Molycorp's Valuation Just Doesn't Make Sense

| About: Molycorp, Inc. (MCPIQ)
This article is now exclusive for PRO subscribers.

There's no debating that rare earth metals (REMs) are becoming an integral component for advanced applications such as wind turbines, superconducters and electric vehicles. However, even a burgeoning industry can be overpriced. Take a look at the data and then try to wrap your head around the valuation for a company that won't not produce significant volumes for at least two years. And that's a best case scenario.

The market size for REMs was $1.3B in 2008, according to Credit Suisse. This revenue came from the sale of around 124,000 tons, implying an average REM price of roughly $10,500 per ton. Of course the data doesn't specific which REM's accounted for what revenue, but I think using the generalized figures along with a conservative application shouldn't be too inaccurate.

As to the company itself, Molycorp's (MCP) mines have actually been around since the early 1950's. The problem, however, is that they haven't been producing new REM's for almost 20 years.

From Molycorp's recent 10-Q (page 7):

Most of the facilities and equipment acquired with the Mountain Pass facility are at least 20 years old and must be modernized or replaced. Under its current business plan, the Company intends to spend approximately $511 million (see note 9(a)) through 2012 to restart mining operations, construct and refurbish processing facilities and other infrastructure at the Mountain Pass facility and to expand into the production of metals and alloys. The Company expects to finance these expenditures, as well as its working capital requirements, with the $378.6 million of net proceeds, from its IPO, anticipated revenue from operations and debt financing, project financing, and/or federal government programs, including the U.S. Department of Energy loan guarantee program for which the Company submitted an application in June 2010.

So, let's just assume that their current meager revenue rate continues and that they continue to produce $25 Million in operating cash flow losses per year until 2012 (looking at past ventures and their proposed CapEx budget, I believe this a conservative scenario). That means they will spend roughly $425 million, which is $75 million more than their current cash balance. According the management, the best case scenario will be new production commencing sometime during 2012, with capacity of 20,000 tons per year (10-Q, page 16).

From 2003-2008, REM's experienced a respectable secular bull market with tonnage volume growing 46% (CAGR of 7.85%). Recently, the price for some REMs has increased 500% in just the past 12 months. That pegs the new average price per ton to around $63,000 (again assuming best-case-scenario conditions).

Now let's add even more fortune to MCP's future. Let's assume that the REM market volume grows by a CAGR of 25% from 2008-2012, implying a new volume of roughly 303,000 tons in 2012 (this would imply huge amounts of growth, larger than ever in history). There isn't much data that suggests the market will grow this fast, but for now, lets factor it in to determine if Molycorp is adequately priced for even the best conditions.

The new market size for REMs would be roughly $19B in 2012 using those assumptions, which is the time when, at best, MCP will produce 20,000 tons of REMs. MCP's revenues would be $1.2B in 2012, which means that MCP is currently trading for 3x 2012 sales. Remember, this assumes hyper volume growth and extreme prices.

I've altered the numbers to demonstrate absolutely everything going right for MCP. It just doesn't not make sense as an investment right now. I would much rather be short Molycorp as of right now than long.

Other companies operation in the same market dynamics for shorting consideration are as follows:

  • Rare Element Resources Ltd. (NYSEMKT:REE)
  • Avalon Rare Metals, Inc. (NYSEMKT:AVL)
  • General Moly, Inc. (NYSEMKT:GMO)
  • China Shen Zhou Mining & Resources Inc. (NYSEMKT:SHZ)
  • Lynas Corporation (OTCPK:LYSCF)

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