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Morningstar | Wesfarmers Is Dipping Its Toe Into Uncharted Waters; Fair Value Estimate Unchanged at AUD 28

Wide-moat rated Wesfarmers’ conditional proposal to acquire rare earth miner and processor Lynas Corporation puts resources back on the agenda. Wesfarmers only just completed the sale of its two coal mines in 2018, reducing its exposure to volatile commodity prices. However, adding Lynas would help diversify the heavily retail-centric portfolio and provide exposure to fast-growing high-tech industries, such as electric vehicles.

Wesfarmers’ non-binding indicative proposal to acquire Lynas for AUD 2.25 per share in cash values the equity at AUD 1.5 billion and the enterprise value at AUD 1.7 billion. The offer price represents a 45% premium to the last closing price of Lynas.

It’s still early days in the negotiations between Wesfarmers and Lynas. Several conditions still need to be met and no timeline has been set. At this stage, we don’t include Lynas in Wesfarmers’ base-case fair value estimate that we maintain at AUD 28. Investors were wary about the proposal, with the stock declining 3.5%, but shares remain overvalued.

In our view, Wesfarmers brings little industry-specific expertise to the table. We see little merit in the acquisition, beyond Wesfarmers’ ability to provide capital to increase Lynas’ production capacity. Although the group owned and operated coal mines until recently, rare earth elements have a different usage and customer base, and mining and processing procedures differ from coking and thermal coal mining. The key rare earths processing facility is in Malaysia, where Wesfarmers currently has no material businesses, and strong relationships with local stakeholders could prove vital to the plant’s prospects.

The proposed AUD 1.5 billion acquisition of Lynas would re-introduce commodity price uncertainty to the group’s bottom line. For instance, the Chinese domestic price of Neodymium-Praseodymium, or NdPr, declined by 31% in the 18 months leading to the December quarter 2018.

Entering into fixed pricing, or less variable pricing contracts with key customers could help mitigate this risk but would also constrain the upside potential.

Lynas may also require additional capital from Wesfarmers. If the acquisition succeeds, Wesfarmers may decide to expand the processing capacity at the existing plant or build a greenfield plant outside of Malaysia. Our preliminary cost estimate of building a similar processing plant in Australia is around AUD 1 billion.

A key near term risk to Lynas’ operations is the outstanding licence renewal at its Malaysian plant on Sept. 2, 2019. However, we expect the acquisition will be conditional on the licence being renewed.