Be Careful Buying Into Molycorp's Hype

Shares of Molycorp (NYSE: MCP  ) shot 20% higher last week after first-quarter earnings were released and investors bet the company will finally be able to turn its fortunes around. Molycorp showed a loss but results were better than Wall Street expected, which is usually all that matters.

Revenue grew 9% sequentially to $146.4 million but the company lost $20.5 million, or $0.33 per share, in the quarter. On an adjusted basis the loss was $0.15 per share and with analysts expecting a loss of $0.27 per share on $137.5 million in revenue investors flooded back into the stock.

Two steps back
Let's keep in mind that Molycorp is still losing money and rare-earth mineral prices are trending lower, which is the biggest red flag for the stock. Below is the company's average selling price for its main segments, which you can see are trending rapidly lower overall. Only the rare metals business has seen prices improve, and this isn't a small portion of revenue. 

 

2011

2012

Q1 2013

Average Selling Price (per kg)

$82 

$36 

$23 

Chemicals & Oxides (per kg)

$45

$45

$34

Magnetic Materials & Alloys

$98

$58

$43

Rare Metals

$178

$215

$339

Source: Molycorp earnings releases

Australian competitor Lynas posts rare-earth element prices regularly and it, too, has seen consistently lower prices, so this is an industry-wide phenomenon.

 

2011

2012

Q4 2012

Q1 2013

Lanthanum Oxide

$104.10

$25.20

$13.92

$11.00

Cerium Oxide

$102.00

$24.70

$15.31

$11.85

Neodymium Oxide

$234.40

$123.20

$87.46

$79.15

Source: Lynas Corp.

Falling prices is the core challenge for Molycorp because supply and demand can get out of whack quickly with rare-earth elements. My biggest concern is management's plan to raise production over the next few months from a current run rate of 7,000 metric tons per year to 20,000 metric tons, and continue to expand to 40,000 metric tons next year. This would flood the market with supply and continue downward pressure on prices.

Remember how fast prices rose when China cut off exports and how fast they fell when Molycorp and Lynas brought mines on line? There's no reason to think that additional supply won't have the same effect. 

The first-quarter loss may have been better than expected but it's still a loss, and there's no evidence prices have stabilized, even if management thinks demand is picking up. Even if you're bullish and you think the company can swing back to profitability, it's impossible to see where the bottom is and how much money the company will make over the long term. Rare-earth element prices are simply too volatile. 

Not the time to bet on rare-earth materials
There's no question that the rare-earth mineral space has peaked, and that it has a lot of questions to surmount. Despite Wall Street's euphoria over the stock, I'd be cautious about Molycorp and would definitely stay away from speculative rare-earth plays Rare Element Resources (NYSEMKT: REE  ) and Avalon Rare Metals (NYSEMKT: AVL  ) , who don't even have the revenue Molycorp is generating.

If you need exposure to the mining space I would stick to broad plays like Caterpillar or a major miner like Freeport-McMoRan. They're safer than rare-earth minerals in these uncertain times.

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 15, 2013, at 3:24 PM, Denverdude123 wrote:

    In response to a question in the recent conference call about scaling up in the near future, the CEO said they would not do so unless they could do so while producing profitably. The commissioning of the Chlor-alkali facility later in the year will enable recycling of reagents dramatically reducing production costs. I think this means no scale-up until Q4 unless market prices rise. They likely have some inventory which can be provided to customers in the mean time.

  • Report this Comment On May 15, 2013, at 3:32 PM, Awyeth99 wrote:

    Denverdude123........took the words right out of my mouth.

    Author needs to pay closer attention to the CEOs statements, kind of negates a central theme of the article.

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