LYSDY - Lynas Rare Earths: Record Production In '24 Mt Weld Expansion Next Step

2023-09-15 15:00:00 ET

Summary

• Lynas Rare Earths Limited stock has sold off sharply in 2023 and is near 2-year lows.
• LYSDY is positioned along the rare earths value chain and has operations in Australia, Malaysia, and upcoming operations in the US.
• The stock sells at high multiples and lacks identifiable catalysts for mid-term repricing.
• Net-net, rate hold.

Lynas Rare Earths Limited ( OTCPK:LYSDY ) has sold off sharply in 2023 and failed to catch a bid at the each wave of the downtrend. The stock now sells near 2-year lows as I write. This report will unpack all the moving parts of the LYSDY investment debate.

As a reminder, LYSDY is positioned at all points along the rare earths value chain, from exploration, to mining and extraction, and processing of rare earth minerals (more on these a bit lower). It has an established footprint in Australia and Malaysia, with U.S. operations set to begin over the next 2 years. The company's corporate structure is seen in Figure 1.

Figure 1. Lynas Corporate Structure. Mt Weld is the flagship asset, with Kalgoorlie and Malaysia critical factors to the growth route.

The stock still sells at relatively high multiples, despite tracking the VanEck Vectors Rare Earth/Strategic Metals ETF ( REMX ) with striking similarity over the last 12-18 months, as seen in Figure 1(a). For reference. LYSDY is a REMX holding as well. You're paying almost 22x forward earnings to buy LYSDY today at a 5.4% forward cash flow yield, without pricing of the underlying resource to back this up. Despite a number of developments in its fiscal '24, there is a lack of identifiable catalysts to see the company trade higher in the mid-term, notwithstanding the volatility of rare earths pricing in CY 2023. Net-net, rate hold.

Note: LYSDY reports in Australian Dollars (AUD). All figures presented here today are presented in AUD unless otherwise stated, where the cross rate of AUD/USD is 1 USD = 1.55 AUD at the time of writing.

Figure 1(a). LYSDY vs. REMX, 2021–date

Critical investment facts underlining investment thesis

1. Overview of rare earths market

Rare earths, or rare earth elements ("REEs"), are a group of 17 metallic elements that share similar chemical statistics. They are most commonly used in modern technologies due to their unique, and largely unreplicable properties. Despite their name, these elements are not actually rare per se, and are quite abundant in the Earth's crust. However, they are not typically found in concentrated deposits, which makes their extraction challenging and costly. China dominates the global production of rare earths, accounting for ~80% of the world's supply, with Australia and the U.S. coming in a distant second and third.

Each element has distinct properties, contributing to their various applications. To name a few.

1. Permanent magnets— Neodymium and praseodymium , also known as " NdPr", are critical components in high-strength permanent magnets used in electric vehicle motors and wind turbines.
2. Catalysts/catalytic converters— Cerium, lanthanum , and other REEs are critical in catalytic converters (these are used to reduce harmful emissions from vehicles, typically located on the exhaust system). Catalytic converters are also mandated in all modern-day combustion engines, so the demand will always be there for these 2 minerals. Cerium and lanthanum are also known as "La and Ce" .
3. Electronics and glass markets —Europium and terbium are used in color television tubes, while yttrium is employed in LED lighting. Rare earths also enhance the performance of nickel-metal hydride ("NiMH") batteries, commonly found in hybrid vehicles. Cerium oxide is crucial in the glass industry for polishing and in the production of optical lenses.
4. Military applications : Finally, REEs are used in guidance systems, radar, and precision-guided munitions.

Demand for REEs has surged in recent years given the electronification trends and movement towards electric vehicles ("EVs") in particular. The move to renewables has been a positive catalyst as well. The increasing adoption of wind turbines and electronics has been central to this, and this trend is expected to continue in the coming years.

2. Breakdown of FY'24 numbers—production volumes up, realized prices, revenues down

• Hitting production milestones despite tight REE spot pricing

LYSDY put up revenues of $739mm for the year , down 20% YoY [note: LYSDY reported its FY'24 results in August, which corresponds to Q2 CY 2023. For consistency and simplicity, I'll be talking in terms of FY'24, unless otherwise stated. As mentioned earlier, all figures are in AUD unless otherwise stated] . It realized this on an ASP of $46.20/tonne, down from $60.30/tonne last year, but above the $29.80/tonne ASP in 2021. The average China domestic price of NdPr declined from US$124.0/kg in June 2022 to US$60.4/kg in June 2023, crimping overall sales growth. Still, LYSDY hit record production of 1,864 tonnes of finished product in fiscal '23. This is a positive, no doubt. The company's ready-for-sale production of NdPr was also up 4% YoY, on the back of record-breaking production volumes recorded in both the March and June quarters.

Figure 3. LYDSY Total Sales and ASP's down YoY...

Figure 4. ...but production numbers at record highs

In August, LYSDY announced an expansion project of ~$500mm to boost capacity at its Mt Weld mine and concentration plant. As a reminder, Mt Weld is its flagship asset. The capital spend is aimed at bringing annual production of 12,000 tonnes p.a. of finished NdPr product. The investment was made toward scaled-up processing equipment, efficiency improvements, and so forth. It also paved the way for 2 additional stages currently in development. Should these convert, it could expand production by an additional 2,400 tonnes of finished NdPr oxide per annum.

Figure 5.

• Strategic Contract with U.S. Department of Defense ("DoD")

Also in August, LYSDY secured a follow-on contract with the U.S. DoD to construct the heavy REEs component of the company's U.S. REEs processing facility in Texas. Under the updated contract, all construction costs allocated to LYSDY will be reimbursed by the DoD under an expenditure-based model. The DoD has committed ~U.S. $258mm toward the project, an increase from ~US$120mm last year.

LYSDY acquired a 149-acre greenfield site in Texas (previously owned by a subsidiary of The Dow Chemical Company ). This site will play host to the company's U.S. processing facility, and it will serve both DoD and commercial clients. LYSDY will source the facility's feedstock from its Mt Weld deposit and the Kalgoorlie sites in Western Australia. The facility is expected to be ready for operation anywhere between 1st July CY 2025 and 30th June CY 2026. So this could be a meaningful tailwind to keep an eye on in the coming 12—24 months.

Figure 5. U.S. facility in Texas. The site will host LYSDY's U.S. processing facility. All zoning and code are taken care of, being that it's already in an industrial zone.

• Lynas Malaysia—multiple challenges throughout the year

NdPr production at LYSDY's Malaysian operations came to 1,725 tonnes, a new quarterly high. This was despite a brief shutdown of the plant earlier in the year (due tor tie-in works related to the MREC receival facility). However, the total rare earth oxide ("REO") production volumes decreased to 4,348 tonnes secondary to a shortage of hydrochloric acid, which affected La and Ce production. Nevertheless, LYSDY ensured a minimum supply of La and Ce to key customers.

We shouldn't look past the water supply disruptions at LYSDY's Malaysia plant that happened last year. This was due to:

1. Unpredictable water supply from the local water utility it is using, PAIP, and
2. Equipment failures in the water supply infrastructure.

LYSDY has faced intense scrutiny for its Malaysian facility in the last few years. The debate centres on concerns over radioactive waste and environmental impacts involved in the cracking and leaching processes involved in producing REEs. Earlier this year, the Malaysian Government put certain restrictions on the company's cracking and leaching process, noting it would not be "not allowed to carry out any activities that will produce radioactive waste in Malaysia after July [CY]2023" . The deadline was later extended to January CY 2024. In my view, the decision shifts focus onto LYSDY's timeline of its cracking and leaching facility in central Australia. Talking on the Q4 earnings call, CEO Amanda Lacaze said:

Under a best case scenario, yes, we have approval to continue to operate in Malaysia. Under a best case scenario, we then would make commitments and decisions related to upsizing the downstream capability. And I think at the last quarterly call, Pol, actually talked about, we had an opportunity to consider how to revamp our ASICs and in particular, but also invest in further product finishing capability in Malaysia, which would allow us to get an uplift in capacity there, which is why we are confident about making a step to the 9,000 tonnes at Kalgoorlie because we will be able to uplift the downstream capacity at the most appropriate time. The other thing to note is that there are No, we’re not sort of concerned that we will add additional capacity if we’re not able to process it ourselves. And of course, finally, the Mixed Rare Earth Carbonate feedstock will be going through to the U.S. facility. So yes, it will be a very big celebration if we had both the facilities operating".

Valuation and conclusion

The stock sells at 21.7x forward earnings , 17x forward EBITDA and 21x forward EBIT when stripping out the depreciation charge. You're getting a 5.4% forward cash flow yield on this in buying LYSDY today. It trades well ahead of comparable peers, and the company sells at a 116% and 83% premium to the sector on these multiples. Consensus is calling for $0.21/share in earnings in the coming year. Assigning the 21.7x multiple to this derives a price target of $4.55/share, slightly below the current market value as I write. This supports a neutral view.

Figure 6.

In short, REEs majors have sold off sharply in 2023 amid a correction in the spot price of the core metals. LYSDY's industry positioning is undeniable, and potential tailwinds are in the fact it is the second major producer outside of China. But the company still has a ways to go in order to see a return on the tremendous capital outlay it has poured into its Australian and Malaysian operations over the last decade. Forward multiples are pricey and not reflective of the assets and earnings in the business. I get to $4.55/share in implied value at 21.7x forward earnings below the current market value as I write. This supports a neutral view. Net-net, rate hold.

For further details see: