Out of date analyst estimates are predicting Molycorp’s (MCP) earnings in the fourth quarter to be -$.10 per share. Market conditions have drastically changed since the third quarter of 2010. These changes, and the company’s resulting behavior changes should be accounted for and new earnings predictions produced. The intent of this article will be to asses Molycorp’s third quarter performance (see MCP's 3Q report here) and to determine how market conditions and released business decisions have affected their bottom line.
To start, let’s paint a picture of how Molycorp was running their pilot plant in the third quarter of 2010 versus how they should have run it in the fourth quarter 2010. In the third quarter, Molycorp's average production rate was 2080 mt/yr. Their average COGS was $14.54/kg of REO, and the average price that they received per kg of REO was $16.14. During the last month of the third quarter, REE prices started to spike. Up until this time their COGS was significantly higher than the prices that they were receiving.
During the majority of the third quarter, Molycorp was running their pilot in an effort to learn about ways to improve their process and train employees in preparation of their new facility coming online. Molycorp was running the pilot plant as a true pilot plant because there was no reason not to when their costs were higher than the prices they were receiving and they wanted operations to be stable as they were just about to go public.
Now, let's fast forward to the fourth quarter and review the effects of a changing world environment on Molycorp's pilot plant operation. During the fourth quarter, the average price per kg of REO was always above $45/kg. This higher price environment should have provided Molycorp the incentive to run the pilot plant at maximum production instead of in research mode. Ramping up production to rates near 3000 mt/yr should not have been an issue as Molycorp had previously rate tested the plant at 3000 mt/yr. In order to account for any production issues or slow ramp up times, 2750 mt/yr will be used in the earnings estimate calculations.
Next, let’s move on to product price. Molycorp's earlier fixed price contracts had all expired by the fourth quarter. By the middle half of the quarter, Molycorp had secured two new market price based contracts. At this point no information has been released to the public that reveals the actual fourth quarter pricing received. In order to be very conservative, one could assume that Molycorp sold products at similar prices last quarter up until December, at which point they had both of their new supply contracts in place. This conservative assumption leads to the following product prices:
Lanthanum Oxide (Oct, Nov, Dec =$11.65, $11.65, $62) Average $28.44
Cerium Oxide (Oct, Nov, Dec =$16.24, $16.24, $62) Average $31.49
Didymium Oxide (Oct, Nov, Dec =$32.59, $32.59, $84) Average $49.73
The third quarter prices quoted above (used for Oct and Nov) can be mathematically extracted from Molycorp’s SEC filings, but were never given explicitly. These estimates are most likely low as market prices were significantly higher in the fourth quarter than the prices that were received in the third quarter. Even taking this into account, however, does not mean that they were able to capitalize on these higher prices at first. Sometimes, companies continue honoring some, or all parts, of old contracts in order to keep selling products while they are securing new buyers or renewing contract terms.
A few more assumptions need to be stated in order to begin estimating Molycorp’s 4Q 2010 earnings. The second most important number required to perform their quarterly earnings calculation is their cost of goods sold, or COGS. By taking 3Q’s total COGS ($7.6M) and dividing it by 3Q’s production in kgs (.52 million kgs), last quarter's COGS was equal to $14.54/kg. Many factors can influence COGS and can make it hard to estimate from quarter to quarter. Some of the factors are fixed and others are variable. Since Molycorp should have been increasing production in the fourth quarter, it can be assumed that their variable costs are roughly the same and the fixed cost is spread across more units of production. In theory, their COGS should go down in 4Q 2010, so it should be safe to assume that it is the same as in the third quarter.
The next most significant number required to produce Molycorp’s earnings estimate is their “Selling, general and administrative” expense. During the third quarter, this was about $4M, or on pace to be $16M per year. Molycorp has estimated that this expense will be between $20-25M in the future when their new plan is up and running. As they should be ramping up personnel now, this expense was estimated 38% higher than in 3Q. The final estimated “Selling, general and administrative” expense for 4Q is conservatively estimated at $5.5M or equivalent to $22M per year.
Stock based compensation was also evaluated as it may or may not be significant. It appears that 37,500 shares were issued to executives in Nov 2010. This could be valued at ~$1.125M, and most likely only 1/3rd will vest immediately and be recorded as stock based compensation. This would be an equivalent expense of $375,000. Most of the remaining expenses should be small enough as to be insignificant in an earnings calculation. Also, please note that at this time, Molycorp should not have to pay any taxes on profits, as they have past losses that they should be able to have carried forward.
The spreadsheet shown below calculates Molycorp’s earnings, which are estimated from the assumptions rationalized above:
click to enlarge
The calculated earnings for Molycorp are $6.2M, or $.09/share for the fourth quarter. This estimate uses multiple conservative factors throughout each component of the calculation. When some of these conservative assumptions are removed, the earnings rise to $.35 per share.
Now, let us look at how even the conservative $.09/share could affect the market. It appears that most of the pessimism in the market place has to deal with length of time to production and future earnings potential. Molycorp’s positive current earnings will improve the general public’s view of REE company profitability. Investors will become a little bit surer of future earnings potential and will be more willing to own REE companies. Lynas (OTCPK:LYSCF) being so close to production should also benefit greatly as this will solidify their investors' estimates.
Molycorp earnings estimates have only been made by a few analysts and no one has updated their estimates in the last few months. By beating these out of date and stale estimates, analysts will be forced to renew their future predictions. These future predictions will bring full year 2011 to near $1 EPS and multiply 2012 and 2013’s current numbers. The ensuing stock run up following a wave of updated earnings predictions will be huge for the entire REE market.
Disclosure: I am long MCP.