Lynas Can't Afford Further Delays

| About: Lynas Corp. (LYSDY)
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Production continues to ramp up slowly at Lynas' Malaysian processing facility, with production at 27% of capacity in December.

Production shortfalls have led to another cash crunch, with management looking to raise capital and/or restructure debt repayment obligations.

Highly leveraged to rare earth oxide prices, even small changes in Lynas' pricing basket lead to large swings in potential cash flow generation.

I thought Lynas (OTCPK:LYSDY) looked like an interesting, albeit very risky, mining story back in December of 2013 ("Weak Prices Have Lynas Fighting An Undertow"). While the shares did participate a bit in the early 2014 run in mining companies, it didn't last and one of my biggest concerns (further issues ramping up the processing facility) seems to be coming home to roost.

Although management believes it could reach a 11ktpa production run-rate (a level where cash flow breakeven seems probable) in June of 2014, this is a company that has built a reputation for missing deadlines and coming in short of their own goals. What's more, the shortfalls in ramping up production have created the need for additional funding, as cash on hand won't be enough to keep up with annual costs and a debt repayment due in September. These shares may still offer a rich reward given the potential or theoretical net asset value, but funding terms are not going to be generous and it is hard to ignore the ongoing declines in near-term EBITDA expectations.

Results On Target...

Owing to prior operating updates, there were not many surprises when Lynas reported results for the December quarter last week (March 11). Revenue for the first half of fiscal 2014 came in at just under A$15 million. More importantly, sales volume nearly doubled to 409 tonnes, while production nearly tripled qoq to 741 tonnes. Realized prices fell 5% qoq in the December quarter, to $21.48/kg. EBITDA was largely as expected, at negative A$54 million.

But Progress Is Lacking

Lynas has thus far struggled to bring its production up as quickly as expected. The company previously had to deal with repairs to its cracking and leaching units at its Malaysian processing facility (called LAMP), and the company also apparently had to deal with the ramifications of heavy rainfall and flooding in Malaysia in December. Although the facility wasn't directly impacted, there were ramifications to the transportation and infrastructure services in the area.

That's all well and good, but the facility was only running at 27% of rated annualized capacity in the December quarter and the update for January (250t) was not exactly a remarkable improvement. Word that the company's basket of prices received has strengthened to $25/kg and that the company is not accepting offers for lanthanum oxide below $15/kg is nice to hear, but it won't help enough if processing volumes don't improve.

Management now believes that it can hit its full Phase 1 capacity (11ktpa) in June of 2014, a quarter later than previously hoped. Prices in the $21 to $22/kg range would likely support cash flow breakeven at that production level, and $25/kg pricing would suggest positive free cash flow in the neighborhood of $10 million to $20 million per year.

More Cash, Please

Unfortunately, reaching 11ktpa in June isn't going to be enough. With net debt of A$402 million, cash of a little under A$75 million and assets available for sale of about A$3 million, that's not enough to maintain the A$215 million or so in annual Phase 1 costs and make a scheduled US$35 million payment in September of 2014 (and I apologize for the intermixing of A$ and US$).

Accordingly, management acknowledged with its December quarter release that it is looking to add some liquidity, either through capital raising (debt or equity) or restructuring its debt obligations. I suppose that Sojitz/JOGMEC could be amenable to restructuring that repayment schedule (they've renegotiated/restructured before), but the sharp drop in the share price on March 11 suggests that the market believes it will be equity and/or debt that fills the gap, potentially diluting existing shareholders further.

Remember, it's not just the repayment that has to be covered, but also the ongoing fixed costs, maintenance capex, and so on. A rare earth oxide (or REO) basket price of $30/kg would fix a lot of Lynas's problems, but even the bullish analysts believe that's a couple of years away.

To Finish First, First You Have To Finish

Writing about stocks like Lynas always flushes out a contingent that will say "ignore all of this, just BUY!" on the basis of expectations for higher REO demand and prices. It is true that although cerium seems systemically over-supplied for the foreseeable future, neodymium and praseodymium are in a more precarious balance where even modest shortfalls in production or demand increases would lead to much higher prices. That said, Lynas has a very real history of missing its own targets and a very real need for additional capital, a need that will likely result in additional dilution to existing shareholders.

It also seems that the bulls on the sell-side are losing patience. The average sell-side EBITDA target for fiscal 2015 has fallen pretty sharply in just three months (from just under A$100 million to about A$68 million) and the delays in ramping up production (as well as greater assumed dilution and lower long-term REO price assumptions) have led to a steep decline in estimated net asset values (roughly 30%).

I don't want to ignore the real impact to valuation from further capital raising, but the reality is that there's not much choice. Lynas can't benefit from those forecasted increases in REO prices if it runs out of liquidity this year. What's more, the potential is still significant even with the added dilution. My estimated NAV drops to about $0.60, but that's still significantly higher than the going price of approximately $0.20.

The Bottom Line

Lynas is more of a speculation than an investment at this point, but there's nothing wrong with taking a chance on a speculative idea so long as buyers know what they're getting themselves into and what the down-side could be.

Buying Lynas today seems like a bet that the efforts to generate more liquidity won't be as dilutive as feared, otherwise it makes sense to wait to see what the company does. That is certainly a possible outcome, but I won't pretend to say I know how likely it is. Lynas is still a very leveraged play on higher neodymium and praseodymium prices (and higher REO prices in general) and today's problems could just be bumps along what proves to be a long road. At the same time, there is the risk that Lynas ends up in the ditch and I wouldn't suggest readers consider this one unless they can accept the risk of significant losses in the pursuit of significant potential gains.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers a stock trading at less than $1 per share and/or has less than a $100 million market cap. Please be aware of the risks associated with these stocks.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.