Since the fourth quarter of 2010, Molycorp (NYSE:MCP), as well as other rare earth miners, has experienced the boom and bust cycle of the global rare earth market. In September 2010 China, in the midst of a spat with Japan over the disputed Diaoyu Islands, responded by denying rare earth minerals to Japan, the U.S. and Europe. The action set off an international manhunt for rare earth deposits. At the time, China controlled over 90% of the market for rare earth minerals which are used in the manufacture of high-tech equipment like smart phones and hybrid cars. Backed by $1 billion in capital from Resource Capital Funds, Molycorp reopened its Mountain Pass Mine containing rare earth minerals, and its earnings and share price soared.
The supply shortage not only attracted increased competition, but China gradually increased its export quotas of rare earth minerals, driving down global prices. According to our earlier article, Molycorp And 'The Pain Ahead':
Declining rare earth prices have since ravaged Molycorp's earnings and stock price. Through six months ended June 2012, the company achieved an operating loss of $51 million on revenue of $189 million. According to Molycorp's 2012 second quarter 10-Q, it sold "1,169 mt of rare earth products at an average price of $45.92 per kilogram as compared to sales of 973 mt at an average price of $77.60 per kilogram during the corresponding period in 2011." This would imply a rare earth price decline of approximately 40% year-over-year. The company's stock price was $13.00/share on September 21, 2012, reflecting its reduced business prospects.
In its January 10, 2013 press release, Molycorp management admitted to shareholders that "the pain" was here; management described a revenue and cash flow shortfall that would delay its Mountain Pass expansion and lead to a dilutive event - a proposed offering of $200 million of common equity and $100 million of convertible senior notes due 2018. In its January 23rd 8-K pursuant to the capital raise, management alluded that fourth quarter 2012 revenue shortfall could be as much as 30% below the previous quarter's:
- For the three months ended September 30, 2012, the company achieved revenues (prior to eliminations and corporate allocations) of $205.6 million and a pretax loss of $26.9 million.
- For the three months ended December 31, 2012, volume, prices, and ultimately revenue, were derived by taking the mid-point of management's estimates for volume and price per segment. The estimates were provided in Molycorp's January 23, 2013 8-K pursuant to its common stock offering.
- That said, estimated revenue for the fourth quarter is $146.8 million, or about 29% less than the third quarter's. The pretax loss would also widen under such revenue decline.
Molycorp Key Products
Below is a description of Molycorp's key products by segment.
- Resources segment - Conducts rare earths minerals extraction to produce rare earth concentrates; REO, including lanthanum, cerium, didymium, neodymium, praseodymium and yttrium; heavy rare earth elements, such as samarium, europium, gadolinium terbium, dysprosium; didymium rare earth metal and SorbX, a line rare earth water treatment products.
- Chemicals and Oxides segment - Includes salts or rare earth elements, zirconium-based engineered materials and mixed rare earth zirconium oxides.
- Magnetic Materials and Alloys segment - Includes the production of Neo Powders which are used to make bonded magnets for a variety of electronic and mechanical products.
- Rare Earth Metals segment - Comprises the production of gallium, indium, tantalum rhenium, tantalum, and niobium. Rare metals are used primarily in wireless, light emitting diode, flat panel display, turbine, solar and catalyst industries.
Light Rare Earths (LREE) vs. Heavy Rare Earths (HREE)
Molycorp's price deterioration begs the question, "Is its price deterioration a harbinger for other rare earth competitors?" The answer is a resounding "Yes." However, all rare earth miners are not the same, so some miners will be less affected than others. Rare earth minerals are broken down between heavy rare earths ("HREE") and light rare earths ("LREE"). LREE is defined as: Lanthanum, Cerium, Praseodymium, Neodymium and Sarmium; all other elements are included in the HREE category. Molycorp has a mere 0.36% heavy rare earths as a percentage of total rare earths ("TREE"). The percentage of light and heavy rare earths as a percentage of TREE for the following selected companies -Molycorp, Lynas Corporation (OTCQX:LYSDY), Avalon Rare Metals (NYSEMKT:AVL), Rare Element Resources (NYSEMKT:REE), Arafura Resources (OTCPK:ARAFF), Quest Rare Metals (NYSEMKT:QRM), Great Western Minerals (OTCQX:GWMGF), Montero Mining & Exploration (OTC:MXTRF), Frontier Rare Earths (OTC:FREFF), Tasman Metals (NYSEMKT:TAS), Ucore Rare Metals (OTCQX:UURAF), Hudson Resources (OTCQX:HUDRF), and Matamec Explorations (OTCQX:MHREF) - is below.
As you can see from the chart, Molycorp's light rare earths as a percentage of total rare earths is 99.64%. In my estimation, those companies with at least a 75% concentration of light rare earths as a percentage of the total - Lynas, Avalon, Rare Element Resources, Arafura, Great Western, Montero, Frontier, and Hudson Resources - have a revenue stream most similar to Molycorp's. Thus, they are most exposed to similar price and revenue deterioration.
Based in Australia, Lynas began rare earth production in 2001 and began operations at its controversial Malaysian plant in November 2012; opponents say the $800 million plant is environmentally hazardous. Along with Molycorp, it was once considered the one major rare earth resource outside of China. According to the company, Phase 2 of the Lynas Advanced Materials Plant (LAMP) in Malaysia is expected to double its capacity to 22,000 tons per annum REO. In September 2011 the company signed a long-term supply agreement with BASF Corporation for the supply of Lanthanum to BASF's Fluid Catalytic Cracking business. The company expects to produce commercial rare earth products at LAMP over the next few weeks. For fiscal years ended June 2011 and June 2012, Lynas generated net losses of A$59.1 million and A$88.8 million, respectively. The company currently has a market capitalization of approximately $1.1 billion.
Avalon Rare Metals
Avalon is a mineral development company focused on rare earth deposits in Canada. Its primary asset is the 100%-owned, advanced development stage project, Nechalocho Rare Earth Element Deposit, located at Thor Lake, Northwest Territories, Canada. According to the company, Thor Lake is emerging as one of the largest undeveloped heavy rare earth elements resources in the world. Avalon's business model includes a proposed heavy rare earth separation facility in the southern U.S. The project start-up is expected in late 2016. The company's portfolio also includes lithium, anorthosite, indium, tin and other strategic metals. For fiscal years ended August 2012 and 2011, the company generated net losses of C$11.2 million and C$8.7 million, respectively. Avalon has a market capitalization of approximately $132 million.
Rare Element Resources
Rare Element Resources owns 100% interest in the Bear Lodge Property in Wyoming which the company claims has the 2nd highest grade rare deposit in North America. Bear Lodge's critical rare earth elements include Neodymium, Praseodymium, Europium, Terbium, and Dysprosium. For the fiscal years ended June 30, 2011 and June 30, 2012, the company generated net losses of $16.7 million and $35.0 million, respectively. Rare Element plans to develop and produce from Bear Lodge, subject to obtaining a definitive feasibility study, the necessary mining permits and secure the necessary financing to construct the mine. As of September 30, 2012, the company was considered an "exploration stage" entity under U.S. GAAP accounting due to the lack of reserves reported under SEC Industry Guide 7. The company currently has a market capitalization of approximately $137 million.
Arafura is an emerging rare earths producer with an advanced Australian development project - the Nolans Project. The Nolans Project comprises two sites within Australia: (i) the Nolans Bore Mine in the Northern Territory and (ii) the Whyalla Rare Earths Complex in South Australia. Annual production will be 20,000 tons of rare earth oxides from Whyalla. Separated REO products include Cerium, heavy rare earth oxide, Neodymium and Praseodymium. For fiscal years ended June 30, 2011 and June 30, 2012, the company generated revenues of $3.3 million and $2.1 million, respectively. It also generated net losses of $7.5 million and $8.7 million for FYE 2011 and FYE 2012, respectively. Arafura has a market capitalization of approximately $73 million.
Great Western Minerals
Great Western is an integrated rare earths processor whose specialty alloys are used in the battery, magnet and aerospace industries. The company has five rare earth exploration and development properties in North America and an equity control interest in the company that will produce rare earth elements from the Steenkampskraal mine in South Africa. For the nine months ended September 30, 2011 and September 30, 2012, the company had sales of C$13.6 million and C$12.9 million, respectively. It generated net losses of C$10.3 million and C$6.5 million for nine months ended September 2011 and September 2012, respectively. The company has a market capitalization of approximately $104.7 million.
Montero Mining & Exploration
Montero is primarily engaged in the exploration program on the Wigu Hill Rare Earth Element project in Tanzania. Wigu Hill is described as a "Mountain Pass look-alike." Mining operations are expected to begin in 2013; Wigu is expected to produce 5,000tpa of mixed rare earth elements and Cerium. In May 2008 RSR (Tanzania) granted Montero an exclusive option to earn an initial 60% interest in the Wigu Hill Project and an additional 10% at a later date. For the years ended 2010 and 2011, the company generated net losses of C$1.0 million and C$2.3 million, respectively. Montero has a market capitalization of approximately $5 million.
Frontier Rare Earths
Frontier is a mineral exploration and development company whose main asset is the Zandkopsdrift rare earth project in South Africa which contains 950,000 tons of total rare earth oxides. In December 2011 the company signed a joint venture agreement with Korea Resources Corporation ("KORES") whereby KORES would help it finance and explore Zandkopsdrift. KORES paid C$23.8 million for the stake, and has an option to increase its interest up to 50% in the project. For the nine months ended September 30, 2011 and September 30, 2012, the company generated a net loss of $5.3 million and $2.2 million, respectively. Frontier has a market capitalization of approximately $64 million.
Hudson Resources is a junior minor engaged in the exploration and development of mineral properties. Based in Canada, Hudson is focused on the Sarfartog rare earth project and Naajat (White Mountain) anorthosite (calcium feldspar) project. It is in the process of developing the economics of Sarfartog; neodymium oxide represents about 20% of the rare earth oxides discovered. It is not yet determined whether its properties contain mineral reserves that are economically recoverable. The company's ability to continue to operate as a going concern is dependent upon the economic recoverability of is mineral reserves, its ability to secure financing to explore those reserves, and the ability to sell its end products at prices that will allow it to cover its production costs.
For the six months ended September 30, 2011 and September 30, 2012, the company generated a net loss of C$5.4 million and C$4.2 million, respectively. Hudson has a market capitalization of approximately $31 million.
Molycorp's revenue deterioration and dilution from its capital raise are largely priced into the stock. However, such revenue deterioration may not be priced into the stocks of competitors with similar LREE exposure. Therefore, I would wait until competitors announce next quarter's earnings or give guidance on rare earth prices before investing in them.