Molycorp (MCP) reported first quarter financial results on May 7, 2014. Revenues declined 18% from the first quarter of 2013, and the operating loss rose to $51.0 million from $45.4 million in the comparable 2013 quarter. Of its four operating segments, only the Magnetic Materials and Alloys division recorded an operating profit for the quarter. The company's cash balance declined from $314.3 million to $236.0 million at the end of the quarter. Capital spending for the quarter was $29.8 million and the company expects to spend an additional $61.0 million during the rest of the 2014 year. At the end of the quarter, the company had outstanding debt of $1.4 billion and a cash balance of $236 million.
The company blamed the operating loss on a "shifting product mix," "softened pricing for rare earths and magnetic powders" and lower sales volumes in its Resources unit. The company continues to suffer from production interruptions at its key Mountain Pass rare earths facility. On the company's earnings conference call, MCP officials suggested that production will be increased "significantly" in the second half of the year. The disappointing earnings results led to analysts downgrades and pushed the MCP shares down to the $3.00-3.25 level. At the $3.25 price, the market cap is only $793 million, compared to net debt at March 31, 2014, of $1.16 billion. Interest expense for the latest March quarter increased to $35.6 million, from $11.6 million in the prior year's March quarter. The MCP results and financial condition are set forth in the company's Form 10-Q and earnings presentation, both of which were made public on May 8, 2014.
While MCP's recent operating performance has pressured MCP shares down to 52-week low levels, it may also have created opportunities in MCP fixed-income securities. At March 31, 2014, the company owed just $16.4 million in bank debt and $22.8 million in capital lease obligations. The bulk of the MCP debt is comprised of three separate convertible issues, one small issue of non-convertible debt and a Senior Note issue. We discuss the largest convertible issue and the Senior Notes below.
The convertible issue is a 6% Note due June 2017. This Note has $350.5 million outstanding and is rated CCC by Standard & Poor's. Moody's does not rate this Note. The CUSIP # is 698753AF6. The conversion price is $12.00, well above the current stock price, giving the Note little conversion value. At May 9, 2014, closing prices of $62-63, the Note's yield to maturity was an eye-popping 22.6%.
More conservative investors might find the Senior Notes more attractive. The Senior Notes carry a 10% coupon and mature in June 2020. This issue is rated B3 by Moody's and CCC+ by Standard & Poor's. The CUSIP # is 608753AG4. At March 31, 2014, this Note had an outstanding balance of $637.7 million. Based on its May 9 closing price of $91.25, this Senior Note offers a yield to maturity of 12.1%. The Senior Notes are the "senior secured obligations of the company" (March Form 10-Q, page 15) and these Notes are secured by "a first priority security interest on substantially all of our property and assets" (March Form 10-Q, page 15-16). Certain minor assets are excluded from this security protection, but the Senior Notes rank highest in the company's capital structure. Bank debt would also carry a high ranking in the capital structure, but the MCP bank debt at the end of March was only $16.4 million. In the event of bankruptcy, the Senior Notes would appear to have the strongest claim on the MCP assets, and there is material asset protection with cash of $236 million, working capital of $350 million and book equity of $1.29 billion, as of March 31, 2014.
One of the biggest fears for equity holders is the possibility of an equity offering that will improve the company's balance sheet, provide additional protection for debt holders, but dilute the current equity holders. The company appears to be able to survive in the near term with cash of $236 million and working capital of $350 million as of March 31, 2014. Capital spending needs of $20.5 million over each of the next three quarters will be less than the $29.8 million invested in the first quarter. The company faces no principal payments until 2016, when $230 million falls due. The company has invested nearly $1.9 billion in its property, plant and equipment, all of which carries a net book value of $1.76 billion at March 31, 2014. The Senior 10% Notes have strong asset-backed guarantees, with the total outstanding balance of $637.7 equal to only 36% of the net book value of the company's property, plant and equipment. This Senior Note is also given short-term protection by the company's cash and working capital balances. In addition, the company reports proven reserves of 26.3 million pounds of rare earth oxides and 2.91 billion pounds of probable rare earth oxide reserves.
Investors who currently own MCP stock clearly believe in the future prospects for the company, but they might be better off swapping some of their stock ownership for MCP fixed income securities, which offer greater security and current income than what the stock offers. Both the convertible bonds and the Senior Notes are highly speculative, but the company is not in any imminent danger of bankruptcy or forced principal payments that cannot be financed. Investors with a taste for risk might want to study and analyze these MCP fixed income securities, which offer above-market returns in a low interest rate environment. If the MCP stock price recovers, then the bonds will be paying out and the bond prices will also recover, lowering yields and raising the prices paid from the current bond price levels.
As with any investment, there are risks, which could exert a negative impact on the bonds. Losses could continue, draining cash and working capital and preventing the company from completing an equity offer that would improve the company's balance sheet. In such an environment, the bond prices would further decline and losses would accrue. In the worst-case scenario, the company would need to file Chapter XI and a protracted court proceeding would take months or even years to resolve. Holders of Senior Notes would end up with control of the company and its assets, but the values at that time may not be enough to cover prices paid today for the Senior Notes. In 2013, MCP was able to raise $495.3 million in three separate common stock issuances, but there is no guarantee that the market would be as receptive to an equity offering since the company's operating losses have continued over the past nine fiscal quarters. In the case of continuing losses, however, the bonds will outperform the MCP stock since the odds would increase that a bankruptcy filing would be necessary. Such a filing would likely wipe out the stock's value.
MCP investors will want to pay close attention to the company's disclosures at its upcoming Analyst Day, which is scheduled for May 14.
Current prices for the bonds and Notes can be obtained from the FINRA website ("Market Data/Bonds").
Tom Burnett CFA is Director of Research at Wall Street Access. He does not own Molycorp securities. Wall Street Access or its affiliates does not beneficially own 1% or more of the MCP common equity securities. In the past 12 months, Wall Street Access did not manage or co-manage public offerings of securities of MCP or receive compensation for these services. Wall Street Access does not intend to receive compensation for investment banking services from MCP in the next three months. At the time this article was published, Wall Street Access made a market in the MCP shares.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.