After a two week delay, Molycorp (MCP) finally released its earnings on March 14th. For fourth quarter 2012, it had a gross loss of $20.5 million and a net loss attributable to shareholders of $362.4 million on revenues of $134.3 million. Part of the net loss was attributable to a $258.3 million goodwill impairment charge, which we warned investors about two months earlier on Molycorp: Price Target $3.50-$6.10/Share Due to Asset Impairment Risk.
For fourth quarter 2012, Molycorp generated revenues of $134.5 million, a 34.7% decline from third quarter revenues of $205.6. Gross profit for third quarter 2012 was $10.9 million while it generated a gross loss of $20.9 million for fourth quarter 2012. Its loss attributable to shareholders for third quarter and fourth quarter 2012 was $18.9 million and $362.4 million, respectively.
The key asset I was looking for -- inventory -- was divulged by the company a few days later when it released its annual 10-K report. In the article, Avoid Molycorp: Substantial Inventory Write-Off Imminent, I estimated [i] year-end inventory of $325.8 million, of which $68.1 million and $128.5 million was work-in-progress and finished goods, respectively. Based on a deterioration in Molycorp's weighted average basket prices of 22% from 3Q 2012 to 4Q 2012 and 56% from year-end 2011 to year-end 2012, I estimated a potential inventory write-off of $43 million-$110 million. Below is how the inventory write-off was estimated in my previous article.
Inventory Estimate Nearly Spot On
Molycorp's actual year-end inventory was $313.5 million; finished goods ($114.9 million) and work-in-progress ($55.2 million) totaled $170.1 million. Though the company's revenue declined 35% from $205.6 million in third quarter 2012 to $134.3 million, inventory increased approximately 8% from $290.7 million to $313.5 million over that same period. This appears to be a case of "slow moving" or "obsolete" inventory. If the company had decreased inventory in line with the decline in revenue, it could have saved between $40 million-$50 million in cash outflow and lessened the dilution caused by its January capital raise.
The following chart illustrates the company's historical inventory levels:
From 2011 to 2012, revenue increased 33% from $396.8 million to $528.9 million. Over that same period, inventory nearly doubled from $116.3 million to $313.5 million, while work-in-progress and finished goods inventory grew 176% from $61.6 million to $171.1 million. Inventory as a percentage of tangible GAAP book value was 5.4%, 13.9%, 45.6% and 57.4% for 2010, 2011, September 30, 2012 and year-end 2012, respectively. Inventory increased after the acquisition of Neo Materials in June 2012. In the second half of 2012, Molycorp began to experience operating losses as rare earth prices declined, yet its inventory levels continued to increase.
Based on an estimated fourth quarter basket price of $36.43/kg, Molycorp's finished goods and work-in-progress inventory equate to 4,671mt, or 6x the 752mt it had in inventory in 2011. Though its revenue increased eleven-fold from 2010 to 2011, its finished goods and work-in-progress in terms of units only increased 12% from 677mt to 752mt. That's a long-winded way of saying that while Molycorp was building inventory, not only was its inventory slow-moving, its market price was rapidly declining.
New Estimate of Inventory Obsolescence
The following chart illustrates Molycorp's obsolete inventory of $133.6 million. From 2010 to 2011, Molycorp's revenue increased eleven-fold its finished goods and work-in-progress inventory increased 378%, yet its units increased only 12%. In 2012, the trend reversed itself as revenue increased 33% (partly due to the Neo transaction), yet its units increased 521% from 752mt to 4,671mt. The company's basket price also declined from $82.00/kg to $36.43/kg, which affected the units in inventory. Simply increasing the units in inventory 33% -- the same rate as revenue growth -- would equate to 1,002mt; 1,002mt at a rate of $36.43/kg equates to finished goods and work-in-progress inventory of $36.5 million, or $133.6 million less than the company's current carrying amount of $170.1 million. This $133.6 million overstatement is approximately 24% of tangible GAAP book value.
Since Molycorp's acquisition of Neo Materials in June 2012, demand and prices for rare earth oxides have declined. The company built inventory from $290.7 million at September 30, 2012 to $313.5 million at year-end 2012, despite the fact that its quarterly revenue and average basket price for rare earth oxides declined over that same period. Based on its current basket price, I estimate that Molycorp's inventory is overstated by approximately $133.6 million. Given the company's inventory mismanagement and near-term operating losses, I rate the company a sell.
Disclosure: I am short MCP.
Additional disclosure: I own July 2013 puts on Molycorp