A Closer Look at Molycorp's Speculative Opportunity

I'm a believer in growth stocks. As an analyst for our Motley Fool Rule Breakers service, I think you should be a believer too. But even I have to admit some growth stories are bogus, hence this regular series.

Next up: Molycorp (NYSE: MCP). Is this miner of rare earth minerals the real thing? Let's get right to the numbers.

Foolish facts

Data current as of Nov. 14.

Bears don't like that Molycorp's valuation is based entirely on what could be. Bulls don't care; they see this as betting on a natural monopoly in metals mining.

"With the 2nd largest rare earth deposit in the world, and the only one in the [western] hemisphere, this is a buy and hold long term winner. They've only begun to exploit the [rare earth oxides]," wrote All-Star investor jah609 in September.

There are 17 rare earth metals for manufacturing a wide variety of necessary devices. For example:

• Cerium for creating the catalyst that allows ovens to clean themselves.
• Holmium for making lasers.
• Lanthanum for making refractive glass used for camera lenses and hydrogen storage, among other things.
• Promethium for making nuclear batteries.

Investors like Molycorp in part because rare earth metals (REM) are expensive to mine, and China, which sources 97% of the world's REM supply, isn't keen on exporting what it needs. According to media reports, officials there have been discussing a plan for reducing REM exports.

This is where jah609's thesis comes into play. Molycorp lays claim to the only substantial rare earths mine in North America in Mountain Pass, California. Plans call for manufacturing more than 19,000 tons annually by the end of 2012.

Getting to that point will require several heavy doses of capital expenditures. But that could be less of a problem than it seems. The Department of Energy is taking applications for loan guarantees for rare earths mining. Molycorp submitted its proposal in June. If approved, the funding could help sustain the company as it spends to modernize the Mountain Pass mine.

The elements of growth

Source: Capital IQ, a division of Standard & Poor's.

Yes, I know. This table doesn't say much. How could it? There's still so much we don't know about Molycorp. But there are a few things we can point to. Let's review:

• First, we can ignore net income and revenue. Growth in these categories is meaningless until Mountain Pass is operating at capacity.
• Having said that, I find it interesting that gross margin has seen steady improvement since 2008. Not that there is much a margin yet. I just like the directional trend.
• The shares outstanding line tells us the most. Molycorp needs to be able to sell shares in order to raise funds to finance growth. According to Capital IQ, Molycorp received $393.8 million in proceeds from a July IPO and has access to another $86.7 million via a shelf registration.

Competitor and peer checkup

Source: Capital IQ. Data current as of Nov. 14.

This table doesn't mean much. In North America, only Molycorp mines rare earth metals, though REM explorer Rare Element Resources has aspirations to join the club. But the business is also just developing. What we really need is a clear understanding of the opportunity here in North America.

Grade: Unsustainable
I've yet to see good data for the domestic rare earths market, though Dian Chu's analysis at Seeking Alpha is about the best I've seen so far. But not even she has hard figures.

Therein lies the problem. All we really know is that the rise of electric cars and complex electronic devices such as smartphones should increase demand for certain REMs. One estimate, from researchers at Australia's Industrial Minerals Co., predicts global consumption will rise to roughly 225,000 tons by 2015, up from around 140,000 tons today.

Presuming Molycorp its 19,000 tons of rare earths into this market each year, that's $281.2 million in annual revenue at current prices. Impressive? Sure, if Molycorp weren't already worth $2.6 billion in market value. Today's valuation assumes a BIG spike in the per-ton value of rare earths. That's possible, of course. I just wouldn't bet real money on bubble pricing. Instead, I'll be shorting the stock in my CAPS portfolio and then seek an opportunity go long when the hysteria subsides.

Now it's your turn to weigh in. Do you like Molycorp at these levels? Let us know what you think using the comments box below. You can also ask Tim to evaluate a favorite growth story by sending him an email, or replying to him on Twitter.

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