Lynas Corporation Limited (LYC.ASX, $0.71/sh, Mkt Cap $1.13b) – Management of residue offshore increases execution risk and costs – TRADING SELL PT $0.50/sh.
•We previously issued a sell recommendation on LYC, predicated on the TOL not being issued until post election given it remains a highly politicised issue.
•We remain of the view that the TOL will be issued post election and reiterate our sell recommendation on growing concerns regarding dilution should the convertible bonds price be reset, project execution risk, and funding implications.
•The only major change in yesterday’s market announcement was LYC announcing it is willing to ensure all material causing concern to the Malaysian public being removed through conversion into co-products and exported elsewhere in a form acceptable to international markets.
•We don’t expect the Australian or WA government will be a willing recipient and anticipate higher execution risk and costs as a result of exporting waste material offshore.
•Latest expectations are that a Malaysian election will be held in late Q4CY12. It’s widely expected that Prime Minister Najib Razak will table the Budget on Sept 28, dissolve Parliament shortly after and then hold an election within two months.
•The expected delays will also have funding implications and cause balance sheet difficulties in the interim.
•While the plant is now completed in Malaysia, there still remains a long lead time until cash flow generation that will need to be funded by sufficient working capital. We estimate a minimum 6-month lead-time from when the TOL is granted, which in itself could be generous given the complexity of the processing circuit, to account for ore being shipped from Mt Weld, plant commissioning, customer product qualification, and receipts from first sales.
•Total cash balance as of June 30 was $205m. $81m of that is restricted for phase 2 expansion, leaving an unrestricted cash balance of $124m. We estimate a minimum $50m was required for completion of phase 1, an additional $15m for sustaining capital, and $16m working capital spend since July. We therefore estimate LYC currently has just $43m in working capital.
•We estimate $8m a month in working capital requirements in a ‘stand still’ scenario. Therefore should the TOL be delayed until next year we would expect additional funding would be required to ensure sufficient working capital is in place to successfully ramp up the plant to full production.
•We would also like to seek clarification regarding a further dilution event if LYC fails to have the TOL issued by the convertible bond reset date on the 15th of October. This is the date at which the $225m convertible bond can be re-set based on a LAMP non - approval event.
•To us, LAMP Non-Approval Event means “the Malaysia Pre-Operating Permit not being obtained by the Group on or before 15 October 2012.” If LYC has not received a TOL by 15 October 2012, we expect the conversion price is reset to 120% of the VWAP 30 trading days post 15.10.12, vs. a current conversion price of $1.25/sh.
•We recommend clients that have a position in LYC to SELL given the licence uncertainty, funding implications and additional risk of managing waste.