Lynas Approaching Blanket Coverage

This story features LYNAS RARE EARTHS LIMITED. For more info SHARE ANALYSIS: LYC

– Lynas Corporation closer to first rare earth production
– Upside potential still significant even if further delays
– Macquarie initiates with an Outperform rating

By Chris Shaw

With the Mount Weld Rare Earth Project close to first production, market interest in Lynas Corporation ((LYC)) is growing. As evidence, Macquarie on Friday initiated coverage on the company with an Outperform rating.

Demand for rare earth elements is estimated to have increased by 8-10% per annum between 2000-2010. Macquarie notes China has been the main player in the market and is forecast to account for 66% of total global demand by 2015.

China is also the main supplier of rare earth elements, with 55 million tonnes of identified reserves according to the United States Geological Survey. This equates to around half of identified global rare earth reserves. China disputes this, the Chinese Society of Rare Earths suggesting China's share of global reserves has fallen from 41% in 1998 to 32% in 2010. 

What is not in doubt are production figures, Macquarie noting at present China accounts for 95% of total global production. This market dominance presents some risk to new entrants such as Lynas, though Macquarie suggests these risks have been reduced by off-take agreements and alliances Lynas has put in place.

The Mount Weld rare earth project is one element of the asset base of Lynas Corporation, the other being the LAMP materials plant in Malaysia. Phase 1 of the combined operation is expected to produce 11,000 tonnes per year of rare earth materials, with first production forecast for late FY12. Macquarie notes Lynas has already started work on the Phase 2 expansion, which is expected to double production. Phase 2 construction is currently expected to be complete by the end of 2012. 

Using a long-term rare earth basket price of US$40.58 per kilogram and operating costs for Lynas of US$15 per kilogram, Macquarie values the Mount Weld Rare Earth project including Phase 2 expansion at $2.42 per share. This would increase to $7.70 per share using the spot basket price of US$125.34 per kilogram and a USD/AUD exchange rate of 1.04. This cost assumption appears conservative, as Lynas itself has estimated operating costs of US$10 per kilogram.

Macquarie's valuation accounts for the major hurdle facing Lynas at present, which is the required permit to begin operations in Malaysia. Completion of LAMP is slightly behind schedule and the Malaysian government has indicated no approval to operate the plant will be given prior to Lynas satisfying International Atomic Energy Agency recommendations for the plant.

Given Lynas has satisfied international safety requirements for the plant, Macquarie remains confident approval will eventually be granted. The broker notes there is potential for further delays to any start-up while this approval process is completed. In the meantime, Lynas is stockpiling concentrate on-site at Mount Weld.

One potential impact from any significant delays to LAMP is there may be delays to cash receipts, so triggering additional working capital requirements. Macquarie's numbers suggest Lynas needs cash receipts from sales by June of next year to avoid any working capital issues.

Macquarie's Buy rating brings to four the number of brokers in the FNArena database that both cover Lynas and rate the stock as a Buy or Outperform. The consensus price target for Lynas according to the database is $2.24, with targets ranging from RBS Australia at $1.84 to Deutsche Bank at $2.42. Macquarie has set a target on the stock of $2.30.

The problems of delays to the plant in Malaysia and a pushing out of the timetable for first production had already been factored into the models of RBS, JP Morgan and Deutsche Bank, so the valuation impact of the news has been minimal.

Given the consensus price target according to the database implies upside relative to the current share price of more than 90%, any minor changes are not enough to impact on the positive views of brokers towards Lynas.

For more on rare earth metals see FNArena's previous feature Make Mine Rare.

 
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