On Thursday evening, November 10, 2011, rare earth miner and producer Molycorp (MCP) reported strong earnings. There were no surprises given the strong guidance CEO Mark Smith delivered the previous week. Molycorp reported record margins and record revenues. Average sales price price increased 75% quarter-over-quarter to $131/kg of REO equivalent.
The volatility in rare earth prices prevents MCP from providing earnings guidance, but it did slightly reduce production guidance to account for some equipment downtime. The market delivered its own surprise by rewarding the company for this news with a 14% one-day loss.
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Market responds poorly to MCP earnings, putting the 52-week lows back into play.
Seeking answers, I listened to the conference call and scanned through the 10Q. I did not note anything in the 10Q that is surprising or in direct conflict with the bullish thesis on MCP. The conference call was only 50 minutes long. MCP executives spent 33 minutes of that time reading the prepared materials. The analyst questions in the remaining 17 minutes revealed no new alarms. Indeed, I was surprised that the questioning did not last longer and was not more skeptical given the vigorous sell-off in the stock. I have to assume the analysts on the call were neither surprised nor disturbed by the results.
Perhaps the following episodes exposed some chinks in the armor…
A JP Morgan analyst asked about the impact of the 60% drop in price in cerium (Ce) from the highs in July. Perhaps Smith’s response was unsatisfactory as he noted that in the first 23 1/2 years of his career, cerium sold for less than $3/kg. Smith believes the current pricing environment is more rational. I believe Smith was trying to reassure that his company can make plenty of money on cerium, but it is possible his comment could have some wondering whether cerium could or even should drop back to those earlier levels. Molycorp’s average production costs are $2.77/kg.
An analyst from Harvest Capital asked about rumors that China’s rare earth export quota will not be completely used up by year-end. Smith did not directly answer that question and instead referred to the uncertainties surrounding what’s going on in China. (See slide #31 of the earnings presentation for a summary of known recent rare earth related actions by China).
The most interesting question came from an analyst at Jacob Securities. She asked for more details on Molycorp’s potential to produce heavy rare earths. Smith stated that the most advanced part of the heavy rare earth strategy is the new cracking facility that will be online at commercial scale next month. The second most advanced component of the heavy rare earth strategy sits in monazite in a local deposit. The new cracking capability means Molycorp no longer needs to send this monazite to its tailing pits. However, Smith said nothing about the timing of actually producing any heavy rare earths for sale. For more speculation on this topic see “What Molycorp Has NOT Said About Its Future Rare Earth Production (Until Now)” in Technology Metal Research.
CNBC’s Brian Schactman had some interesting explanations for the negative market reaction (see “Molycorp Earnings: Hit or Miss?“):
The $72 million in earnings translates into 67 cents a share, 3 cents below expectations…the consensus estimate was sharply increased after Piper Jaffray assumed coverage late last month with an earnings per share estimate of 84 cents. If that estimate wasn’t there, the consensus estimate would have been 5 cents lower, and we would be talking about a Molycorp beat.
And on the revenue side:
Revenues pose another dilemma for investors and analysts. In its fiscal third quarter, Molycorp’s sales were $138.1 million. That’s well below estimates, which ranged from $142 million to $192 million. The company did not include $37.2 million it earned from selling material to its subsidiary in Estonia. If that’s included, revenues would have been above consensus.
In other words, if the market dropped MCP stock because of missing “expectations”, the market is looking in the wrong place.
At $33.45/share, Molycorp is more of a bargain than ever. MCP’s forward P/E is 9.2 with strong earnings growth ahead. Even the preferred shares (MCP-PA) are a bargain with an effective yield of 7.9% at Friday’s closing price of $69.92 (next quarterly payment is $1.375/share).
Regardless, it probably makes sense to maintain downside protection with puts. Friday’s sell-off could represent some on-going nervousness in the market that is likely to last for some time until worries about recession and/or a crash in China finally abate.
Be careful out there.
Additional disclosure: I am also long MCP calls and puts and the preferred shares.