Molycorp's (NYSE:MCP) stock has been on a wild ride since its 1Q 2013 earnings call on May 9. Management announced that revenue was up 9% over 4Q 2012 and cash outflows were only $37 million - more positive than expected. The stock closed at $5.59 per share on May 9, bounced to as high as $7.34 per share (up 31.3%) on May 10 and appeared to have settled at $6.52 (down 11.1%) on May 17. However, it jumped 10.7% to close at $7.22 per share yesterday. How much higher or lower the stock will trade remains to be seen. The article, "How I profited From Molycorp's Wild Trading Day," explains my reaction to the wild ride shareholders experienced on May 10 triggered by 10 times normal trading volume.
The stock opened trading on Friday up $0.42 (7.5%) to $6.01. Around noon the stock traded at $6.73 (up 20.3%) and began an ascent to as high as $7.75. After massive short covering - at the end of April, the stock had short interest of 44.8 million shares with an implied 8.9 days to cover - the stock eventually closed at $7.34 (up 31.3%). Nearly 61 million shares changed hands - 10 times normal trading volume. After the smoke had cleared, I had made multiples from my investment in Molycorp call options, more than enough to cover the losses on my puts.
The following chart illustrates the gyrating stock price over the past month.
The gyration in the stock has been on trading volume that at times have seen multiples of normal trading volume, which leads me to believe that short sellers have been covering since the 1Q earnings call. That said, Molycorp is a "bear trap" for the following reasons:
Longs Are as Rabid About The Stock as Shorts
At the end of April, short interest was 44.8 million shares. However, longs are just as rabid as shorts. Molycorp has millions of loyal fans who seem to have an emotional, as well as financial attachment to the stock. On the article, "Molycorp Earnings Surprise: 'Pain Ahead' For Shorts," commenters showed just how much confidence they had in the stock:
Commenter 1: Molycorp's business is turning around and in 2 years from now, it can earn over $1 per share, and if metal prices get stronger, it could earn close to $2 per share. I think Molycorp can get into the $10 to $20 per share range within 18 months. I am long on Molycorp.
Commenter 2: Shorts are getting burned left, right, and center. Molycorp should earn a normalized $1-$1.25 per share - and with recent events [1Q 2013 earnings surprise], it is much more likely that it will. Add in a short squeeze and $10 per share is in the cards.
Longs, bullish about Molycorp's business prospects, have used its declining stock price to buy on the dips. Buying ahead of expected positive earnings reports from the company may or may not pay off. However, at a minimum, it keeps the stock from going completely into free fall and mutes potential profits by short sellers.
Shorts Appear to Have Priced in Bankruptcy
At the end of April the stock price closed at $5.84 per share - about 3% below the company's $6 per share secondary offering in January. To go short at this price level, short sellers must have priced in a bankruptcy scenario for the company. However, with run-rate cash outflows from operations of $37 million and planned capital expenditures of about $69 million to complete its Mountain Pass expansion and Chlor-Alkali plant, I don't see the company running out of cash prior to 1Q 2014, if at all. The following chart displays Molycorp's cash balance, assuming quarterly cash out flows and capital expenditures of $37 million and $30 million, respectively.
Cash on hand was $405 million at 1Q 2013. The company's cash out flows from operations were $37 million for 1Q 2013. Management has been focused on alleviating "cash burn" by cutting corporate overhead costs, reducing salaries, and working down currently inventory balances.
- Instead of building inventory like it has in the past, Molycorp sold through about $16 million of inventory on hand, representing an important "source of cash" during the quarter. I assumed that in 4Q 2013 this "source of cash" would be muted and cash out flows from operations would be $53 million.
- The company spent $181 million in capital expenditures during the quarter. It expects total capital expenditures of $250 million for the year. I assumed $30 million of quarterly capital expenditures going forward.
- With the aforementioned assumptions on cash out flows from operations and capital expenditures, Molycorp's cash on hand by the end of 4Q 2013 would be approximately $188 million. This would be below the $227 million cash on hand at the end of 4Q 2012 when it announced its secondary offering.
- At a minimum, it would take at least three quarters before Molycorp's cash balance would signal it was headed for bankruptcy or in need of another capital raise. By that time, short sellers will have lost their shirts - either from a loss of capital or carrying costs related to holding a long term short position.
With better than expected revenues and cash outflows from operations during 1Q 2013, Molycorp has bought itself more time to right the ship. It will take at least three more quarters before its cash on hand reaches levels that will signal bankruptcy or another capital raise. That said, the stock represents a bear trap for shorts. At its current price of $7.22 per share, I think the stock is overvalued. That said, it may be prudent to look for a lower entry level for the stock or go short only after a bankruptcy scenario or capital raise is more imminent.