Yesterday Molycorp (NYSE:MCP) fell 10.8% to $11.59/share - the second biggest percentage decline on the New York Stock Exchange. Several shareholders attributed the sharp decline to an article from Shock Exchange which hit the Internet just before the market opened. The article, "Molycorp and The Pain Ahead," explained how a September 2010 dispute that resulted in China denying rare earth minerals to Japan, and subsequently to Europe and the U.S., "set off an international manhunt for rare earth deposits" putting Molycorp, and its Mountain Pass rare earth mine in the catbird seat. However, an increase in supply has since caused rare earth prices to decrease, and with it, Molycorp's earnings:
Declining rare earth prices have since ravaged Molycorp's earnings and stock price. Through six months ended June 2012, the company achieved an operating loss of $51 million on revenue of $189 million. According to Molycorp's 2012 second quarter 10-Q, it sold '1,169 mt of rare earth products at an average price of $45.92 per kilogram as compared to sales of 973 mt at an average price of $77.60 per kilogram during the corresponding period in 2011.' This would imply a rare earth price decline of approximately 40% year-over-year. The company's stock price was $13.00/share on September 21, 2012, reflecting its reduced business prospects.
The article drew the ire of MCP longs who, in the "comments" section of the article, "Molycorp and The Pain Ahead," made the following claims:
Shock Exchange ... Trying to make a shock for a stock but selected a wrong one ... MCP is the best equipped rare-earth manufacturing company around the world. Top management bought over 10 million of their own shares recently. Long and hold the shares strong.
If it's not bad enough that we have so called professionals like Greenberg killing stocks by saying things or writing stupid articles, now we have amateurs writing even more stupid articles that take down an already beaten down stock by 10 percent in a day. All of your concerns have been factored in long ago ... All you did was kill MCP for a day or two.
What world do you live in? People also buy and sell stocks on pure fear and you created it out of old news. The reason that the stock was a $13 stock was because of that old news ... now it's an $11 stock because you restated the obvious. Why even write such a thing? I hope you were short so someone profited from this. Investors sure didn't. Sometimes it's better to not say anything. Just ask Romney after his 47% ordeal.
Quite the contrary, I am actually a big fan of Molycorp and was kicking myself for not buying into the stock in September 2010. I like the story but am looking for an attractive entry point. I still have not found it. My interpretation of yesterday's down day is as follows:
Opportunistic Play, Market Need
There are several pieces to the Molycorp story. Investors have invested or shorted the stock based on those "pieces." Yesterday's article put those pieces together in a complete puzzle, and that is what investors reacted to. China's rationing of rare earth minerals drove up prices and created a market need for more suppliers. Molycorp was an opportunistic play on that market need. The supply/demand dynamics of the industry have since attracted competition - the addition of low-cost, high-volume production has and will continue to drive down prices. Investors, realizing the expiration on Molycorp's "opportunistic play" may be over, reacted by selling. There is a reason why (A) the Mountain Pass mine was shut down in 2002 and (B) Molycorp directors and controlling shareholders were accused of dumping over a $1 billion of their personal holdings onto the market from February arch 2011 to June 2011.
Given the increase in supply for rare earths, prices have indeed declined, and the price declines are reflected in Molycorp's revenues. According to the company's second quarter 2012 10-Q, average prices for rare earth products declined over 40% in comparison to second quarter 2011. Rare earth products accounted for approximately 76% of its revenue for second quarter 2011. That price decrease was offset by average price increases of 10% and 122% for rare earth metals and rare earth alloys during that same period. Rare earth metals and rare earth alloys accounted for 14% and 7% of second quarter 2011 revenue, respectively.
Through six months ended June 2012, the company achieved an operating loss of $51 million on revenue of $189 million. Going forward, investors should remain cognizant on assertions from management on what the company's "break-even point" is, i.e. the amount of revenue, (A) price per kilogram for its rare earths, and/or (B) production volume needed to cover operating expenses. This will give investors a clear way to understand Molycorp's evolving business model, and ascertain the quality of management information and controls. Understanding these various drivers of the business will determine if Molycorp's value and its story make sense.
Quality Management Team
Management's decision to reopen the Mountain Pass mine in 2010 has been a calculated gamble that has paid off for investors, at least initially. Management recently raised approximately $150 million in common stock and $300 million in senior notes. The capital was designated to fund operating expenses, working capital, and capital expenditures for work at its Mountain Pass mine, and other cash requirements. Though management was criticized by some analysts and shareholders for diluting the stock, it showed management's willingness to make hard decisions for the long-term viability of the company. The common equity proceeds will give Molycorp the flexibility to stave off near-term operating losses, if need be.
"National Security" Angle
Rare earth minerals are needed in the manufacture of high-tech equipment like hybrid cars, smart phones, computer screens and military equipment. Molycorp's main asset, the Mountain Pass mine, is the only major rare earth mine in the U.S. Therefore, one could argue that Molycorp is key to our national security. Its existence also alleviates the need for the U.S. to "kowtow" to China for rare earth supplies, in the manner that Japan has had to recently. If rare earth prices continue to deteriorate, the U.S. would be loathe to allow the Mountain Pass mine to shut down again like it did in 2002. Molycorp's "national security angle," and the fact that it gives the U.S. a major weapon in future international relations with China, potentially provides a floor to the stock.
Not for the Faint of Heart
Declining prices for rare earth products and Molycorp's lack of operating leverage, coupled with stiff headwinds from the U.S. economy, equate to a bumpy ride for Molycorp investors. According to the article, "Long-Term Unemployment and 'The Pain Ahead,'"
Big ticket items like housing and autos drive the economy. The Fed initiated its Quantitative Easing program in the fourth quarter of 2008. Yet housing starts have been flat since that period; starts were 906 thousand in 2008 and ranged from 554 thousand to 609 thousand from 2009 to 2011. Auto sales were 13.5 million in 2008, reached a trough of 10.6 million in 2009 and rebounded to 13 million in 2011. But they still pale in comparison to the roughly 17 million just prior to the financial crisis.
Molycorp is not for the faint of heart. If you are looking for a stock that provides steady gains quarter to quarter, this may not be the stock for you. However, Molycorp may be a stock with a limited downside given its importance to our national security, and a robust upside if it continues to enjoy pricing power in rare earth metals and rare earth alloys, and the market for neo powders materializes as expected.