Molycorp (MCP) which is the largest non-Chinese rare earth company, has gone through a rough patch recently. In 2010, post IPO, MCP saw a massive run-up in its stock price due to spiraling REE prices, as China clamped down sharply on REE exports. China and Japan had clashed over the ownership of islands in the South China Sea. The increasing tensions saw China unofficially stopping REE exports to Japan, which led to desperation amongst the top Japanese companies such as Toyota (TM), Honda (HMC), etc. The Chinese monopoly over the production and supply of these commodities has even made EU and USA approach the WTO and G20. China wants to use these minerals as a strategic resource to force green companies to relocate to China and transfer rare technologies to local Chinese companies.
REE prices after increasing 5-10x times dropped sharply in 2012 due to:
- Global economic slowdown
- Increasing production from Molycorp (now at a run rate of 5000 tons per quarter)
- Japanese looking at alternative production in Mongolia and India as well as additional recycling.
This has led to bursting of the bubble in REE stocks like Lynas (LYSCF.PK), Avalon (AVL) and Molycorp. MCP which had gone up to $77 dropped to an all time low of $5.75, on reports of a SEC investigation, delays and additional costs at its Mountain Pass mine.
What we like about Molycorp
Molycorp, which started out as a one trick pony with its mine in California, has become a vertically integrated producer from rare metal oxide to finished high purity REE products. Its takeover of Neo Materials provided MCP with access to the processing part of the REE supply chain. REE processing technology is not easily accessible and restricted to a few western companies only. MCP has also become one of the largest producers of REE magnetic powders, which are used extensively in the wind turbine and electric car industries.
Only big non-Chinese US producer of REE
Molycorp is currently the only big non-Chinese producer of rare earth oxides with phase 1of its Mountain Pass mine completed. The company, which has a yearly production of 20,000 tons, should see production doubling to 40,000 tons by 2013. The rare earth mining frenzy had led to investment in a number of projects outside China. Lynas is its biggest competitor with its 20,000 ton mine in Australia. However, the company is facing local opposition to its processing facility in Malaysia. Companies such as Avalon and others are still in the building out phase. An REE project takes a long time to get online as multiple approvals are needed. In developed countries such as the USA, getting these approvals are a long drawn and a tedious process. Other mines are located in geopolitically unstable places which makes them highly risky. The Molycorp mine in California is of strategic importance to the U.S. government because of REE use in the sensitive aerospace, defense and space industries.
New REE products such as Sorbx
Molycorp produces the lighter REE Cerium, which does not have as much demand as the heavier REE elements. In order to increase the demand for Cerium, MCP has come out with a water purification product: Sorbx. This product users Cerium which will help increase the company's revenue.
The company recently saw its CEO leaving the company abruptly, after the company faced an SEC investigation. The new CEO Constantine Karayannopoulos comes with high credentials for building Neo Materials into one of the world's leading REE technology companies. Many investors think that the new CEO has the right credentials for leading the next phase of Molycorp evolution as a leading global REE company.
Mountain Pass Phase 1 is completed
Molycorp, after navigating through numerous hurdles, has completed the first phase of the Mountain Pass facility. The company is expected to double the capacity next year, which will lead to higher margins and revenues. As the fixed costs get dispersed over a wider revenue base, the margin should increase even at the lower REE prices.
Molycorp has manufacturing and processing facilities in almost 11 countries, after a number of takeovers. The company is consolidating its operations after the furious pace of expansion.
Molycorp has signed deals with marquee customers like Hitachi (HMTLF.PK) for long term supply of REE products. This gives the company visibility over the long term as well as increases the company's reputation as a reliable supplier.
The SEC requested information from the company on August 28 in connection with the accuracy of the company's public disclosures. This investigation leads to uncertainty about the company, which is never good for a stock's price performance. We don't think this is a life threatening issue for MCP, however until the problem is resolved it will cap the stock gains.
The sharp run in the price of Rare Earth Oxides has led to a number of junior miners advancing their plans of producing REE. China Rare Earth Holding, Avalon, Rare Element Resources are progressing rapidly towards production. Lynas is close to starting its 22,000 tons mine in Malaysia, which will add almost 15% to the global REE supply. This will lead to additional pressure on REE prices. However, starting an REE mine and a processing facility is a regulatory nightmare. MCP has spent almost $150 million on meeting environmental norms for its California mine. This shows that starting an REE mine needs a lot of money and patience.
The company's recent quarterly conference call saw most of the questions being directed about the company's capital expenditure plans. Molycorp needs to spend another ~$500 million to fully develop its mine by 2013. The company has spent a lot of money in takeovers which have not been consolidated. The general industry exuberance led to empire building by the previous MCP management. This has led to the stretched capital position. The company's new management has to consolidate the numerous acquisitions and increase profitability. The good news is that, the stock has dropped sharply due to these risks and is not factoring a turnaround yet.
The company is cheap at around 1.5x P/S and around 0.8x P/B. The company bought Neo Materials for $1.3 bb (Canadian Dollars) in August and Molycorp's current market is around$1.3bb (with net debt of ~$800mm). From an assets based perspective, the valuation seems quite cheap. The company's mine is worth at least $1 billion considering the development and approval costs. Neo Materials is also worth at least $1.3 billion, which means that the company should be valued at $1.5 bb (subtracting the debt). We are not considering its other assets and profit potential. If the REO prices goes up to their 2011 levels, then net profit would shoot up to $500 million/year, which means a forward P/E of 2x.
We think that the market is not valuing the MCP stock correctly, as the company has a lot of valuable assets. The sentiment towards the REE sector has completely reversed and is at an all time low. This can be seen from the sharp fall in REE stocks over the last one year (60-70% drop). The time to invest in a stock is when everyone is bearish. For Molycorp, the fundamentals and sentiment both seem to be at an all time low. The market is not considering positive catalysts for the stock such as an increase in REE prices. A major environmental disaster in China could lead to a cut in REE production and exports leading to a big jump in REE prices. Molycorp has seen the exit of most speculative short term investors pulled in by the REE bubble. It's a good time for long term investors to start building positions in a unique basic materials story.