For anyone wondering, rare earth is not undercooked dirt that someone forgot to leave in the cosmic oven for the proscribed portion of time. Rather, it is more like the true delicacies of the mineral world; not everyone has heard of them, but the people who have are willing to pay a lot to sample them. Rare earth materials include metals, oxides, alloys and magnets that are used in applications ranging from entertainment technologies to defense weapons to clean alternative energy. Examples include terbium, neodymium, yttrium, scandium and gadolinium. These elements are used for everything from flat panel televisions and the screens of smartphone to the batteries in hybrid cars and critical elements in low-energy CFL light bulbs.
In addition to the pure investment ramifications of these materials, there are far reaching geopolitical concerns at play within the sector as well. Currently, the dominant player in this space, as a nation, is China. As companies and nations become increasingly dependent on these minerals, the political landscape is likely to be influenced by international relations as major players scramble for increased control. In a recent article, one analyst points out that while the prices for these elements has been increasing rapidly, concerns about demand from Japan has stalled the increase in stock prices of rare earth companies. The analyst correct suggests that this may be a long-term buying opportunity.
Political Meets Military
When a specific sector is expected to have a significant economic impact on multiple markets, particularly when commodities are involved, this can create real political pressures. Take, for example, the impact of copper prices on international businesses that deal with China. The rate of building and expansion, both which impact the demand for copper, have impacts on copper prices, shipping prices, the demand for other materials, and a general impact on any business that touches any of these industries. Positioning for trade within and control of these industries, therefore, become politically important very quickly.
In the case of rare earth products, the military applications of most of these materials make them even more important. The economic element is intensified because control over these markets can result in both financial and military advantages. This reality is not lost on either institutional investors or the governments of every major industrialized nation on the planet. As positioning for these products intensifies over time, the value of those companies that control the market will be significant. Investing in companies over direct commodities investments allows you to be less precise in timing your investment because an equity holding can be held until the price move occurs.
Within the space, one company that stands out as a particularly attractive option at current levels is Molycorp (MCP). The company is one of the largest players in rare earth materials outside of China and has significant operations inside of the U.S. Named for molybdenum, the company has diversified interests that have far-reaching applications. Competitors include Avalon Rare Metals (AVL), Xstrata PLC (XSRAY.PK), Freeport-McMoRan (FCX) and Rare Element Resources (REE).
This is both an odd industry and an odd collection of competitors. While a few major financial metrics are compared and discussed below, these are challenging comparisons. For example, Avalon has a market capitalization of under $250 million, but trades over 800,000 shares per day. Freeport is a massive basic materials company, but its exposure to rare earth materials is limited as a percentage of its total earnings. Xstrata has a market capitalization of over $52 billion, but the stock is thinly traded on the pink sheets; this lack of liquidity makes it of limited usefulness. Rare Elements is a microcap who metrics fail to be useful given the company's small size. Given this diversity, comparisons of classic financial metrics are of limited importance. In this context, Molycorp has a market capitalization of $2.2 billion, trades nearly 4 million shares per day and is focused on the industry under consideration.
On a valuation basis, Molycorp has a trailing twelve month price-to-earnings (P/E) ratio of 21 relative to 9.1 for Freeport, 9.2 for Xstrata and a negative earnings reading for Avalon. Putting this into perspective on a growth basis, Molycorp had year-over-year quarterly revenue growth of 512%. When this is used in conjunction with the P/E ratio, the company has a price-to-earnings over growth (PEG) ratio of 0.65. A reading under 1.0 is considered favorable. Freeport has a PEG ratio of 1.8 and the others do not have positive growth or earnings. On this basis, Molycorp significantly exceeds its peers.
In terms of the quality of management, as measured by operating margin as an indicator of efficiency, Molycorp has an operating margin of 41.6% relative to 40.1% for Freeport and 24.5% for Xstrata. For a development stage mining company to have this level of efficiency, edging out a company as well run as Freeport, speaks well of its future prospects.
The company is expected to report earnings this week. This may serve as a key catalyst that drives the stock's price and bears watching. If the numbers are good, the stock may spike. This should not be seen as a missed opportunity because the upside potential for Molycorp is significant. If the numbers are weak and the stock sells off, this should be seen as a buying opportunity. A moderate approach would be to buy half of one's position ahead of the announcement and half after. This will balance the effects of the announcement against the long-term appeal of the name.
Overall, Molycorp and the collective rare earth industry are a great place to position oneself for the long-term. If and when crisis hits, this is an industry that should remain immune and indispensable. When one considers both the technology and military applications targeted by this industry, few companies should be as unshakeable over the extended-term.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.