The Case For Molycorp
By:
Joseph Hogue
When it comes to fundamentals, Iwill be the first to
admit that
Molycorp (
MCP
)
is not what I usually look for in astock .Earnings for this
once-thriving miner have been negative for the last
twoquarters and managementguidance for productionputs 2012
fourth-quarter sales as low as $145 million, 30% below
sales of $206 million in the previous quarter.
But investors only looking for "
Forever Stocks
" with great balance sheets andcash flows may also miss out
on hugeinvestment opportunities to make double- or
triple-digit returns in less than a year.
And Molycorp could be one of these opportunities...
Themarket for rare earth elements
China supplies more than 90% of the world's rare earth
elements, largely because the most populous country in the
world has had an aggressive mining program since the 1990s
-- at the expense of the environment.
[See also: "
As Shortage Grows, These Rare Metals Grow in
Value
"]
Prices of rare earth elements soared in 2010 when the
country cut its exportquota of metals to 40% of production,
bringing many new companies to market. It was during that
time that Molycorp started trading as apublic company .
When China resumed higher exports, prices of rare earth
elements came down significantly. As a result, miners
worldwide took a hit, with manystocks underperforming the
market since. Molycorp, for example, is down an astonishing
73% during the past year, underperforming the
Market Vectors Rare Earth Strategic MetalsETF (
REMX
)
, an exchange-tradedfund that tracks the rare earth metals
market, with a slide of 31% during the same period.
But things could change soon...
China recently started imposing stricter environmental
controls on the industry. First to confront a growing
pollution problem in the country, which caused the near
shutdown of Beijing in January, but also to be used as a
geopolitical bargaining chip for the country, as China
would be able to cut off the industry and the supply of
needed resources when it doesn't get its way.
[See also: "Is China on the Verge of a Comeback?"]
In addition, despite current weakness in prices and high
extraction costs, demand for these elements is only going
to increase as more new products, including smartphones,
tablets, electric vehicle motors, military drones, wind
turbines and solar panels, need them in order to function.
Increasing demand and the possibility of political turmoil
are good news for miners like Molycorp.
Already priced for the worst
In January, management released a plan to offer $200
million in stock and $100 million in convertible debt, both
of which diluted shareholder value. The company has already
warned of a $250 million cash shortfall due to cost
overruns at the Mountain Pass complex in California, where
Molycorp plans to spend up to $1.4 billion to increase
output to 40,000 tons of rare earth oxide equivalent per
year.
And while those bad news were not unexpected,shares
still plunged 22.7%. The good news is, it's likely only to
get better from here. And this is why now is the worst time
for investors to get out.
First, because the stock and debtoffering will shore up
the company'sbalance sheet and provide financing for at
least this year, giving the miner the rest of the year to
finish development, increase production and watch for
higher prices.
Second, because shares are becoming scarcer as short
sellers focus on them andinstitutional ownership is
increasing at a fast pace. Short sellers have accumulated
33.5 million shares, about 24.3% of the totalshares
outstanding . It has been a winning bet so far, but one
that could change very quickly. After all, institutions and
companyinsiders have a different idea about the
stock.
Molymet, a Chilean holding company and second-largest
owner of Molycorp, bought 15 million shares for $90 million
on Jan. 30, doubling its holding to 18.3% of the company.
Molymet is engaged in the treatment and processing of
molybdenum, a common steel additive, so the stake increase
in Molycorp is more likely a way to lock in resources from
a supplier.
On that same day, MolycorpCEO Constantine
Karayannopoulos doubled his holdings with a purchase of
16,667 shares for about $100,000. In fact, in the past
year, insiders have bought more than 2.7 million shares,
with nobody selling.
The takeover chatter has been hot since these two deals,
causing the shares to almost double from $6.06 in November
2012 to $11.56 this year, before coming down after the news
of capital needs. While abuyout would face tough oversight
by regulators as a strategic national resource, there is a
good chance for further strategic investments like the one
from Molymet.
Totalinsider and institutional ownership is at 73.6%,
according to Thomson Reuters. Much of this is related to
strategic and long-term investments, so the stock will not
likely be sold any time soon. This leaves barely enough
shares, 36.4 million, available to cover the 33.5 million
short-sellers have borrowed.
Daily tradingvolume has spiked more than 20 million
shares 10 times during the past six months. With funding
needs met for the rest of the year and the stock already
priced for the worst-case scenario, any positive
development could send the shares skyward as short-sellers
get squeezed.
Risks to Consider:
Cost overruns and lowerrevenue , along with headline
risks from the SEC investigation into the company's
reporting, could weigh on the shares. Investors should only
risk a small amount of their overall portfolio for this
highly-speculative position.
Action to Take -->
The shares are priced for the worst at just 0.66 timesbook
value , even though funding needs for the year have been
met. Any good news, or even a stabilization in the sector
and subsequently the stock price, could force short-sellers
into the market to buy shares that may not be available
without a surge in share-count.
Investors willing to stomach some risk should definitely
consider buying this stock.
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The Case Against Molycorp
By: James Brumley
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Two years ago was the perfect time for
Molycorp (
MCP
)
to get back in the business of mining for rare earth
metals, after a hiatus of eight years. The price of rare
earth elements was skyrocketing and China had announced
plans to cut its export of these metals, which are used in
everything from disk drives and hybrid cars to LCD
screens.
Investors agreed with the decision, too, and backed it
up with dollars. Shares rallied from their July 2010IPO
price of $14 per share to highs of $79 by May of 2011,
hand in hand with what ended up being more than a 200%
price hike for rare earth elements.
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As is too often the case, however, the market made a
long-term assumption based on what was only a short-term
situation. Prices for rare earth elements didn't remain
at the high levels that drew Molycorp back into the
business in the first place. And with prices of rare
earth minerals back to pre-bubble levels, Molycorp
appeared to be right back in the same situation that had
driven it out of business before.
It leaves an investor wondering whether there's
actually a fruitful future here... And I think there
is.
Here's why...
That was then
The year 2010 was something of a perfect storm for
miners of rare earth elements. Electric vehicles -- which
require rare earth metals like lanthanum and neodymium to
power them -- such as the Chevrolet Volt and
Tesla (Nasdaq: TSLA)
Roadster had become a reality. Wind energy turbines,
which also need rare earth magnets to create power, were
popping up in more places then ever. And, though LCD
screens were already common, the advent of tablets and
smartphones with interactive touchscreens further drove
demand for rare-earth minerals.
[See also: "This North American Miner is Sitting on a
30-Year Supply of a Scarce Metal"]
As proof of that swelling demand, neodymium, which
happened to be Molycorp's chief product, and its
end-product neodymium oxide saw a five-fold surge in
prices during that time. Specifically, neodymium oxide
soared from $15 a pound in July of 2010 to $114 a pound
by mid-2011, supporting the case for Molycorp to reopen
its primary mine in 2010.
When it was all said and done, Molycorp sold $396
million worth of rare earth elements in 2011, at an
average of about $35 a pound, and turning a per-share
profit of $1.26. In that light, the $500 million from the
2010 IPO in addition to $1 billion worth of
private-equity funding was a brilliant investment.
It wasn't to last, though.
This is now
Since then, neodymium -- which is a popular additive
in glasses for its fluorescent effects -- has fallen back
from its peak price of nearly $227 a pound to less than
$45 a pound. Neodymium oxide is now trading at $41 a
pound , more than 60% below its peak price. As it turned
out,speculation drove the price runup more than actual
consumption.
This weak demand has taken a toll on Molycorp's
numbers, too. Though revenue for the past four quarters
has grown to $527 million versus $286 million for the
four quarters before that,operating profit has fallen to
only 51 cents per share compared to an operating profit
of $1.10 per share during the preceding four-quarter
period. That's a 53% decline in earnings on an 84%
increase in revenue, reflecting the underlying plunge
from neodymium prices and all rare earth element prices
for that matter.
The company's average selling price for rare earth
minerals has fallen from $35 a pound to about $20 a
pound. Moreover, with older sales contracts expiring and
new ones replacing them at lower prices, income is
projected to keep falling into thered at least for the
next couple of quarters.
And that may be the least of the company's woes.
Underestimated costs/overestimated
demand
The rise and fall of Molycorp's results is a microcosm
of the rise and fall of the entire rare earth industry.
Although prices reached levels in 2011 that convinced
Molycorp and several other miners to get into the
business, that steep price ascension was a bubble that
won't likely re-inflate again -- at least not to the
extent we saw two years ago.
There are a few reasons why. One of them is the fact
that the higher rare earth prices go, the more willing
(and able) its users are to find alternatives. Take
Toyota (
TM
)
as an example. In 2011, when neodymium prices were
through the roof, the company announced it had begun work
on a hybrid engine that doesn't require any rare earth
elements to function.
An alternative may be the least of Molycorp's
stumbling blocks, however.
Though the intent for most of the $500 million the
company raised in its 2010 IPO was to restart mining
operations at its Mountain Pass mine in California,
Molycorp recently announced it needs another $1.25
billion to ramp up that mine'sproductivity to
originally-planned levels. The cost of reopening the mine
has exceeded initial estimates, yet one has to wonder
whether that extra $1.25 billion would be enough to crank
the mine's output up to the initial target of 19,050
metric tons of rare earth elements per year. After all,
the company was wrong the first time around.
And therein lies the bigger-picture. As prices of rare
earth elements move higher, the more demand falls. As
prices move lower, the less profitable they become for
miners, up to and including operational losses.
That's where Molycorp found itself a couple of
quarters ago. But after two years of being back in the
business, it's starting to look like there is no happy
medium between "sustainable" and "profitable" for
Molycorp.
Risks to consider:
None of this is to say Molycorp's shares can't or
won't move higher at any point in the future. Sentiment,
buzz and a herd mentality can drive stocks upward for a
flimsy reason, or even a non-existing reason. It's just
that the current math implies there's nothing to sustain
strong prices from this stock.
Action to take -->
Simplyput , long-term investors should steer clear of
Molycorp, at least until prices of rare earth elements
stabilize and Molycorp can prove it can mine in a
cost-effective manner. After two years of inconsistency
on both fronts, however, that could be a long wait.
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