Seeking Alpha
Long/short equity, long only, short only, special situations
Profile| Send Message|
( followers)  

In early March I read an innocuous press release from Molycorp (NYSE:MCP) stating that it had lowered the minimum benefit on early termination for certain members of senior management. The company lowered its severance policy to 13 weeks of base salary. My reaction to the news was "So what?" A week later on its fourth quarter earnings conference call, the company's interim CEO divulged that there would be layoffs at the company. However, said layoffs would only come from "corporate & other" costs. Actual corporate & other costs totaled $17.2 million for third quarter 2012 and increased significantly after the acquisition of Neo Materials Technology. Below are the company's actual third quarter 2012 financial results and my previous estimate of fourth quarter 2012 results, including corporate & other costs.


(Click to enlarge)

Bloodletting Begins

In the second week of March the company announced its fourth quarter earnings. 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 fourth quarter 2012 and loss attributable to shareholders of $362.4 million, which included a $258.3 million goodwill write-off attributable to the Neo acquisition. Management represented that revenue and earnings are likely to continue to decline in the first half of 2013. Less than two weeks later, the company followed up on its promise to decrease corporate expenses when it severed ties with John Ashburn Jr., executive VP and general counsel, and John Burba, executive VP and Chief Technology Officer. Both men had also held positions at Chevron (NYSE:CVX), the predecessor to Molycorp. Each is entitled to receive a one-time payment of $220K and $600K equal to his 2013 target bonus and annual salary, respectively. Molycorp also announced that it had elevated Geoffrey Bedford, former executive VP of Rare Earths and Magnetics, to Executive Vice President and Chief Operating Officer. Bedford had been the COO of Neo since August 2011.

More Layoffs Ahead?

At a fourth quarter gross loss of $20.5 million, rare earth prices are currently below the company's cost of production. In reaction to the company's dismal business prospects, on April 1st shareholders drove the stock to a 52-week low of $4.91 and into my price range of $3.50 - $6.10/share. Molycorp's goal is to be the industry's low cost producer. However, that is predicated on much higher levels of production, higher levels of demand and higher rare earth prices. If prices and demand do not bounce back, the company will not have the economies of scale necessary to reduce it production costs. To merely breakeven, it will have to layoff employees and cut costs in addition to "corporate & other." To stem losses, the company also needs to adopt the partnership culture I recommended for Morgan Stanley (NYSE:MS) weeks ago; senior executives should take a lower than normal base salary in these difficult times for a higher upside later. Management may need to reduce hours and salary expenses until demand for rare earths increases. If revenue continues to decline quarter-over-quarter, I do not see how the company cannot announce additional layoffs or other alternatives to stem losses.

Inventory Greater Than Quarterly Revenue

At year-end 2012 the company had work-in-progress and finished goods inventory of $170.1 million. Its fourth quarter 2012 revenue was only $134.3 million. In effect, Molycorp could drastically reduce production and still satisfy first quarter 2013 demand from inventory on hand. Reducing production, operating costs and salaries during the first half of 2013 to match demand, could save much needed cash flow and the potential dilution from another capital raise in the future.

Conclusion

I am bearish on the U.S. economy, and the stock market as a whole. I am particularly bearish on Molycorp given its deteriorating revenue and near-term operating losses. According to management, first half 2013 operating results are expected to deteriorate further. That said, I believe there will be additional layoffs at the company beyond corporate & other expenses. And if the company cannot develop creative ways to stem operating losses, there will be blood for shareholders as well. I rate the stock a sell.

Source: Molycorp: There Will Be Blood