Yesterday in late afternoon trading Molycorp (NYSE:MCP) was down 6.9% to $5.28/share - a 52 week low. This was on trading volume of 8.3 million shares - 10 day average trading volume is 6.8 million - and the Dow Jones Industrial Average up 92 points. Several investors were caught unawares; however, the decline in the stock has been in the making for over a week. My interpretation of yesterday's down day is that the market has come to a landing on he following issues:
Dismal Earnings Will Only Get Worse
The following chart displays the company's fourth quarter 2012 earnings in comparison to third quarter 2012.
Molycorp's fourth quarter revenue of $134.3 million was approximately 35% below third quarter 2012's of $205.6 million. The company also experienced a gross loss of $20.5 million in the fourth quarter versus a $10.9 million gross profit in the third quarter. Fourth quarter loss attributable to shareholders of $362.4 million included a $258.3 million goodwill write-off which we foretold in January. Moreover, it will only get worse. On last week's earnings call, management represented that the first half of 2013 will most likely be worse than the second half of 2012.
Wall Street Has Soured on The Company
Analyst Paul Forward of Stifel Nicholaus lowered his earnings estimates on the company due to expected higher costs in the first half of 2013 caused by production costs at its Mountain Pass facility. Forward's "Hold" rating also put pressure on the stock. According to CNBC:
Forward, who kept his "Hold" rating on the stock, said he now expects Molycorp to post a 2013 loss of 70 cents per share. He previously predicted a loss of 45 cents per share. Analysts polled by FactSet expect a loss of 70 cents per share. For 2014 Forward cut his earnings prediction to 26 cents per share from 51 cents per share. Analysts, on average, expect a profit of 44 cents per share.
Forward's action may prompt other analysts to cool to the Molycorp story, and the stock as well.
Building Inventory Instead of Profits
Molycorp's inventory ballooned to $313.3 million at year-end - an eye-popping 57.4% of tangible GAAP book value. Inventory balances increased after its $1.2 billion acquisition of Neo Materials Technology in June 2012. However, rare earth prices have been in free fall since the second half of 2012, particularly for the light rare earths Molycorp has become synonymous with. From third quarter 2012 to fourth quarter 2012 alone, the company experienced price declines of 30%. Though rare earth insiders do not believe prices will fall to the 2003 levels that caused junior minors outside of China to shut down, junior minors with high operating costs will experience losses in the near term. Granted, if Molycorp built inventory in expectation of demand that did not materialize then it's a problem that can be rectified in the near term. However, if prices have fallen below its production costs, then there is a fundamental problem with its business model.
Investors Have Adopted my Valuation Methodology
I have been focused on the company's balance sheet since late January. In lieu of profits, the way to value Molycorp is as a multiple of book value. That said, ensuring its balance sheet is "marked-to-market" has important implications for its market capitalization. In the article, "Molycorp Has Entered My $3.50 - $6.10/Share Price Range, Now What?" I explained the proper way to value a company who's stock is the equivalent of trying to "catch a falling knife":
Prior to the announcement of the capital raise, Molycorp's stock was around $8.84/share. Its market capitalization was $1.2 billion or a 25% discount to its $1.6 billion book value. Given the deterioration in Molycorp's revenue and earnings, this is where the market thinks the stock should trade.
Under a "base case" scenario, the company writes off the entire $502 million in goodwill associated with Molycorp Canada. I assumed the deferred taxes (tax shield) created by the goodwill write-down was not admitted since the company needs to earn future profits in order to utilize the deferred taxes.
At 75% of its pro forma book value of $1.2 billion, Molycorp's market capitalization would be $840 million, or $6.09/share.
In the "downside case" all of Molycorp's goodwill and intangibles of $978 million are written off. At 75% of its pro forma book value of $643 million, its market capitalization would be approximately $484 million or $3.51/share.
At yesterday's close of $5.35/share, Molycorp is within the price range I predicted two months ago. I will reaffirm my new price range this week; given the company's book value has decreased from $1.6 billion in my previous example to $1.2 billion today, one commenter has come to grips with the fact that Molycorp's valuation will also decline:
Commenter: Shock Exchange's projection was based before the impairment write down and to give readers an idea of what write downs were coming and how much they could impact the stock price. This was very insightful. Considering the write down was not as much we thought, we may not see $3.50 a share, but I won't be shocked to see $4.50 (which I may go long at that price).
"The pain" is real for Molycorp - the stock has reached a 52 week low and could decline further. It is now time for management to prove it can execute on its ability to generate demand and cut costs in the face of stiff headwinds. Molycorp's pricing power and earnings are in free fall. Given no near term catalysts to the stock - capital raise, buyout news or ramp up in demand or prices for rare earths -I rate the stock a "sell."