Molycorp (MCP) stock has been a big roller coaster ride for investors in the last few years. The stock spiraled upwards, post its IPO in 2010 when rare earth element (REE) prices went parabolic due to a Chinese embargo on exports. There were real fears amongst U.S., Japan and European Union about a REE shortage creating a huge disadvantage for their industries. The governments and companies went looking for REE substitutes as well as new REE sources. Even junior miners that were not supposed to start producing in the next few years became multi-baggers almost overnight. Molycorp used the REE bubble to go on a buying spree spending almost $2 billion in becoming a vertically integrated player. However, the post-REE bubble time period has not been too good for Molycorp. As REE prices have gone down, Molycorp is finding it hard to fund its inflated costs. The expansion of its Mountain mine has also been curtailed to conserve cash. The company has also used a secondary offering of stock and convertible debt to get through the downturn. The good news for the investors is that they can now buy Molycorp at a very cheap value. When the REE up cycle returns, they can expect a substantial return as Molycorp has the largest non-Chinese production capacity in the world. The stock, which reached an all-time high of ~$77, is now trading at just ~$6.5. I think that the stock represents a good risk reward opportunity at the current price.
What we still like about Molycorp despite the troubles
1. Diversification and Vertical Integration - Molycorp has become geographically diversified and vertically integrated, thanks to its buying spree. The REE supply chain not only requires mining of toxic elements, but also sophisticated processing of those elements to the metals, which can be used by end users. The acquisition of Neo Materials provided MCP the access to the processing part of the REE supply chain. REE processing technology is not easily accessible and restricted to a few western and Japanese companies only.
2. Strategic Importance - Molycorp is strategically important because it is the only big American producer of rare earth oxides. The company has a yearly production of 20,000 tons, which can be easily doubled to 40,000 tons when the prices stabilize. Molycorp has already spent more than $1.2 billion in increasing its capacity and it will only require a small amount to double the capacity. When the REE cycle changes, MCP will benefit from increased volumes and prices.
3. New Management - The company was almost made bankrupt by the old management, which went on an expansion spree during bubble times. The new CEO Constantine Karayannopoulos has impressed with his focus on conservative expansion and cost cutting. He comes with an excellent resume and the company seems safer in his hands. The CEO is spending money to decrease the production cost rather than on increasing volumes.
As our production levels increase, we expect our cost of production to steadily decline. The low cost power we generate from our natural gas-fired combined heat and power plant is a big driver for these declining costs. And when our chloralkali facility comes online later this year, we will see our reagent and wastewater management's costs decline even more.Our initial target or cash production cost in the $6 to $7 per kilogram REO range still appears to be achievable in my view. When we reach our cost profile, we will be the lowest cost rare earth producer in the world.
4. Weak Competition will be weeded out - One positive side to the low REE prices for Molycorp will be the elimination of weaker REE competition from the industry. A number of new companies had started to make plans of investing in new mines due to the REE boom. The current gloom will make a number of these junior miners rethink their plans. A number of other REE companies like Avalon Rare Metals (AVL), Rare Element Resource etc. are planning to invest heavily in starting new facilities and mines. These companies will think twice seeing the current troubles being faced by MCP. Even if these companies do not completely stop their plans, they will at least slow down their projects to ride out the downturn. AVL is trading near its all-time lows of 90 cents, while REE has also seen a steep decline in its stock price and is trading at just $1.91.
- REE Overcapacity and Low prices - The whole REE industry has been hurt by the overcapacity and low prices of REE. While the Chinese government has imposed a strict export quote on REE, illegal mining and smuggling of REE has made this policy ineffective. REE mining is complex and expensive as it requires a lot of environmental safety measures. However, the Chinese illegal miners are able to circumvent costly processes and undercut the legal miners. This has made the job tough for Molycorp.
- Weak Balance Sheet and Losses - Molycorp's balance sheet has deteriorated due to losses in the past few quarters. This has made it difficult for the company to finance the expansion of its Mountain Pass mine. That said the company has halted new expansion and raised enough cash in January 2013 to survive the next couple of years. The company seems comfortably placed currently, with a cash position of ~$400 million and debt of ~$1.33 billion. However, if the market does not improve, then Molycorp may have to raise more cash by selling either equity or assets.
Molycorp, Inc. ("Molycorp" or the "Company") today announced that it intends to offer and sell, subject to market and other conditions, $200 million of its common stock (the "Common Stock") (or up to an aggregate of $230 million of Common Stock if the underwriters of such offering exercise their option to purchase additional shares of Common Stock in full) (the "Primary Shares Offering") and $100 million aggregate principal amount (or up to an aggregate of $115 million aggregate principal amount if the underwriters of such offering exercise their over-allotment option in full) of its Convertible Senior Notes due 2018 (the "Notes") (the "Notes Offering") in separate registered public offerings.
Molycorp remains a cheap stock with a P/S of 1.4x and a P/B of 0.9x. The company's current market capitalization stands at ~$1.2bb (with net debt of ~$900mm). The company remains cheap, if you consider the valuable assets that the company owns in terms of IP and mines. The long approval procedure for starting a REE mine in the West also is a significant competitive barrier for the company. Lynas is having a very hard time in setting up a REE processing facility in Malaysia, due to fears of environmental pollution.
Molycorp has seen a wild ride ever since its IPO going up from $12 in 2010, to reach $77 during the peak of the REE bubble. The stock has come down substantially from the ~$9 when I had recommended buying MCP. However, the stock has rallied sharply in recent days from its all-time low of $4.7 on hopes that the new management will be able to engineer a turnaround. The stock is currently trading at ~$6.5.
Molycorp is a stock that is not for the fainthearted investor given the large number of variables affecting the company. Molycorp is also in the building phase, when capital expenditure puts a strain on the balance sheet and liquidity. The company did not conserve money during the boom times as it went in for some very expensive acquisitions. Molycorp is not an isolated failure given all REE stocks have seen a sharp decline in their stock prices. The new management seems competent and focused. This will serve the company well as it looks to survive the current downturn. The company has got some tremendous assets, which are not being undervalued because of the depressed industry conditions. I would look to slowly build a position in MCP stock.