For the convenience of Seeking Alpha readers, we have divided this report into three parts:
- Our Macro Perspective on the REE Sector
- Molycorp: Understanding the Misunderstood
- Valuation: Putting it All Together
The key timeline factors on Project Phoenix are the following:
1) Molycorp will initiate a six month sequential start up process on April 1st, 2012 that will result in Phase I production rates being achieved by October 1st, 2012.
a. On the fourth quarter earnings conference call in early March, we expect management to give guidance as to whether or not Molycorp is on track to meet this April 1st start up commencement date (which CEO Mark Smith referenced at the JP Morgan conference in December 2011).
b. Hitting this landmark will be a major execution landmark and will help restore company credibility on Wall Street with investors who have felt burned by a great fundamental story but crashing rare earth prices from their summer 2011 highs.
2) The natural gas pipeline that will enable on-site electricity generation is scheduled for completion during the summer of 2012.
3) The magnet JV facility in Japan will be fully constructed and ready to produce rare earth magnets by the end of January 2013.
4) Phase II production capacity will be online by July 1st, 2013 through the oxide stage.
5) Phase I metal & alloy capacities will be online by the end of 2013.
6) We at The Strategist estimate Phase II metal & alloy capacities will be online by the beginning of 2014, the original date for Phase II pre-acceleration.
We see the fourth quarter earnings conference call (guidance on if April 1st start date is achieved), a press release announcing an on time commencement of the Phase I sequential start up, the natural gas pipeline completion, and Phase I production commencing on time (October 1st or earlier) as the major catalysts to Molycorp trading higher towards our price target and the P/NPV multiple converging to 1.0x. We would add that successful completion of the magnet manufacturing facility in Japan in January 2013 is an additional execution landmark in the next twelve months that should drive market valuation to the upside.
Operational Metrics Through the Oxide Phase
The engineering study Molycorp has based its business model on assumes 65% concentrate recovery and 94% recovery at the separation stage at Mountain Pass (these are the figures on which the $2.77/kg rare earth oxide operating cost is calculated). The current guidance from management is that Molycorp is achieving 68% recoveries at the concentrate stage and 98% at the separation stage. Project Phoenix will improve the 98% recovery rate as the piece of equipment causing the lost 2% is being replaced.
With respect to the concentrate recovery rate, we have used 68% in our model, but individuals in the rare earth industry not affiliated with Molycorp have informed us that the industry chatter is that Molycorp has the potential to significantly improve its concentrate recovery rates. This speculation is not at a stage where we are comfortable incorporating it into our base case operating assumptions. However we would note that a 1% increase in concentrate recovery, assuming all incremental yield can be processed into final product, would increase our net present value by 1.52%.
The improvements from 94% to 98% and 65% to 68% result in production costs through the oxide stage declining by 8.4%. We expect rare earth oxide production costs to come in at $2.54/kg. However, the potential impact of improved concentrate recovery is significant. Given the industry chatter, we think in the long term there is a chance for Molycorp to produce rare earth oxides at under $2/kg. The reason for this is because the cost of processing a ton of ore is basically fixed, but these improved recoveries mean the company can get more kilograms per tonne for the same cost.
The really intriguing possibility though is that the mining permit for Mountain Pass is for the company to mill 2,200 tonnes per day. Since we did not build or design the Project Phoenix processing circuit, we are not privy to what the potential bottleneck would in this scenario but consider this:
1) Assuming the 65% concentrate recovery and 94% separation recovery rates from the engineering study, Molycorp has the potential to produce at most 40,000 tonnes per annum if they feed 2,200 tonnes per day of ore into the mill.
2) Assuming the current 68% concentrate, and 98% separation recovery rates being guided for Project Phoenix, Molycorp has the potential to produce at most 44,000 tonnes per annum.
a. And the company has the capacity to process 43,000 tonnes once Phase II of Project Phoenix comes online. We know, because our editor-in-chief asked CEO Mark Smith on the second quarter 2010 conference call:
<Q>: All right. Just last question on the Silmet facility should we include those 3000 tons as part of the Phase 1 or is that incremental to the 19050 metric tons?
<A>: We'll always be incremental to the 19050 tons at Mountain Pass and when we achieve 40,000 metric tons at Mountain Pass that 3000 will also be incremental.
3) Every 1% improvement in concentrate recovery rates has the potential to increase annual production by 1.47% on a REO basis.
We have assumed that there is some limiting factor in the processing circuit that would prevent Molycorp from achieving all of these potential gains from improved extraction (maybe the separation circuit cannot process all of the additional material, or something along those lines). And when we questioned Molycorp investor relations on the potential for improved concentrate recovery rates, we were told the focus right now is on Project Phoenix and yield improvements are something for the company to investigate once Project Phoenix is up and running. Since we cannot determine if there is a limiting factor in the processing circuit, we have opted to leave these potential gains from improved recovery rates to the side. In our base case analysis we assumed Molycorp reduces the tonnes per day fed to the mill when adjusting for the improved recovery rates (65% to 68%, 94% to 98%). We did not increase annual production beyond the 22,050 metric tonne and 43,000 metric tonne nameplate capacities for Project Phoenix Phase I & II.
In addition, we have assumed 365 operating days each year and $10 million in maintenance CAPEX every year (significantly more than the engineering study).
We also in our base case scenario have included the mining of the NI 43-101 compliant measured & indicated resource at Mountain Pass after the current proven & probable reserves are exhausted. The reason for this is because other than Mt. Weld, we do not see any junior rare earth deposits with a compliant NI 43-101/JORC resource estimate and similar ore grade and as a result we feel comfortable assuming Molycorp will mine those tonnes in the long term.
The acceleration of Phase I & II of Project Phoenix only applies to through the oxide stage of the supply chain Molycorp is constructing. We asked management if metals and alloys were accelerated along with the Mountain Pass construction, and we were not told yes. As a result, we anticipate Molycorp will achieve its metals & alloys capacities for 2013 as outlined in the IPO prospectus based on the original timeline: 
Our research and conversations with individuals involved with the rare earth sector indicates Molycorp has the following current metal & alloy capacities:
- 900 tons didymium metal at a tolling facility (location not disclosed)
- Silmet: 120 tonnes Nd Metal which will increase to 240 tonnes by YE 2012
- Tolleson: 2000 tonne NdFeB alloy furnance, plus a 600 tonne furnance that may not be used
- Tolleson: Sm Metal for SmCo alloy
Given the projected revenue breaks down for Molycorp, the only place where we have a cause for concern versus the projected capacities in the IPO prospectus is regarding the NdFeB alloy capacity. 2,600 tonnes of capacity at year end 2012 (though there may be more capacity our research and conversations did not uncover) does not equal 8,163 tonnes by any stretch of the imagination. We have conservatively assumed only 2,000 tonnes of NdFeB alloy is produced by Molycorp in 2013 with full capacities achieved by year end 2016. This will be discussed in more detail in the valuation section. With the exception of this one adjustment to the metal and alloys production profile, we expect Molycorp to bring all Phase I & II metal and alloy production capacities online based on the original Project Phoenix timeline.
We note that we have held constant the oxide-to-metal, and metal-to-alloy production costs outlined in the engineering study on page 75 of the IPO prospectus, and we additionally have added $2/kg (on a TREO basis) to account for the production cost of XSORBX which is not included in the engineering study and for which we have not been able to locate a publicly disclosed production cost figure for XSORBX.
Molycorp is expected to produce three rare earth metals – neodymium, praseodymium, and lanthanum. The company also has some niobium and tantalum metal capacities at the Silmet facility in Estonia, but we have not incorporated them. In all scenarios, we have modeled the split between lanthanum oxide and metal production to be identical to that outlined in the IPO prospectus. With respect to neodymium and praseodymium, we have set aside 10% of neodymium metal production for direct sales (similar to what is outlined in the IPO prospectus). The rest of neodymium metal is modeled as going into the production of NdFeB alloys. Neodymium production is the limiting factor in determining how much NdFeB alloy can be produced from Mountain Pass production instead of Praseodymium. As a result, we have assumed all surplus praseodymium metal is sold direct to customers.
Molycorp will be producing two alloys – neodymium iron born and samarium cobalt. We discuss NdFeB below, but we have modeled that all samarium oxide production is converted into samarium metal and that all samarium metal production is dedicated to samarium cobalt production.
Given how the projected revenue breaks down for Molycorp, the only place where we have a cause for concern versus the projected capacities in the IPO prospectus is regarding the NdFeB alloy capacity. 2,600 tonnes of capacity at year end 2012 (though there may be more capacity our research and conversations did not uncover) does not equal 8,163 tonnes by any stretch of the imagination. We have conservatively assumed only 2,000 tonnes of NdFeB alloy is produced by Molycorp in 2013 with full capacities achieved by year end 2015. This will be discussed in more detail in the valuation section. With the exception of this one adjustment to the metal and alloys production profile, we expect Molycorp to bring all Phase I & II metal and alloy production capacities online based on the original Project Phoenix timeline.
We have modeled XSORBX demand to grow at a high single digit rate with 100% of Mountain Pass cerium oxide production being reserved for XSORBX in 2027. In a presentation at JP Morgan conference in December, management indicated that 40% of Phase I cerium production has been reserved for XSORBX. We have modeled for strong growth in 2014 of 26% given the expansion to Phase II and with a secure feedstock, we anticipate consumers develop a comfort with XSORBX. After 2014, we have Molycorp reserving an additional 5% of total cerium oxide production for XSORBX going forward each year which suggests an 8% growth rate between 2013 and 2027 in terms of XSORBX demand. We find this perfectly reasonable given the importance of water treatment as the emerging world industrializes.
Note that we have modeled XSORBX on a cerium oxide equivalent basis, and our pricing has also been done on a cerium oxide basis.
In late November 2011, Molycorp announced they had signed a definitive agreement to form a magnet joint venture with two partners in Japan. We do not have enough information to properly model the net present value of this joint venture except to say that should the accretion be similar to accretion created by NdFeB alloy production, we view this joint venture as a net positive. First production can be expected to start by the end of January 2013. We will be listening for management to offer more guidance with regard to operating costs, CAPEX, realized sales price on the JV as 2012 progresses.
Continued in Part III
 Our notes from discussions with management indicate July 2012. We note that this construction has been contracted out.
 We derive this based on the 2013 production estimates in the IPO prospectus (see graphic in article). Prospectus locateable on SEC EDGAR
 Probably one of maybe a handful of nice things we have heard a junior REE management say about a competitor.
 Pulled from the Bloomberg transcript
 Molycorp IPO prospectus page 41 (see graphic in article)
Disclosure: I am long MCP, QRM, REE.
Additional disclosure: The facts in this newsletter are believed by the Strategist to be accurate, but The Strategist cannot guarantee that they are. Nothing in this newsletter should be taken as a solicitation to purchase or sell securities. These are Mr. Evensen’s opinions and he may be wrong. Principals, Editors, Writers, and Associates of The Strategist may have positions in securities mentioned in this newsletter. You should take this into account before acting on any advice given in this newsletter. If this concerns you, do not listen to or consider our opinions. Investing includes certain risks including potential loss of principal. The commentary of The Strategist does not take into consideration individual investment objectives, consult your own financial adviser before making investment decisions.