Thompson Creek Bull Case Remains, But Investor Confidence Is Gone

| About: Thompson Creek (TCPTF)
This article is now exclusive for PRO subscribers.

The bad news continues at molybdenum producer Thompson Creek Metals (TC). After surviving the 2008-09 recession, when the price of the company's key product fell below $5 per pound, TC stock rebounded nicely in 2009, and provided a solid return into 2010. In July of that year, the company expanded into gold and copper mining through the acquisition of Terrane Metals. Terrane's major asset was the undeveloped Mt. Milligan gold and copper project in British Columbia. The market clearly liked the purchase, and TC moved over $15 in the months following the acquisition's close.

From there, it has been nothing but struggles for Thompson Creek. The stock was halved in 2011, and, at Wednesday's close of $4.37, is down another 37.2% so far in 2012. The key issue has been cost overruns at Mt. Milligan, whose capital expenditure budget has ballooned from an original C$915 million to the current expected range between C$1.4 and C$1.5 billion. (The US and Canadian dollars are currently trading roughly at par.) In addition, the company's legacy Endako mine saw C$100 million of overruns in its expansion, which was completed earlier this year.

But, for TC shareholders, the past week has probably been the worst of the 18-month decline. Last week, first quarter earnings disappointed investors. The company guided toward the higher end of its $7.75-$9 per pound average cash cost range for molybdenum, citing ever-present "inflationary pressures." Furthermore, operating cash flow was just $3.1 million, raising fears of yet another round of funding to complete the Mt. Milligan project. TC had already sold 40% of the project's gold stream to Royal Gold (NASDAQ:RGLD) in two separate transactions: one announced in conjunction with the Terrane purchase and a second addition of 15% in December. As I noted at the time, the second deal appeared to close the company's funding gap, boosting the stock; but the past two earnings reports showed that weaker-than-expected operating cash flow and higher-than-expected costs might have re-opened the gap. Indeed, the company's first quarter earnings presentation [pdf] showed the funding shortfall had re-emerged, ranging between C$225 and C$365 million.

This week, the company took steps to ensure that Mt. Milligan -- which still requires between C$799 and C$929 million in additional spending -- would be completed. On Monday, the company issued between US$220 and US$250 million in so-called "tMEDS", or tangible equity units, a debt-equity hybrid. Those tMEDS will create between 40.38 and 53.88 million new shares in TC, representing dilution of between 24 and 32 percent. On Tuesday, Thompson Creek priced US$200 million of senior notes. The total inflow of US$410-$440 million (net of underwriting expenses) should, at last, close the funding gap required to pay off the Endako expansion and complete the Mt. Milligan project.

But, of course, investors have heard that before. And given that the weak earnings, new debt, and dilutive equity offering caused the stock to fall 27% in the last week alone, few would be blamed for running for the exits. The company has made misstep after misstep, and failed to control costs both on the Mt. Milligan development and the legacy Endako mine. Yes, higher input costs, such as labor and in particular fuel, have hurt mining stocks, which continue to underperform relative to the commodities they sell. But the lack of confidence in TC management is shown not only by the stock's steep collapse but by the coupon on the senior notes issued this week: a staggering 12.5%. Given the current low-interest rate environment, the 12.5% interest rate awarded TC shows the bond market's belief that a strong possibility of continued bad news exists.

In addition, higher input costs and lower gold and copper prices (which have declined 3.3% and 6.3%, respectively, over the last month) have lowered the future valuation of the Mt. Milligan project. In its recent earnings presentation, TC estimated $220 million in annual cash costs once Mt. Milligan came online, up from its $200 million estimate after the fourth quarter. [pdf] Back in April, I calculated the net present value of the company, given Mt. Milligan as its only asset. With the updated information, and lower gold and copper prices, here is the updated valuation outlook for TC, disregarding its legacy operations and the undeveloped Berg and Davidson properties:

Mt. Milligan Breakdown

Asset/Liability Value (MIL)
Mt. Milligan Mineral Rights1 $2,045
Future CapEx (high end of range)2 ($972)
Gold Stream Proceeds Due2 $172
Cash On Hand $163
Total Liabilities3 (914)
Total $494

1 -- based on calculations made in April, adjusted for 3.3% drop in gold, 6.3% drop in copper, and 10% rise in estimated cash costs between 4Q11 and 1Q12 earnings presentations; total value declined approximately 11%

2 -- data from 1Q earnings presentation

3 -- excludes gold stream deferred revenue

In short, the net present value of the Mt. Milligan project has declined some $218 million from where I calculated it just five weeks ago, with the increase in input costs accounting for much of the drop.

This remains the problem with the bull case for TC; even with Mt. Milligan valued at a now-lower $494 million, the stock looks cheap. The remaining $240 million in market capitalization includes the legacy Endako and Thompson Creek mines, which produce 26-28 million pounds of moly this year, or roughly $400 million per year of revenue at the first quarter's average realized price of $14.74 per pound. (Even at the high end of anticipated cash costs, 2012 gross profit from the mines would be $150 million at current prices.) It includes $36 million in restricted cash, $66 million in accounts receivable, and $120 million in inventory. In short, with tangible book value (accounting for the high end of tMEDS dilution) still at $7.70 per share, TC looks to be trading at about liquidation value.

But, of course, I've written this article before, with TC at $8, then $7, then $6, and now $4.37 per share. The price keeps dropping because shareholder value is being decimated by higher costs and dilutive and/or high-cost offerings. The interest alone from this week's issue of 12.50% notes will, should the loans not be called before their 2019 maturity, cost some $175 million, or nearly $1 per diluted share. The cost overruns at Mt. Milligan and Endako, now projected around C$600 million, represent another nearly $3 per diluted share in lost value. With those kind of figures leading the stock from $16 to $4, it's difficult to see the bull case as compelling, given that the company has another 18 months before Mt. Milligan is (hopefully) completed. New investors can look to cash-secured puts to create an even lower entry price; existing investors should consider dollar-cost averaging to lower their cost basis. But, given the recent performance of both the stock and the company, it's getting harder and harder to believe that TC's falling knife is worth trying to catch.

As it has for at least a year, the sum-of-the-parts case for Thompson Creek Metals looks bullish. But management must get costs under control, must deliver Mt. Milligan on time, and must have closed the funding gap for good. The events of the past week prove that investors have very little confidence that TC will succeed -- and it's awfully hard to blame them.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.