Thompson Creek provides the lowdown on Mt. Milligan

VANCOUVER — As the old adage goes, it tends to always be darkest before the dawn, and that seems an apt description for Colorado-based molybdenum (moly) player Thompson Creek Metals (TCM-T, TC-N). The company is bulling through a stage of major expansion despite falling moly prices, temperamental equity markets, and rising costs in a bid to diversify its commodity basket, and provide long-term shareholder value.

Thompson Creek’s strategy involves the development of its large-scale Mount Milligan copper-gold project northeast of Smithers, B.C., which is expected to produce roughly 81 million lbs. of copper and 194,000 oz. of gold per year over life of mine at adjusted cash costs of around 50¢ per lb. copper and US$690 per oz. gold,

“That’s been the upside and downside of our business forever, we’re uniquely sensitive to the price movements of moly,” comments chairman and CEO Kevin Loughrey during an exclusive interview with the Miner. “Mt. Milligan makes us more diverse in regards to our commodities, adding copper and gold to the mix. I also believe, over the long term, that when metals like copper and moly are depressed there is a good chance you’ll see gold prices pop.”

Thompson Creek was victimized by lower production, falling realized prices, and rising operating costs during the first quarter. Its two flagship moly assets — the Thompson Creek mine in Colorado and the Endako mine in northern B.C. — saw cash costs rise from US$5.37 per lb. over first quarter 2011 to US$12.95 per lb. to start 2012. At the same time, average-realized moly oxide prices have fallen from highs of US$17.37 early last year to a low of US$14.74 per lb. during the first quarter of 2012,

“Mid-to-long term we still feel good about the supply-demand fundamentals, and where the metal is headed,” Loughrey explains. “But there is no denying there is a lot of market uncertainty, predominantly due to the global economic situation, which creates caution in the mines and then in the activity of the buyers. That’s sort of the ‘watch word’ in the industry right now, and as long as Western Europe remains unresolved I think it will stay that way for a while.”

To compound its problems, Thompson Creek saw a drop in production during the first quarter due to the commissioning and ramp-up of a new mill facility at its Endako mine. Thompson Creek’s quarterly production fell from 10.3 million lbs. moly in first quarter 2011 to 4.4 million lbs. moly to start 2012. As a result, year-on-year quarterly net income plummeted from US$128.9 million to just US$1.1 million.

The Endako expansion has cost the company US$221 million to date, with US$83 million in capital expenditures (capex) locked-in on the project for 2012. The new mill will increase throughput levels by 77% to 55,000 tonnes per day, and reduce operating costs. Yearly throughput rates are expected to jump to 15 to 16 million tonnes per year, with full production targeted for the end of the second quarter. Thompson Creek also augmented its mine fleet with eight new haulage trucks, as well as two mining shovels and additional support equipment,

“Our cash costs increases over the first quarter were primarily because of the Endako mill, and its timing,” Loughrey says. “We actually thought we’d keep the old mill going longer than we did, which would have meant we’d have gotten close to full production until we closed it down. Instead we closed the old mill down early, and started up new operations, which meant the period of reduced production came earlier in the year than we thought it would. With reduced production come those increased unit costs since our costs are relatively fixed.”

Thompson Creek’s biggest problem was cost inflation during its build-out at Mt. Milligan. The company was a casualty of ongoing work shortages in the mine development sector, with labor turn-over and competition causing costs on the project to leap from around US$980 million to a range of US$1.4 billion to US$1.5 billion.

Thompson Creek spent US$409 million on the project in 2011, with an additional US$750 million to US$825 million pegged for development this year. Increasing pressures on labor and other consumables forced the company to review its build-out model, and release the higher capex number in February,

“When you have rising costs and labor turn over you have a hard time finding people, and that causes issues with productivity as well,” Loughrey comments. “We had a lot of hard working people up there, but we may not have had all the experience you would expect. All those things together triggered the inflationary pressures.”

Thompson Creek has attempted to maintain a more experienced workforce through increased scheduling flexibility, upgraded accommodations, and improved contract conditions. According to Loughrey the strategies appear to be working, though the company intends to keep a close eye on inflationary pressures on the labor front.

Mt. Milligan’s new capex figure was reportedly put through an improved and more stringent set of stress tests to assure unexpected cost increases do not continue to haunt the project. Thompson Creek says it cannot guarantee consumable prices will not rise again, but it remains much more confident in the updated cost ranges.

“We took the inflation rates we’d seen so far at Mt. Milligan as our assumptions, as opposed to making a ‘best guess’ or going with any sort of hypothetical. We projected forward based on hard, historic experience,” Loughrey declares. “We’ve broken it down better, we’re doing a better job of managing those costs, and we’ve hired outside consultants along with our own people to oversee the spending up there. We think we can foresee and handle any cost increases sooner and more effectively.”

As a result of the capex jump, Thompson Creek was forced to participate in a renewed bout of financings in early May. The company had originally attempted to avoid share dilution via equity placements, but due to funding shortfalls at Mt. Milligan it was forced to loosen its share structure.

With costs on the rise, Thompson Creek was facing a capital gap of between US$225 million and US$365 million. In a bid to cover the difference the company settled on a creative financing option that included US$200 million worth of seven-year senior notes at 12.5%, as well as a unique mechanism called tangible equity units (tMEDs) worth US$200 million that are priced at $25 per unit. tMEDs are basically convertible bonds minus the bondholder right to be paid out in cash, and return 40¢ per unit quarterly before transitioning to between 4.6 million and 5.4 million shares in 2015, depending on Thompson Creek’s share price.

“We had initially attempted to do the financing without any of the equity aspects, but that became impractical with the scope and size of financing we were attempting to complete,” Loughrey comments. “The tMEDs, unlike a straight equity offering, cause less dilution over time assuming the stock price goes up, which we believe it will.”

Thompson Creek is hedging that its shares have reached a bottom insomuch as the offering could cause dilution of as much as 28% if prices remain in current ranges, but trigger only a 24% share dilution assuming the company’s performance improves over the rest of the year.

Loughrey explains that the size of the financing was tailored to assure Thompson Creek was financially capable of finishing development at Mt. Milligan even if costs were in the higher US$1.5 billion capex range, and in the event that moly prices remained depressed through the financing period. It is important to note that all of the company’s capital assumptions do not account for cash flows stemming from operations.

The other major inflationary risk at Mt. Milligan is delays due to winter weather conditions. Thompson Creek is under the gun to get certain pieces of infrastructure finished over the summer so that development can proceed unhindered during its winter build-out season.

“I have to be honest in attributing this to luck. The way the timing has worked out with the winter work is that we should be able to get our mill building enclosed before the winter hits again, which is the key when working in those types of climates,” Loughrey explains. “Given the schedule now, where we’re heading into long British Columbian summer days, I think we’re going to get everything built we need to get built before we start to run into that bad weather again.”

Thompson Creek expects an improved production outlook to help bolster confidence through the second half of 2012. Not only is the mill at Endako slated to hit full capacity, but the company expects higher grade ore at its Thompson Creek mine later in the year,

“We’re seeing pretty much the mirror image of what we saw last year at Thompson Creek,” Loughrey says. “At the beginning of 2012 we were in higher-grades and moved into lower-grades. With the grades down in the first portion of the year, we saw costs go up, and we’d expect the inverse to be true as the year progresses.”

Thompson Creek’s shares have suffered mightily over the past 52-weeks, with prices down 66% or $6.88 year-on-year to a $3.55 presstime close. The company lost 50% or $3.63 per share since the beginning of March on rising costs and falling commodity prices.

According to Canadian Imperial Bank of Commerce World Markets analyst Ian Parkinson, however, the company should be on its way back up as it moves to complete Mt. Milligan. Parkinson maintains a $10 target price on the stock with a “Sector Outperform” rating.

“We believe the large disconnect between Thompson Creek’s valuation versus its peer group should be abated as this cash comes in the door and management is able to put a lid on capex creep,” Parkinson notes in a May research report. “Investors should also consider the market discount rate applied at Mt. Milligan and that as this project is built, de-risked, and ramped up the required return should lower to a more traditional rate; we see roughly $2.00 in upside just from this process.”