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Summary

  • Moody's downgraded Molycorp to "Caa2."
  • Moody's noted that the company's debt level may be unsustainable.
  • Investors should avoid the bonds until the company turns cash flow positive or raises more capital.

Everyone who has read my articles knows I am bearish on Molycorp (NYSE:MCP). I believe the stock is overvalued given the potential for a dilutive event and the convertible bonds are worth from 3-5 cents on the dollar. The following chart describes the company's senior indebtedness.

(click to enlarge)

In the article, Molycorp's Long-Term Debt Does Not Reflect Bankruptcy Risk, I stated my case:

Molycorp recorded approximately $35 million in quarterly interest expense on long-term debt of $1.3 billion. Unless it raises capital by 1Q 2015, the company will most likely be unable to repay the interest or principal on the bonds. The price of the bonds do not reflect this risk. Therefore, I rate the bonds a sell.

That said, today the stock rallied inexplicably. The shares closed up $0.16 (5.94%) to $2.94/share on trading volume of 11.8 million; average trading volume is approximately 4.6 million. Some attributed the move to a nondescript press release from management that the company had settled claims with M&K Chemical Engineering Consultants. The claims arose from a commercial dispute pursuant to the modernization of the company's Mountain Pass facility; the terms of the settlement were confidential.

One of the commenters on my previous article, Molycorp: Recent Insider Sales A Bearish Indication, could not wait to gloat about it:

Shock Exchange, your last article that I took the opposite side of [long], was written when the stock was around $2.60 per share. Today it's just under $3... I will ask if you need to continue the bear argument with additional articles? ... I will look forward to hearing more from you especially when the stock is headed back to $4.

The commenter may have spoken too soon. After hours today, Moody's downgraded the corporate family rating (CFR) of Molycorp from Caa1 to Caa2 and affirmed the B3 rating on the company's senior notes. The Moody's downgrade highlighted the following issues:

  • The downgrade reflects continued weakness in rare earths pricing environment.
  • Mountain Pass construction left the company with debt levels that may be unsustainable.
  • Molycorp had debt of $1.4 billion (at March 31, 2014) and $140 million of interest expense for the preceding 12 months, amid negative EBITDA ($140 million) negative cash flows ($210 million) for the 12 months ended March 31, 2014.
  • Despite cash on hand of $236 million, liquidity could become strained in the next 12 months given the current cash burn rate.

What are the odds of Molycorp putting out a positive press release on the same day Moody's downgrades its bonds? Anyway, in after hours trading, the stock was down 3.74% to $2.83. I would prepare for a wild day of trading tomorrow.

Conclusion

The Moody's downgrade reaffirms what I have been saying all along about Molycorp's cash strain and high debt level. I advise investors to avoid the convertible bonds until they enter my trading range of 3-5 cents on the dollar, or until the company raises more capital.

Source: Moody's Cuts Molycorp To "Caa2," Notes Debt Level May Be Unsustainable

Additional disclosure: I own June puts on September puts on Molycorp.