Molycorp: Looks Highly Attractive After The Recent Sell-Off

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 |  About: Molycorp, Inc. (MCPIQ)
by: Efsinvestment

By Siraj Sarwar

Molycorp Inc. (MCP) is one of the largest rare earths and rare metals corporation in the U.S. Molycorp owns a rich rare earth source at Mountain Pass, California. The company has ultra-high-purity rare earth and rare metal materials handling abilities. Molycorp is a vertical company that extracts, processes, and distributes rare earth resources. It generates custom engineered products from 15 distinct, rare earths with purity degrees of approximately of 99.9999%. MCP also generates six other metals (niobium, tantalum, gallium, indium, rhenium, and zirconium) as a byproduct.

QUARTERLY RESULTS

Molycorp Mountain pass

Molycorp silment

MMA

Molycorp Canada

Eliminations

Corporate and other

Total

Sales

External

16,533

31,541

12,870

43,633

-

-

104,577

Intersegment

400

712

-

14

-1126

-

-

Total sales

16,935

32,253

12,870

43,647

-1126

-

104,577

Gross Profit

-7,573

-7,220

-4,321

4,697

10,344

-

-4,073

Operating loss/income

-18,985

-9,166

-4,437

-28

10344

-28124

-50396

Click to enlarge

(Chart is sourced from company website)

Molycorp produced net sales of 104,577 million in the Q2 of 2012. Sales are up by 5% from the Q2 of 2011. Molycorp Silment and Molycorp Metals & Alloys [MMA] were acquired in the last year. Molycorp Silment generated revenue of $32.25 million in Q2 of 2012. MMA contributed revenue of $12.87 million in Q2 of 2012. Molycorp Canada was acquired on June 11, 2012. Molycorp Canada contributed healthy revenue of $43.65 in Q2 of 2012. The company reported a GAAP loss of $67.6 million at the end of the second quarter.

Decreasing rare earth prices has adversely affected Molycorp's earnings and stock price. Molycorp's sold 1,169 ((NYSE:MT)) of rare earth products at an average price of $45.92 per kilogram in Q2 of 2012. Unfortunately rare earth product prices had decreased from $77.60/kg in Q2 of 2011 to $45.92 in the Q2 of 2012. Declining rare earth prices adversely affected Molycorp margins.

Molycorp had a gross margin of -3.89% in the Q2 of 2012. The sharp decline in gross margin was primarily attributable to the lower rare earth product prices. Company produced a remarkable gross margin of 59.91% in the Q2 of 2011. According to the corporation's second quarter 10-Q report, average prices for rare earth products dropped over 40 percent in comparison to Q2 of 2011. Rare earth products accounted for approximately 76 percent of Molycorp's revenue in Q2 of 2011. So, Molycorp's margins are wholly dependent on rare earth product prices.

Stock Performance

Click to enlarge

(Chart is sourced from Finviz.com)

MCP is a real volatile stock. The stock dropped to its all-time low of 9.61 recently. At one point, it was trading for as high as $75. The company has a market capitalization of $1.3 billion. The company has an attractive forward P/E of 10.72.

While Molycorp is growing fast in terms of revenues and production size, the problem is the extreme exposure to rare earth prices. The decline in prices had a catastrophic effect on the company's balance sheet. However, the risk can be transformed into an excellent opportunity if the rare earth prices go higher. If the rare earth prices go back to $76, the company might generate an operating profit of more than $200 million, assuming a gross margin of 60%. This is an amazing speculative stock if you are capable of managing the big swings.

2012 Market Dynamics

Prices for most of the Molycorp's products have already stabilized. The diversity of Molycorp's vertical integration strategy is showing its value. Molycorp has discovered strengthening markets for specific downstream rare earth products, such as bonded magnetic powders generated by Molycorp Magnequench. I believe that the rates of rare earth oxides have hit bottom, although the floor stays soft. It is very likely that the supply chains will bring on destocking over the next half of 2012. The long term supply and demand remains high as Chinese restrictions increase and the industry proceeds to consolidate within China. Molycorp remains well-positioned to meet the demand gap as it provides a reliable supply.

Outlook for the Remainder of 2012

Molycorp will continue to expand its products and markets through the remainder of 2012. The company will penetrate its XSORBX technology into the water treatment industry. Molycorp Mountain Pass facility will maximize shipments of certain REO to Molycorp Canada's facilities in Asia. MCP is expecting its REO generation in 2012 to be between 8,000 and 10,000 over their facilities at Molycorp Mountain Pass. I believe that consolidated sales in 2012 will be sufficient to fund normal operating activities throughout the year.

Risks

There are certain factors which might push things worse for Molycorp. First the euro zone crisis. It began having an effect on global economic output. Euro zone problems pushed down the rates of niobium, tantalum and other major metals that make up the key product base of Molycorp. Second, the costly acquisition in Canada might turn out to be a bad investment. Third, the corporation started an intense capital expenditure program to build its mine and asset situated in Mountain Pass, California. If the company cannot meet its cash outflows from operations, it has to keep borrowing.

Summary

Molycorp is a major developer and distributor of key metals. It has a greater economic motive and a defensible business model. Basically, demand for its products is extremely inelastic, which presents it with a strong and defensible business model. The rare earth products are essential to many industrial applications. I believe a lot of things will have to go according to plan for MCP to achieve previous year levels. The company will have to achieve synergies from the acquisitions, new and improved production levels, controlled capital expenditures to get back on track. In addition, the prices of the product will need to recover significantly. However, if things go on track the stock could be a huge outperformer.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: EfsInvestment is a team of analysts. This article was written by Siraj Sarwar, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.