/kg) 67.10
Lanthanum Oxide (USD/kg) 64.10
Neodymium Oxide (USD/kg) 110.00
Praseodymium Oxide (USD/kg) 103.50
Samarium Oxide (USD/kg) 61.10
Dysprosium Oxide (USD/kg) 375.00
Europium Oxide (USD/kg) 646.00
Terbium Oxide (USD/kg) 640.00
Gadolinium Oxide (USD/kg) 83.00
Click to enlarge

Prices Courtesy of asianmetal.com
Looking at Lynas Corp.’s Mt. Weld Deposit we find the deposit is composed of the following elements, and we have assumed here that production will mirror the composition of the deposit as a whole. A fair assumption over the life of the deposit, but production numbers will vary from time to time as various parts of the deposit are mined.
Element Estimated % in Production Mining
Mt. Weld Ore Phase 1 Revenues (1)
Cerium Oxide 46.74% 5,141 344,987,940.00
Lanthanum Oxide 26% 2,805 179,800,500.00
Neodymium Oxide 18.50% 2,035 223,850,000.00
Praseodymium Oxide 5.32% 585 60,568,200.00
Samarium Oxide 2.27% 250 15,256,670.00
Dysprosium Oxide 0.12% 14 5,115,000.00
Europium Oxide 0.44% 49 31,479,580.00
Terbium Oxide 0.05% 6 3,520,000.00
Other REEs (Incl. Gandolinium) 1.05% 116 0.00
100.00% 11,000 864,577,890.00
Click to enlarge

Courtesy of theinvestar.com
For Phase 2, production will be doubled. Our number is off by 1 metric tonne due to rounding, so it actually comes in under the official Lynas projections. For Phase 2 production, revenues should look something like this:
Element Estimated % in Production Mining
Mt. Weld Ore Phase 2 Revenues (2)
Cerium Oxide 46.74% 10,283 689,975,880.00
Lanthanum Oxide 26% 5,610 359,601,000.00
Neodymium Oxide 18.50% 4,070 447,700,000.00
Praseodymium Oxide 5.32% 1,170 121,136,400.00
Samarium Oxide 2.27% 499 30,513,340.00
Dysprosium Oxide 0.12% 27 10,230,000.00
Europium Oxide 0.44% 97 62,959,160.00
Terbium Oxide 0.05% 11 7,040,000.00
Other REEs (Incl. Gandolinium) 1.05% 231 0.00
100.00% 21,999 * 1,729,155,780.00
Click to enlarge

Courtesy of theinvestar.com
Lynas will be first to production outside of China, and we believe that they will be sold out of material moving forward. It is our understanding that they have favorable supply contracts that do not hamper them in the way many juniors get bogged down when they first bring production online.
Molycorp has been a controversial stock here in the States. Our viewpoint has been that it is going to be the 800-pound gorilla in the industry moving forward, and will be a hybrid mining, manufacturing, and technology concern. Below are the numbers for the Mountain Pass deposit, once again using the REO prices specified above, and specifying that this is the production from Phase 1.
Element Estimated % in Production Mining
Mtn Pass Ore Phase 1* Revenues (1)
Cerium 48.80% 9,760 653,920,000.00
Lanthanum 34% 6,800 435,200,000.00
Neodymium 11.70% 2,340 256,230,000.00
Praseodymium 4.20% 840 86,520,000.00
Samarium 0.79% 158 9,638,000.00
Gadolinium 0.21% 42 3,486,000.00
Europium 0.13% 26 19,370,000.00
Dysprosium 0.05% 10 3,730,000.00
Other REEs (Including Terbium) 0.12% 24 0.00
20,000 1,468,094,000.00
Click to enlarge

Courtesy of theinvestar.com
Phase 2 production will set the company apart from the rest of the industry as it will ramp up to 40,000 metric tonnes.
Element Estimated % in Production Mining
Mtn Pass Ore Phase 2* Revenues (2)
Cerium Oxide 48.80% 19,520 1,307,840,000.00
Lanthanum Oxide 34% 13,600 870,400,000.00
Neodymium Oxide 11.70% 4,680 512,460,000.00
Praseodymium Oxide 4.20% 1,680 173,040,000.00
Samarium Oxide 0.79% 316 19,276,000.00
Gadolinium Oxide 0.21% 84 6,972,000.00
Europium Oxide 0.13% 52 38,740,000.00
Dysprosium Oxide 0.05% 20 7,460,000.00
Other REEs (Including Terbium) 0.12% 48 0.00
40,000 2,936,188,000.00
Click to enlarge

Courtesy of theinvestar.com
Molycorp’s numbers appear to indicate that if REE prices can at least maintain their current levels the revenues would be significant, however we stress that this is the ‘base case’ for production. That is, if Molycorp simply mined the REEs and sold the REOs on the market.
The business plan MCP will use is to sell the highly desirable products into the open market and to take the cerium and others which could have a supply overhang going forward and actually manufacture them into products to sell, thus actually providing for a higher revenue total than our mining only numbers indicate. Cerium for instance is the main component of the patented water filter they will market. Our analysis indicates that Molycorp could be a net purchaser of Cerium in the years ahead. Although we will not delve into the earnings potential at this time, it is believed that MCP will have a mining cost of about US$2.77/kg TREO according to Dundee Securities estimates.
MCP, using the latest technology, will become the world’s low cost producer of REEs as the Chinese continue to raise the cost of the REE industry through their new compliance requirements and environmental laws. It is our belief that MCP will have the highest margins in the industry due to this business plan based on the estimated mining costs and current business plan.
Lynas, according to Dundee Securities, will have mining costs of roughly US$7.00/kg TREO, which should still provide for ample profits. Lynas is also trying to develop a brand known as ‘RED’ (Rare Earths Direct) to differentiate its product from that of others. They hope to develop RED into a brand that customers know stands for quality.
Investors are free to place their own multiple on these numbers to ‘guesstimate’ a fair value for the shares, and in all honesty the figures vary wildly. The revenue multiple is a whole new argument for another day, but one could look at the diversified miners and use a multiplier of somewhere in the neighborhood of 5ish or use the uranium stocks which we think are a little bit more of a fair comp. Using Cameco (NYSE:CCJ), the revenue multiplier would have to be 15 to get the value of shares based on that theory.
It takes conviction in one’s own thesis and the assumption that REO pricing remains strong going forward, but based on the above numbers it is apparent that the REE sector could still power higher based not on rumors anymore but actual fundamentals as these companies near production.

Disclosure: I am long OTC:QSURD, OTC:STZYF.