Molycorp: A True Value Play

| About: Molycorp, Inc. (MCPIQ)

Rare earth metals have been arguably the hottest, and fastest growing sector throughout the past year. Leading the charge has been Molycorp (MCP) who owns a massive amount of rare earth metals (also known as green elements) in its Mountain Pass, California property. MCP is currently trading at $57.52 per share and is up 477% in the last year, despite having declined over 35% since its high in early May.

The supply for rare earth metals is extremely limited and they are necessary for new technologies including; lithium car batteries, incandescent light bulbs, iPods, cell phones, PDAs, CD/DVD players, lasers, sonar, military radars, water sanitation. The list goes on. The point is that these elements are in great demand but very short supply. That is why MCP stands to benefit a great deal from rare earth metals in the future.

Shares of MCP have already reflected a substantial increase in expected future demand for rare earth metals. The company is currently valued at $4.83 billion despite being only projected to pull in around $380 million in revenue for all of 2011. There is no doubt that MCP has a huge amount of speculation baked into its current price. But however "huge" that amount of speculation is, it's clear that it is just not enough. In the last 60 day MCP's projected earnings for 2011 have gone from $-.08 to $1.81 per share, mostly due to an extreme rise in the price of rare earth metals in that time period. In that same time period we've seen Lanthanum climb over 200%, Cerium Oxide over 300% and Neodymium over 100%. Yet MCP stock has gone nowhere since these massive price shifts in rare earth metals. The MCP bears will tell you that this is because W. R. Grace & Co. (NYSE:GRA) has already bought MCP's rare earth supply through 2012 and a price ceiling was included in the deal, so MCP will not realize any of these recent gains in the price of its rare earth metals. But, that is oh so wrong.

First off, let's assume that GRA is the only person to profit from this recent spike in rare earth prices through 2012. Either way MCP still has a big supply that they can sell after 2012 for the market price then. And, after their current mistake, there is almost no doubt MCP management will not make another GRA type deal anytime in the near future. The only way something could go wrong in this scenario is if the price of rare earth metals somehow crashes. Which, at this point seems highly illogical to me. In the next five years, a growing demand is projected in nearly every sector that the rare earth metals service, so it is more than reasonable to conclude that as the demand keeps rising, so will the price (as is the case with any resource with a limited supply).

Another thing that MCP bears overlook is that with rare earth prices at these record highs, it now becomes profitable to MCP to go back through it's discarded land in search for smaller element chunks that may have been passed up during the original mining process. As MCP begins to go through and mine these piles, they will be able to sell these rare earth metals at current market prices, therefore being able to take advantage of favorable price levels before 2012 after all.

Now, let's get dirty and look at some hard numbers to determine just how cheap MCP is. MCP is projected to double its $380 million 2011 revenue to around $640 million by 2012, and have an annualized growth rate of 43% for the next five years. These are astounding growth numbers that warrant a second glance. If we annualize a 43% growth rate each year based off of the $380 million in projected 2011 revenue, we get around $2.72 billion in revenue for 2016. Which would be around an 800x increase from 2010 revenue of $35 million. MCP's PEG ratio is only .84, less than half of Chipotle's (NYSE:CMG) 2.01, Netflix's (NASDAQ:NFLX) 1.85, or Amazon's (NASDAQ:AMZN) 2.99. The point being that MCP shouldn't be thrown with the highly priced growth stocks because MCP is cheap.

Finally, here's what gets me really excited about MCP, with 2012 revenue expected to be around $640 million and 2012 profits expected to be $3.72 per share, we can assume that for every $172 million in revenue MCP will earn $1.00 per share. That is if profit margins stay the same. But they won't because the price of rare earth metals will rise and the cost to mine them won't. So, we can assume to see a few percentage points increase in MCP's profit margin every year. Finally here's my calculation:

$2,720,000,000/160,000,000 (adjusted from 172,000,000 for increasing profit margins) = $17 per share in 2016 earnings.

But, that is assuming a certain growth rate in the price of rare earth metals, which I believe to be highly underestimated. As all the current technologies that need rare earth metals become more mainstream and garner a more solid foundation within our society, demand must increase. Infact, the demand stands to increase so much that there physically may not even be enough rare earth metals mined in 2011 to cover the total demanded. (Go here for National Geographic's take on the upcoming Rare Earth shortage).

MCP is a long term value play and with the recent pullback in the stock due to the share unlock, now seems like an excellent time to initiate a long position. By 2016, assuming MCP is trading at a 20 P/E, we could be looking at a $340 stock, if not something a lot higher if the demand for rare earth metals can continue rising at its current rate. I'm willing to wait five years for a potential 10 bagger. That's why I'm long MCP at these prices.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in MCP over the next 72 hours.