- Despite disappointing Q1 earnings and ongoing concern around their cash levels and bottlenecks at their Mountain Pass facility, MCP's underlying processes are improving.
- The company, based on month-over-month throughput trends, could be significantly closer to ramping production than market participants believe.
- MCP is positioned to emerge as a low-cost producer in an industry that has consolidated suppliers.
- Mines a product that has meaningful long-term demand from rapidly growing industries (clean energy, energy-efficient lighting, hybrid vehicles, battery technologies, etc.).
Molycorp (NYSE:MCP), one of the world's leading manufacturers of custom-engineered rare earth and rare metal products, has come under intense scrutiny following disappointing Q1 earnings and on-going process bottlenecks at their Mountain Pass, CA, facility. However, investors have reasons to be cautiously optimistic about the next 12 months.
Following the company's May 14 analyst day in California, those watching Molycorp see two paramount issues plaguing the organization currently: the rate at which they are consuming cash on hand and the difficulty in ramping up production at their Mountain Pass facility. Taking a closer look at both issues might help illuminate the course of the stock over the coming 12-month period (leading into their first debt expiration in June 2015).
At the end of Q1, Molycorp reported a cash balance of roughly $236mm. Of that $236mm, 25 percent of it currently resides in China (roughly $60mm), leaving $176mm in U.S. cash assets. Over the balance of 2014, Molycorp has committed $60mm in additional capex - combination of maintenance capex ($13mm per quarter) and additional Mountain Pass capex of $21mm. The $21mm dedicated to completing the Mountain Pass facility and debottlenecking the process should be the end of any major capex expenditures at the plant. Thus, after committed capex and interest service, Molycorp would have a balance of $36mm in U.S. cash reserves (+$60mm offshore), barring any additional negative cash flows from operations.
Turning to cash flows from operations, Molycorp expects to be cash flow breakeven at a 12-13k metric ton annual run rate, while they currently have a year-end annualized monthly production target of 20k metric tons. Is this achievable? This segues nicely into the next issue, that of the ongoing debottlenecking process at Mountain Pass.
Debottlenecking at Mountain Pass
Molycorp's new Rare Earth Facility at Mountain Pass was designed and constructed to incorporate a number of technology innovations to make the production of rare earths more environmentally friendly and cost effective. Included in those innovations are (taken directly from Molycorp's webpage):
- On-Site Combined Heat and Power: Highly energy-efficient power from clean-burning natural gas.
- Lower Greenhouse Gas Emissions: Cogenerated power is less emissions-intensive than legacy operations.
- Greatly Reduced Wastewater Discharge: New facility recycles water and sodium chloride to re-generate chemical reagents used in processing.
- Higher Rare Earth Recovery From Ore: Can produce more product using the same amount of ore as previously mined.
- Reduced Fresh Water Use: Water recycling allows for less intensive use of fresh water.
- Innovative Paste Tailings: Permanent disposal technology eliminates tailings "dam."
With all of these new innovations to incorporate into a difficult chemical-refining process, it is easy to understand how setbacks have occurred throughout implementation. However, the sole remaining bottleneck that stands between current production levels and significantly improved output have nothing to do with any of the above-mentioned advancements.
In order to optimize recoveries and increase output, Molycorp needs to simply add more tanks to improve the leaching process. Leaching is not a new technology and is one that current management is both familiar with and confident they can improve. In addition, the processes downstream from the leach system have been run at high rates in the past-giving increased confidence to the thesis that bolstering the leaching process will allow the subsequent ramp-up in production to take place.
Furthermore, the Chloralkali and CHP (combined heat and power) plants are both operating at high levels and will afford significant reductions in reagent costs and wastewater haulage, and will produce power at much lower rates than power from the grid in the coming and subsequent periods (all of which are huge advantages over Chinese suppliers). May's throughput, though not reported, is indicated to be better than April's production based on investor commentary. April's haul (520 metric tons) was dramatically better (+24%) than March's output (420 metric tons). And I am confident June will beat May when we get a quarterly update. The ramp-up has begun. Molycorp is finally poised to benefit from their investment in new technology that will equate to a significant cost savings once production reaches full capacity-an achievable goal in 2014.
Negative sentiment surrounding the company has been focused on their potential need for an imminent capital raise. While I would acknowledge that the company may very well have a need for additional financing, I believe they have two options: 1) raise additional funds today in case production ramps more slowly than expected and the company's liquidity situation diminishes more rapidly than anticipated or 2) continue to focus on debottlenecking the production process at Mountain Pass and, once capacity has ramped up, look to negotiate additional financing on better terms. I believe the latter is the better course of action, especially considering the fact that the current issue with the process is a known and fixable problem. Negotiating financing from a position of relative strength is much more appealing than begging for additional funds at the peak of negative criticism.
Molymet is a Chilean company that works in the treatment and processing of molybdenum and related products and is currently the largest shareholder of Molycorp's common stock. With a 19.1-percent ownership stake (46,700,700 shares), Molymet has a deep and vested interest in the success of Molycorp. While this is pure speculation, I would have a hard time believing that Molymet, if the situation at Molycorp continues to improve, would not be an ally in an additional capital raise or financing program. Molymet's balance sheet, despite the negative affect Molycorp's falling stock price has had to date, remains stable and their core business remains strong.
There was positive news on the Chinese policy front last week as Chinese authorities announced that the current export tariff being applied to rare earth materials is going to be a moving to a resource tariff. This subtle change will have a two major impacts. First, it will force local Chinese buyers to pay the same price as their offshore counterparts-effectively leveling the playing field. Second, the broader application of the tariff will raise the overall price of production, supporting current average selling prices and potentially a price increase in coming months.
In addition, Chinese ministers are contemplating issuing environmental-compliance certificates for rare-earth exports. If implemented, the plan would curb illegal and excessive mining - reducing the overall supply of rare earth materials and helping to balance the supply/demand dynamic. It will also require Chinese producers to adhere to more onerous environmental standards which, in addition to the increased tariff application, will raise the overall price of production.
Along with Molycorp and Chinese suppliers, Lynas is a major player in the rare earth mining business. However, their financial condition has deteriorated much faster than Molycorp's. In addition, the Malaysian government is under tremendous pressure to downgrade or withdraw their energy subsidy. Lynas has been left in a situation in which there's zero room for error. They are currently micro-marketing all company statistics in an effort to support their stock price. In the short run, a Lynas bankruptcy would probably be screened as a negative for Molycorp from a sentiment perspective, but would most likely be a net positive in the long term from an industry/supply standpoint.
Molycorp is a company that has built a facility that, when completed and streamlined, will be the most advanced and environmentally friendly rare-earth extraction process in the world and positions Molycorp to be, or very nearly be, the world's low-cost producer. Management is acutely focused on ramping up throughput by decreasing costly bottlenecks within the Mountain Pass facility. The improving month-over-month production trend highlights the success of their efforts. Demand growth for rare earths is being driven by the increased adoption of new technologies (clean energy, energy-efficient lighting, hybrid vehicles, battery technologies, etc.), which is a trend that should persist and accelerate well into the future. In addition, the company operates in a strategically important industry for the U.S. Defense Department and continues to fully integrate all of its operations.
Molycorp's cash burn and debottlenecking process must continue to be closely monitored. There is no doubt that the company is in a compromising financial situation, but to steal a quote from Warren Buffet: "The best thing that happens to us is when a great company gets into temporary trouble … We want to buy them when they're on the operating table." I believe Molycorp is going to successfully pull through this operation and emerge as the low-cost producer of a product that has returned to high demand, in an industry that has consolidated suppliers.