METC - Ramaco Resources: Why Stock Value Will Continue To Increase Into 2024

2023-09-20 23:32:37 ET

Summary

• Ramaco Resources reported a drop in Q2 2023 revenues, but its discovery of rare earth elements in its Brook Mine presents a significant opportunity for future growth.
• The production and demand for rare earth elements have been affected by China's dominance in the market and the increasing use of REEs in renewable energy technologies.
• Ramaco Resources has the potential to increase its coal production for export purposes and strengthen its exposure to pricing variability, creating a stronger revenue stream.

Metallurgical coal operator, Ramaco Resources ( METC ) reported Q2 2023 revenues of $137.47 million indicating a drop of 0.86% (YoY). While revenue missed estimates by $7.55 million, the EPS of $0.17 missed consensus estimates by $0.30. It was a challenging quarter for the met coal industry which faced lower pricing and pressure from inflation that adversely affected costs.

Thesis

Ramaco Resources’ discovery of the largest unconventional deposit of primary magnetic rare earth elements ((REE)) in its land is what I would describe as the future of the company with a significant add-on value. By 2024, I expected the company to post record net income and adjusted EBITDA boosted by an increase in met coal production, sales, and a decrease in mine costs per ton sold.

Ramaco Resources has yielded a return of 21.53% in the past year and more than 32% in the past 6 months boosted by a discovery of significant deposits of unconventional rare earth element deposits in its Wyoming site. In August 2023, METC announced that the REE deposits had increased by up to 50% compared to its initial May 2023 target discovery.

REEs are classified as a group of 17 chemical components or metals occurring together in the periodic table. Among the deposits found in the Brook Mine area are Neodymium, Praseodymium, Dysprosium, and Terbium secondary magnetic rare earth oxides (REOs). Ramaco Resources through analysts from Weir International determined that the company’s exploration target size had increased 50% by August 2023 to 0.9-1.2 million tons of total REOs from May 2023 target of 0.6-0.8 million tons. According to the company's statistics, the last 10 years have seen the US domestic consumption rate reach about 10,000 tons per year of REEs. What is more interesting is the fact that Ramaco Resources is only assessing a third of the Brook Mine area and is yet to fully determine the full amount of REE in the entire mine.

Production and Demand for Rare Earth Elements

China has been at the forefront in the production of REEs especially after it began selling low-priced REEs in the late 1980s. Onwards, production in the US and other areas was reduced until China cut back exports in 2010. Over the years, the Chinese government has been imposing export quotas and limiting illegal mining operations that have since lowered production in Asia and increased production in the rest of the world.

Firstly, REEs are prominently used in the renewable energy space such as in the production of wind turbines, batteries, catalysts, and electric cars. Due to the erratic demand and volatile nature of the REE market, some elements such as neodymium oxide have increased from below $10 per kg in 2001 to up to $239 per kg in 2011.

Neodymium’s price has lost 39.18% (since January 2023 when it stood at $209.30/kg) but has gained 81.75% since January 2018. Over the last 10 years, there have been subsequent price increases in other REOs such as Europium, Dysprosium, and Terbium oxide in the range of 300% to 500%. Chinese REE producers have had issues with environmental pollution, especially from the mining locations as well as smuggling that have forced government intervention. The subsequent result is a reduction in Chinese REE that has pushed prices bringing other producers such as Korea, the US, and Canada into the limelight. But even with this reduction, China is still at the forefront in REO production into 2023.

Correlative financial performance

The FY 2022 saw China produce 210,000 metric tons of REO. The US current production stands at 43,000 metric tons which is about a fifth of China’s produce.

In the US, MP Materials Corp ( MP ) which operates the Mountain Pass- the only REE mining and processing site in North America reported a 9% (YoY) increase in total value of assets in Q2 2023. Despite incurring costs related to demolitions of old infrastructure from Mountain Pass mining, was still planning future expansion of its REE processing site into 2024. MP has a market cap of $3.6 billion and its Q2 2023 revenue came in at $64 million. Additionally, its net profit as of the FY ended in December 2022 stood at $289 million indicating a recovery from the Covid19 related shocks that forced a net loss of $21.8 million in the year ending in December 2020.

For Ramaco resources revenue came in at $137.5 million in Q2 2023 while the value of its total assets increased 34.85% (YoY) to $660.4 million. In Q2 2022, the company acquired Ramaco Coal whose royalty fees as well as those from Amonate reserves were responsible for 3% of the total coal sales recorded in the quarter. Other CORE assets considered as non-cost-bearing revenue sources for Ramaco that played a role in the period included infrastructure fees. Ramaco charges $5 per ton of coal processes at its plants and up to $2.50/ ton of loaded coal from its rail-load centers.

In my view, the addition of rare earth elements will add on to Ramaco Resources’ revenue stream considering the available resources at the company’s disposal. Ramaco’s board approved the initial mine development of the REE expected to commence in Q4 2023. At the moment, coal and its related sales have formed part of the company’s revenue. Export revenue in Q2 2023 (excluding Canada) recorded the highest revenue at $84.1 million against North American sales at $53.4 million.

It is vital to note that coal sales outside the US (export revenue) have been growing, offsetting the decline in North American sales.

Coal export sales outside the US have increased 77.9% (YoY) in the three months ended on June 30, 2023, offsetting the 41.57% (YoY) decrease in North American coal revenue in the same period. In the six months ending on June 30, 2023, coal export revenue has risen 47.22% (YoY) to $210.4 million, offsetting the 37.97% (YoY) decline in North American coal sales over the same period. I expect that the increase in export sales of met coal into 2024 which will include index-based product pricing will continue to create stronger exposure to pricing variability in the year as compared to that of 2023.

Additionally, I expect the company to increase its coal production for export purposes. In H1 2023, Ramaco sold 1.5 million tons of coal and realized a total revenue of $303.8 million. Of the amount sold, 31% was sold in North America, while 69% was exported. In H1 2022, Ramaco sold 1.2 million tons with 51% going to North America while 49% going to the export market. This operation realized $293.5 million, which was about $10.3 million lower than the previous amount. Ramaco’s management made the right call to increase sales and tonnage into the export market as opposed to the North American segment that includes Canada.

Risk and valuation

At the moment, China is the principal customer of rare earth metals. Cases of political or social-economic instability in the region such as the COVID-19 lockdown will affect the sale or export of REOs.

These metals are also not traded in the normal commodity markets such as the London Metal Exchange ((LME)) so establishing their correct prices has been a challenge.

For MP, Chinese miner, Shenghe is its main customer and as of Q2 2023 accounted for more than 90% of its product sales. Having one primary in this case poses a risk of customer-centricity and may push the company to downgrade its innovative potential. Ramaco may also face the same challenge and may look to establish its primary export market in China, which is also the main processor of REOs. Further, Ramaco like MP will be affected by the main client’s REO realized prices in China.

As noted earlier, there was a drop in the coal consumption levels in the US due to its substitution with cleaner energy sources such as wind and solar. Additionally, the mining of REEs may contaminate and disrupt the environment as it occurs in vast open pits. Ramaco will need to regulate mining to avoid the production of wastewater, heavy metals, and the leakage of radioactive material into groundwater.

Ramaco announced in its recent SEC filing that it plans to carry out a mixed-shelf offering of securities valued at $400 million. This move will cause significant stock price dilution since the company had 52.7 million total shares outstanding as of Q2 2023. We may also be on the verge of an acquisition, which is phenomenal as Ramaco is pursuing a major mineral discovery.

In regards to valuation, Ramaco’s P/E ((FWD)) stands at 5.95 against the industry average of 14.51. It shows a difference of -58.96%. METC’s EV/Sales ((TTM)) is 1.09 against the industry average of 1.47 indicating a difference of -25.79%. These metrics show that Ramaco is highly undervalued with a stronger upside potential.

As of 2022, the global market value of rare earth metals was $5.37 billion. It is projected to reach $14.24 billion by 2030, growing a CAGR of 14.9% during the forecast period.

Bottom Line

Ramaco Resources made a significant move by identifying rare earth elements in its US Brook Mine. I expect the product to form a solid alternative revenue stream to coal whose consumption is declining in the US. It is also vital to consider the company's intended $400 million mixed shelf-offering which to me can cause a major dilution looking at the total share outstanding. Still, I believe the stock has a strong upside potential especially if it proceeds to mine the REE. For these reasons, I propose a hold rating for the stock.

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