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Summary

  • Costs of goods continue to drop from $27/kg to $16/kg. Expecting $6-$7 by EOY with Leach 2.0.
  • Average sales price increased 16% to $39.02.
  • Molycorp's customer base has demand for full production capacity.

Molycorp, Inc. (NYSE:MCP) had their Q2 2014 last week, and most of the focus has been on their financials. While financials are certainly important, now that their short-term cash flow issues are resolved I'd like to look at MCP from a long-term perspective.

MCP is trying to do something fairly unique in the rare earth elements (REE) industry. They are developing techniques for processing REE at a low cost and still be environmentally friendly. China develops REE at low costs, but at a terrible impact to their environment. If MCP can prove that it can continue to drive down costs as it ramps up production, it will establish itself as a leader in this growing market and possibly even help China with its "war on pollution."

During the Q2 2014 earnings call, MCP announced that in Q2 it had lowered its costs from $27/kg to $16/kg. This is a significant drop and, more importantly, it was done while continuing to ramp up production. From the last earnings call:

At our Mountain Pass facility production volume increased in Q2 to 1,639 metric tons, a 48% increase over Q1 volume of 1,111 metric tons. As production rose our production cash cost declined sharply from $27 per kilogram in Q1 to $16 per kilogram in Q2. -- Geoff Bedford, president and CEO

These cost reductions are without one of the most important parts of the MCP strategy: Leach 2.0. Leach 2.0 is the last part of their cost reduction strategy. This allows them to recycle the chemicals, saving o the cost of chemicals and reducing waste water, as well as saving onp the cost of water hauling. When Leach 2.0 is fully operational, MCP expects to lower their costs to $6-$7/kg. This will make them extremely competitive, even with current Chinese miners who are currently not adhering to any environmental regulations.

Many analysts have dinged MCP for delays in their production facility. As an engineer, I'm fully aware that estimates are almost always wrong, especially when the project involves innovation. Even the top technical companies in the world often have grossly underestimated a project duration. To me, this is just the normal process for developing a state-of-the-art facility.

Demand for REE has been hurt not just by higher prices, but also by not having a stable supply. Molycorp hopes to provide that stable supply that will be immune from geopolitical issues. MCP indicated during its last earnings call that customer demand is there at full production levels:

Based on conversations with our customers, we currently see demand sufficient to support running Mountain Pass at an annual rate between 20,000 to 23,000 metric tons. Beyond Mountain Pass, our vertically integrated supply chain continues to perform well. As I mentioned earlier, every molecule we ship downstream from Mountain Pass is ultimately sold in a higher value form. In particular, we have been steadily growing downstream shipments from Mountain Pass of light rare earth concentrate what we call LREC to feed our Silmet and Zibo plants. Demand for the value-added products these plants produce including cerium is improving. -- Geoff Bedford, president and CEO

Some have speculated that demand will fall as MCP increases their production volumes. This may be true for some raw elements, but MCP's vertical integration strategy will allow it to move those elements downstream to higher margin products. Also, many customers will also be willing to pay a higher prices for stable supply. An interruption in supply is much more concerning to manufactures than price fluctuations.

In addition, there are numerous indications that long-term demand for REE is going to be much higher than originally thought. For example, China's "war on pollution" has several experts predicting that clean energy and hybrid cars could see explosive growth in China.

Conclusion

Molycorp's strategy is working. The company is lowering costs, increasing production, building a customer base, and raising prices through value-added vertical integration. MCP needs to complete Leach 2.0 to get its costs down to $6-$7/kg and ramp up production to 20,000-23,000 metric tons. With these metrics, MCP will be cash flow positive.

Long-term investors should ignore the stock price fluctuations and pay attention to the costs and production levels. If MCP continues to lower costs as it increases production, then MCP has a bright future.

Source: Molycorp - Everything Is Moving In The Right Direction For Long Investors