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Editors' Note: This article discusses a micro-cap stock. Please be aware of the risks associated with these stocks.

The rare earth metal miner Molycorp (NYSE:MCP) is going through a bad patch. On November 7 this year, the company released its third quarter results. The consolidated net revenue of $149.1 million is up 9% over last quarter, but it has declined 27.3% year over year. The company's non-GAAP adjusted loss per share increased to $0.27 from $0.05 in 2012's third quarter. The steep decline in the average selling price of its rare earth metals is the reason behind this hampered result.

However, Molycorp's CEO Constantine Karayannopoulos feels the demand in rare-earth markets will normalize in the coming quarters, which will improve the average selling price, and he predicted long-term growth trends for its two high valued metals, neodymium and praseodymium. These two metals constitute about 15% of the total rare earth production from Molycorp's Mountain Pass facility. The company's magnetic material segment customers demand neodymium and praseodymium, as both of these metals can be used to create strong magnets due to their high field strength.

Less production, more cerium

In the fourth quarter, Molycorp's Mountain Pass will start increasing production gradually. At present, annualized production at this facility is 10,600 metric tons, or mt, of rare earth oxides, and in the fourth quarter, the company plans to increase it to 15,000 mt, which is still under the facility's capacity of 19,050 mt. The reason behind the slower production rate could be abundance of cerium, as it constitutes about 49% of total rare earth production. At present, cerium has low demand, but Molycorp is trying to change this. It has manufactured a water-purifying compound, SorbX, using cerium. SorbX is more effective compared to iron and aluminum based solutions, which water treating facilities have used for many decades. SorbX can remove many kinds of undesirable impurities from water like industrial chemicals, organic molecules, pharmaceuticals, viruses, and bacteria. The company entered a five-year agreement with Univar Inc. for distributing SorbX to municipal and industrial wastewater treatment facilities in North America. Univar is a chemical distribution company, and it has 300 distribution centers globally with a wide network in North America, which will help Molycorp expand its customer base. However, just like any advanced technology, SorbX will take time to increase its customer base, and considering this time factor, the company has stated that, at least in 2014, it may not be able to sell a major portion of its total cerium production.

Cost reduction is a lone positive factor

Although production volume at Mountain Pass is still under its designed capacity, the company is successfully cutting production cost for this facility. Its third quarter adjusted production cost reduced to $25/ Kg from $35/ Kg in the second quarter. In the coming quarters, the cost is expected to reduce below $15/kg due to construction phase completion of its two major units, the chloralkali plant and its multi-stage cracking plant. Both of these units are expected to begin operations in December this year.

The chloralkali plant will recycle wastewater and regenerate chemical reagents like hydrochloric acid and caustic soda, which are required for rare earth's separation process. Regeneration of these chemical reagents will reduce variable cash cost for this facility. The multi stage cracking plant will increase the company's current recovery rate of rare earths. These two units will help Molycorp become more competitive with global rare earth producers.

What is going on with other rare earth producers?

The rare earth elements industry is dominated by China, as more than 90% of rare earth elements are produced within China. Outside China, there are two major companies; one is Molycorp and other is Australian company Lynas Corporation (OTCPK:LYSCF), which has one of the world's best rare earth deposits at its Mt Weld mine in Western Australia. The company imports raw minerals from Australia and processes them into metallic elements in Malaysia. Lynas started operation in Malaysia to break China's strong hold on the rare earth market, but the company isn't performing well. In its first quarter of fiscal year 2014, which ended in September, the company produced 253 metric tons of rare earth oxides, which is 76% more than last quarter, yet the company is way short of its annual target of 11000 metric tons of rare earth oxides.

Lynas is unable to increase its production due to opposition from the Malaysian inhabitants about its improper waste storage facility. According to experts, Lynas's refinery near Kuantan, Pahang has several problems, and due to some accident or carelessness, it could harm the residents near the factory. Without solving this issue, the company's production will remain constricted.

Another rare earth producer that catches my attention is Avalon Rare Metals (NYSEMKT:AVL). Avalon owns 100% of the deposit at its Nechalacho property in Thor Lake, Canada. The company has completed feasibility studies for this project, and the Canadian government approved its developmental proposal on November this year. At present, the company is applying for required land use permits and water licenses. Avalon is expecting annual production volume of about 10,000 metric tons of rare earth oxides with a 20-year lifespan. The commercial production may start in 2017.

The Nechalacho property is known for its large, heavy rare earth metals content outside China. Heavy rare earth metals are the rarest and more complex to mine, which is why their demand is also higher than other rare earth metals. Almost the whole world relies on China for these metals, therefore this project provides an opportunity for Avalon to sell heavy rare earth metals to markets other than China.

(Investors should be aware that AVL is a microcap and there are certain risks associated when investing in a stock such as this one.)

Conclusion

For Molycorp, everything now depends on Mountain Pass, where the production rate will increase this quarter. There is demand for its rare earths oxides of neodymium and praseodymium. What matters most for the company is how much cerium it can sell, which will be produced at a higher rate than its demand. The company is optimistic about its cerium based water-purification compound SorbX, but it will take time to attract customers.

On the cost front, the company is doing good, and its cost will further improve when its chloralkali plant and multi-stage cracking plant's operation starts. However, the impact these will have on the company's production rate and production cost is yet to be determined. With so much uncertainty all around, I recommend investors hold their position on this stock, and wait for positive development in order to make new positions.

Source: Are Things Really Dismal For Molycorp?