Earlier this week, Morgan Stanley slashed its price target for Molycorp (NYSE:MCP) to $2.50 and downgraded the company's stock to an underweight from an equal-weight rating. The firm cited weakness in rare earth prices and production bottlenecks at the Mountain Pass facility.
The downgrade comes just few days after Molycorp posted a wider than expected fiscal first-quarter loss. The company felt the pressure as rare-earth prices remained weak due to an imbalance between demand and supply fundamentals. Indeed, the outlook for Molycorp remains bearish due to weak prices. However, two recent developments in the rare earth markets could help push prices up.
Molycorp reported disappointing results
The rare-earth market has been witnessing a very similar problem faced by the iron ore market. For years demand exceeded supply in the global iron ore market, prompting miners such as BHP Billiton (NYSE:BHP) and Rio Tinto (NYSE:RIO) to ramp up production. Now that miners are in a position to increase supplies, demand from China is expected to slow as the world's second largest economy rebalances. Not surprisingly, iron ore prices have fallen sharply this year on concerns of an anticipated supply glut.
Rare earth prices have also fallen sharply due to this demand/supply mismatch. During the first quarter, Molycorp's average selling price dropped to $33.69/kg from $44.71/kg in the same quarter of the company's last fiscal year. The price drop, coupled with lower production, meant that Molycorp's loss for the first quarter widened.
The company reported a net loss of $86 million, or $0.40 per share, compared to a loss of $38.2 million, or $0.27 per share, reported for the same period in the previous year. Excluding one-time items, the company's loss was $0.29 per share compared to Street estimates calling for a loss of $0.21 per share.
Given the weak performance, it is not surprising that Molycorp shares have fallen nearly 50% this year. I have noted in previous articles that the outlooks for Molycorp and the rare earth market are bearish due to weak prices. However, two recent developments could provide some support to prices.
China mulling an increase in taxes on rare earth producers
According to a report carried out by one Chinese daily, Chinese authorities may levy higher taxes on rare earth producers starting the second half of 2014. The report said that the taxes would be levied on the value of rare earths produced rather than the volume, which is the current practice.
If taxes are raised at the producer level, then rare earth prices are bound to rise. Higher rare earths prices in China would have a huge impact on the global market given the fact that the country accounts for nine-tenths of total rare earth production.
Officials believe that tax increases would push prices higher on the production side, which would help in bringing a balance to demand/supply fundamentals as well as discouraging illegal mining and smuggling.
To curb illegal and excessive mining, Chinese ministers are also contemplating issuing environmental compliance certificates for rare-earth exports, according to an official cited in the report. The plan, if implemented, could further restrict rare earth supplies.
Another major story in the rare earth market that could help in altering the fundamentals is Australian rare earth miner Lynas' severe cash-crunch, which could affect its production.
Lynas, which announced plans to limit its production by half last October, has invested about AUD$1 billion on a processing plant in Malaysia. The company, however, has been stretched financially amid falling rare earth prices. Recently, it announced plans to defer its debt payments and raise more funds by selling shares in the primary market.
The two recent developments could possibly provide some support to prices. However, I would recommend a wait-and-watch approach when it comes to Molycorp and the rare earth market.
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Varun Chandan Arora has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.