Wednesday, 4 December 2013

No respite in sight as Lynas bleeds - Soo Jin Hou

DECEMBER 04, 2013

I attended the Lynas annual shareholders' meeting (AGM) on 29/11/2013. During the meeting, I asked 2 questions.

The first: "In view of Molycorp's intention to ramp up their rare earths production by 130% from 10,000 tons to 23,000 tons per year, how does Lynas intend to do the same without a collapse in rare earth prices?"

The second: "The Malaysian government is under tremendous pressure after the Fitch rating downgrade to reduce or withdraw energy subsidy. How much will Lynas be affected if the energy subsidy is withdrawn?".

Neither question was satisfactorily answered and this suggests that it is likely that Lynas will continue to bleed red ink in the near to medium term.

Rare earths prices have collapsed spectacularly over the past 2 years (see Table at bottom of page). The 2 primary products from Lynas, i.e. lanthanum (LaO) and cerium oxides (CeO), which make up 72.2% [1], saw a 95% collapse in prices. Their current prices of less than AUD$6/kg (RM17/kg) are well below Lynas' current production cost, and more shockingly, below the optimal production cost of AUD$14-$15/kg (RM40.70-RM43.60/kg) Lynas needs to achieve by running at maximum capacity of 22,000 tons per annum (tpa) [3]. This is distressing because if Lynas cannot make money from these two products if conditions are ideal, Lynas will never make money from them.

Interestingly, the depressed prices come amid Molycorp running at only half its capacity [4] and Lynas at 19% of capacity [5]. So if both simultaneously ramp up production, REO prices will be crushed. Molycorp has expressed intent to increase production from 10,000 to 23,000 tpa by end of 2014 [6], while Lynas has expressed intent to increase from 4,200 to 11,000 tpa by next quarter. The combined increase is a whopping 239% from current production levels! The problem with Lynas and Molycorp is that their combined capacity of 42 tpa is 60% of the global demand outside China. They are so big they control prices. In the case of LaO and CeO, the spectacular collapse may be explained by them making up 72.2% and 83% [4] of Lynas and Molycorp's portfolio respectively.

Therefore, the more likely scenario is that both companies will ramp up production slowly to prevent REO prices from collapsing. By running below nameplate capacity, Lynas will not achieve economies of scale to turn profitable. It is easy to deduce that both companies will run each other to the ground.

It is quite obvious what Lynas' strategy is. Lynas hopes the profit made from the remaining products, chiefly neodymium (NdO) and praseudymium oxides (PrO) will be sufficient to overcome the losses incurred on LaO and CeO. Lynas is betting that NdO and PrO prices will go up. Unfortunately for Lynas, NdO and PrO also make up 14% of Molycorps' product [7], so premium market will also get competitive. With both players ready to ramp up production, prices are unlikely to grow much in the near term, in the best case; and in the worst case, will collapse just like LaO and CeO.

The most crucial question now is, what is Lynas' current real production cost? That data will enable us to forecast its profitability based on rare earths prices. In the absence of such data, an appropriate estimate may be production cash flow divided by November's production numbers of 350 tons (4200 tpa) [5], the highest output on record. For the period ending 30 Sep 2013, Lynas dispensed AUD$40 million (RM116.7 million) in operational, production and administration costs to produce only 253 tons (1012 tpa) of REO. Assuming the best case scenario that costs stay constant despite a fourfold increase in output, the current cost is AUD$38.1/kg (RM111/kg), an ocean divide from the targeted AUD$14-15/kg.

In essence, Lynas is caught in a catch-22 situation. If it ramps, it loses money with depressed selling prices. If it doesn't, it loses money from high costs. Damned if it ramps, damned if it doesn't.

Lynas may see an increase in production costs. During the AGM, I raised the inevitability of the government of Malaysia withdrawing the energy subsidy, to which Lynas replied that they are minimally impacted as they are not an energy intensive company. The 3rd day after the AGM, the government of Malaysia raised electricity tariff by 15%. Electricity may not be a significant part of Lynas' expenditure, but liquefied petroleum gas (LPG) might be.

Lynas uses LPG to heat its rotary kiln, where the ore concentrate is dissolved by sulphuric acid at 650°C. According to the PEIA, Lynas consumes 12,820,000 Nm3/year [6]. That is equivalent to approximately 25.6 million kg/year or about RM 47.4 million/year. The subsidy is approximately half [7], therefore Lynas may need to fork out another AUD$16.2 million (RM47.1 million)/year if this subsidy is pulled from under Lynas' feet. Since Lynas burns approximately AUD$100 million (RM291 million)/year, I find it hard to accept AUD$16.2 million as negligible.

In addition to production woes, Lynas lost badly in the court of public opinion, despite winning all litigation cases. Pakatan Rakyat, who ran on an anti-Lynas platform, won the popular vote in the general election. More significantly, 6 out of the 7 representatives around Kuantan won on the anti-Lynas platform, proving that the local community rejected the project. Shortly after, Himpunan Hijau collected 1.3 million physical signatures (not online ones) in a petition against Lynas. Lynas provoked further anger by behaving like an ostrich, refusing to answer any allegations raised in the Oeko Report commissioned by Save Malaysia, Stop Lynas. Therefore, Lynas will be on the agenda in the next election, if it is still alive by then. It will be another stressful period for Lynas investors, who then have to dabble in political science to bet on a regime that is experiencing eroding electoral support.

The conclusion is, Lynas will fail. It is not a matterof if, it is a matter of when. It will happen when creditors stop throwing good money after bad and just let Lynas die. At the current cash burn rate at AUD$ 100 million a year, Lynas' cash pile amounting to AUD$101 million [3] can last only about a year. Is there any more creditors foolhardy enough to throw money at it?

In the face of certain failure, the residents around Balok and Kuantan should get concerned about the permanent waste disposal solution, particularly, the sufficiency of funds. If Lynas have not left sufficient deposit with the incompetent government, the taxpayers might once again, be made to bear BN's blunder.

[1], "Average Mt Weld Composition Price". Earlier reports have distribution data.
[2] Lynas stopped updating the composition price regularly and provided no FOB China price in the latest quarterly report. 21 Nov numbers taken from Arafura's website
[3] Lynas quarterly report for the period ending 30 Sep 2013.
[4], "Presentations, Q3 2013 Molycorp Inc Earnings Conference Call Presentation".
[5] Novermber estimated output found in CEO's Address to AGM, download here:
[6] Preliminary Environmental Impact Assessment and Quantitative Risk Assessment,
Proposed Advanced Materials Plant, Gebeng Industrial Estate, Kuantan, Pahang
Malaysia. Volume 1: Main Report. Environ Consulting Services (M) Sdn. Bhd. January
[7] A Citizen's Guide To Energy Subsidies in Malaysia, The International Institute for Sustainable Development, 2013. Download here:

1 comment:

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