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Molycorp Inc. (NYSE:MCP) beat estimates by $0.12 in Q2 2011 ($0.52 versus an estimated $0.40). This was a huge beat for a company that had not recently even shown a profit. MCP’s management reiterated that the $781 million expansion project at its Mountain Pass facility is on time and on budget. It effectively substantiated or even enhanced the analysts’ estimates for future quarters. It substantiated MCP as a successful mining concern with a bright future. This is so true that there has even been recent insider buying by MCP President Mark Smith. He recently bought 4,200 shares at $59.02 (nearly $250,000 worth) on Aug. 15, 2011. This is the first insider buy in a while, and it may mark a turning point for the company.

It hasn’t hurt MCP’s earnings that the average sale price for its rare earths rose to $72.10 per kilogram equivalent, compared with $7.16 per kilogram in the year ago quarter. This price was also up from the mid-$30 range in the previous quarter. To get a better look at the overall price movement lately, Lynas’ rare earths price chart below is helpful.

Click to enlarge



As you can see from this chart, the rare earths prices have been going up all year long. They have only faded a bit in August. Given that the higher prices are pricing some manufacturers out of business in their industries, this seems a normal occurrence. An example of this would be the hard disk drive business. The price of the rare earths components used to be $0.25 per hard drive. Rare earths now cost $5 per hard drive. This has effectively priced many of the lower capacity hard drives out of the market. The hard drive business was already being hurt considerably by the flash memory competition on the low end.

The hard drive example above is worrisome, but it is not necessarily a game changer. The table below shows the major categories for rare earths use.

Click to enlarge



As you can see the hard disk drive business was not a major part of the rare earths business. In other areas such as rechargeable car batteries, the extra cost is noticed, but the demand is fairly inelastic for the amount of price change. As an example, MCP recently announced that it had reached an agreement with Hitachi Metals to supply the company with rare earth metals. This extended and expanded on MCP’s former agreement with Hitachi Metals. The rare earths MCP will supply include didymium (a mix of neodymium and praseodymium) metal and alloy, and Lanthanum Oxide. This further validates the recent acquisitions of the Silmet facility in Estonia and the Santoku America facility in Arizona (now Molycorp Metals and Alloys). It indicates MCP’s management team is doing a good job, which is always a reassuring thought to an investor.

The table below shows some of the relevant fundamental financial data for MCP. The data is from Yahoo Finance. I have not presented more, because MCP is newly profitable. Some more long-term data would only cloud the situation. 

Stock

MCP

Price

$48.65

1 yr. Average Analysts’ Target Price

$94.40

Predicted % Gain

94%

PE

176.91

FPE

12.64

Avg. Analysts’ Opinion

2.3

Miss Or Beat Amount For Last Quarter

$0.13

EPS % Growth Estimate for 2011

374.30%

EPS % Growth Estimate for 2012

89.70%

5 yr. EPS Growth Estimate per annum

50.00%

Market Cap

$4.08B

Enterprise Value

$3.60B

Beta

N/A

Price/Book

5.00

Total Cash per share (mrq)

$8.11

Short Interest as a % of Float

23.40%

The above data indicates MCP is a financially solid company. However, its huge short interest percentage is important. That level of short interest will allow momentum players and HFT traders to drive the stock up quickly on any good news - to short-squeeze it. An overall market bounce upward would be such good news. Plus MCP has had its own great news such as its recent quarterly beat and the new Hitachi contract. These should help stock traders drive the price upward. The fact that MCP may deserve a higher price should help. Its FPE (FY2012 earnings) is only 12.64. Its PE at the end of 2011, using today’s price and the current analysts‘ EPS estimates for FY2011, is only 23.97. Considering MCP's five-year estimated EPS growth per annum of 50.00%, one could easily argue that these PE multiples are too low for such a high growth stock. The analysts’ predicted 94% one-year stock price gain tends to agree with this thesis. Buying MCP now (or at least starting to leg in) seems like a very reasonable strategy.

Let’s look at the two year chart of MCP to get an idea of the technical state of the stock. The chart is below.

Click to enlarge



The Slow Stochastic sub chart indicates that MCP is in a nearly oversold state. It is ready to bounce upward. The two red lines I have drawn on the chart indicate areas of substantial support and resistance. MCP is at a point of strong technical support. It could go down a little more, but it is more likely to rally from its current level. Substantial overhead resistance does not occur until approximately $60. This would be more than an $11 move upward from the current price. Plus the recent high close in April 2011 was at $77.54. This would be easily attainable given the current fundamentals.

Are there possible problems? Yes. If the world economy deteriorates enough, China will probably start selling more of its rare earths on the international market. This would drive the prices down demonstrably. It would also hurt MCP’s earnings potential.

Lynas’ production could possibly hurt prices soon. However, there is likely enough demand to keep prices high for the time being. Plus rare earths demand is set to roughly double by 2020. It will pay to watch all rare earths developments closely. However, there is good reason for the analysts’ 5 year estimated EPS growth to be 50% per annum. Any investment has risks. MCP is no different. Its recent earnings beat means that at least some of the short interest should cover. The beat put the lie to many of the naysayers’ negative assertions about MCP. This short covering has not happened with the recent large fall in the overall market. It seems likely to occur very soon. MCP’s stock price may shoot up when this happens.

This could be a classic short squeeze. You might want to participate. The recent bullish comments by Abby Cohen of Goldman Sachs may help you have the courage to do so.

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

Source: Molycorp Set Up For A Classic Short Squeeze