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Summary

  • The cash flows concerns and debt ratings have created some problems for the company.
  • Savvy traders might make some quick gains on the short-term price movement as there are over 66 million shares short.
  • Competition from China and focus on finding rare earths alternatives might create further problems for the company.

Molycorp (NYSE:MCP) is one of the largest manufacturers of custom-engineered rare earths. The company has been under a lot of pressure over the last two years due to the falling rare earths prices. The stock has lost about 62% year-to-date and is continuously losing value due to uncertain future prospects. Further, the company's debt ratings have also been slashed by Standard & Poor's Rating Services which has put further pressure on the company and the stock price. There has been some positive comments by analysts which has allowed the stock price to make a small recovery; however, the performance of the stock over the last few months has been alarming.

Molycorp: A High Risk Bet

The problem of oversupply has impacted the global market and resulted in poor performance of Molycorp over the last three years. The company produces a wide range of rare earth minerals, including Lanthanum, Cerium, Neodymium and Praseodymium. The table below shows the minerals that Molycorp produces.

(click to enlarge)

Source: SEC Filings

Molycorp has relied heavily on Lanthanum and Cerium in the past and has derived huge profits from these two products during 2011; however, the sharp decline in the prices of these minerals resulted in severe fall in revenue and profitability. Although the company has increased its production after the second quarter of 2013, the production increase has been canceled by the decreasing prices of rare earths.

(click to enlarge)

Source: SEC Filings

The poor performance over the last two years has also resulted in a severe shortage of cash to meet short-term expenses. Despite the production increase, this cash scarcity will further decrease the company profitability in the long run.

Debt Rating Downgraded

Moreover, Molycorp, similar to its Australian competitor, Lynas Corporation (OTCPK:LYSCF), is considering refinancing its debt in order to bring down the cost of capital and decrease the cash outflow. However, the company's bond ratings have been recently slashed by Standard & Poor's Rating Services from CCC+ to CCC. The outlook is negative, and S&P believes that the company's capital structure is unsustainable. A negative outlook means that the ratings might be adjusted downward in the future - usually a negative outlook indicates poor quality of credit. Moreover, the company's sources of liquidity may not be sufficient to cover the operating expenses and working capital needs, capital spending, and interest payments. Any bond with ratings below BBB is considered as speculative grade, commonly known as junk bonds - these bonds are considerably different from investment grade bonds and do not receive a good response during refinancing. Therefore, the new bond ratings will prove to be another hurdle for Molycorp, which complicates the process of its debt refinancing options.

Risk Factors to Consider

The global supply of rare earths is largely controlled by China, which contributes approximately 83% of the total global supply, representing a virtual monopoly on rare earths. However, over the last few years, authorities have tried to control the over-supply, which has sharply decreased the commodity prices during the period. China's new leadership also declared a war on pollution and announced to impose new taxes on rare earth producers by the second half of 2014 while removing the previous export restrictions. But, this ease in restrictions and price improvement will encourage producers to increase the supply in order to harvest the profits, which will eventually worsen the market conditions for rare earths in the long-run.

Rare earths are critical inputs in many existing and emerging applications, including clean energy technologies, such as hybrid and electric vehicles and wind power turbines, multiple high-tech uses, including mobile devices and tablets, and critical defense applications. The impact of the recently imposed taxes on the producers will likely shift to the customers, and manufacturers might have to pay higher prices. This will substantially increase their materials procurement costs and decrease their margins. Therefore, another concern for rare earth miners is manufacturers switching to alternatives. Last year, Samsung (OTC:SSNLF) decided to invest a substantial amount of money into a research project focused on finding alternatives to rare earths.

Conclusion

Things are not looking good for Molycorp - the company is fighting with internal as well as external issues. Internally, Molycorp is facing cash flow problems and externally, the company faces severe competition from China and falling rare earths prices along with poor debt ratings. The debt ratings issue has somewhat hampered the company's ability to tackle its cash flow problem as it will be expensive to raise debt. We believe Molycorp is a high-risk speculative play at the moment - the fall in the price over the last few months might give the traders an opportunity to make some money. At the moment, over 66 million shares of the company are shorted - any more comments from analysts or some sort of positive news might cause a short squeeze, and allow traders to make some quick gains.

Disclaimer: This article is for educational purposes only and it should not be taken as an investment recommendation. Investing in stock markets involves a number of risks and readers/investors are encouraged to do their own due diligence and familiarize themselves with the risks involved.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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Source: What Now For Molycorp?