If you were a regular watcher of the business news channels in the spring of 2011, you couldn't escape one of the hottest, most heavily hyped stocks we've seen in the modern investing era.
An out-of-nowhere company suddenly sported a billion-dollar market value, and analysts and hedge fund managers alike proclaimed that it was still sharply undervalued. Its smooth-talking CEO made the rounds with the financial media, casually claiming that his company was on the cusp of a mining revolution that would outshine the 1849 gold rush.
Yet with each passing quarter, it became apparent that the whole story was mere smoke and mirrors. Rare earth miner Molycorp (NYSE: MCP) become a dirty name among the legions of investors that got caught up in the hype, and its stock has been tossed into the discard bin.
In hindsight, about the only thing this company was good for was its ability to separate investors from their money. At the time of its IPO in the summer of 2010, Molycorp had roughly 38 million shares outstanding. A series of capital raises led to the issuance of 130 million more shares, and the company still has yet to fulfill its promise, let alone deliver any profits.
If you're among the many investors that have been badly burned by this stock in the past, then you probably don't want to keep reading. But if you managed to steer clear of this debacle until now, and have an interest in looking ahead and not behind, then read on.
All of those fresh capital raises were deployed to help build out Molycorp's mining operations at its facility in Mountain Pass, Calif. Is that process complete?
No, management is expected to spend roughly $375 million on capital spending every year through 2018. But management believes that rising production will produce the cash flow to meet those spending needs, and though you can't rule out yet another capital raise, it is looking a lot less likely than it had in the past.
Molycorp is also finally benefiting from a shift in supply and demand for rare earth oxides (REOs). China appears to be getting more serious about consolidating domestic production and restraining smuggling activity. As this recent article in The Wall Street Journal notes, the Chinese government is setting up a "a group to coordinate rare-earths production quotas, mining permits and other policies." That is expected to lead to more controlled pricing, halting the downward trend that has been seen for REOs in recent years.
To be sure, REO pricing will never surge to the bubble conditions seen in 2011, but even a very modest firming would be very beneficial to Molycorp.
According to analysts at Morgan Stanley, "Every $1 change in average REO prices drives (a roughly) $0.80/share move in (discounted cash flow) valuation at 10% discount rate." Translation: The inherent value of Molycorp's shares rises by nearly $1 for every $1 move in REO prices.
Avinash Kant, who follows Molycorp for D.A. Davidson, thinks the company has begun to turn the corner, thanks in part to a desire by REO buyers to cultivate new sourcing arrangements: "There is a clear desire among customers to source their materials needs away from China. Based on recent capacity expansion plans, Molycorp and Lynas (an Australian-based rare earth mining company) present themselves as the two viable alternatives. As the larger of the two, we expect Molycorp to benefit significantly from this sourcing trend over the next 4-5 years."
He adds that "recent rare earth pricing trends reflect stabilization with modest growth, which leads us to believe that most of the excess inventory has been consumed." Kant also thinks last month's hiring of CEO Geoff Bedford, a seasoned industry veteran, will help the company to regain credibility with the investment community. Kant's $8 price target, recently bumped up from $6, represents 45% upside from current levels.
Risks to Consider: Shares of Molycorp are unlikely to budge until REO prices start to strengthen, which could take several quarters to materialize.
Action to Take --> Molycorp consumed a truly stunning amount of capital as it sought to develop its Mountain Pass facility. But much of the heavy lifting is done, and as output rises, analysts see sales rising 40% in 2014 to around $830 million. DA Davidson's Kant sees that figure rising to $1 billion in 2015 and $1.3 billion in 2016. By then he sees the firm generating more than $200 million in annual cash flow. That would be good news for a company with a history of unmet expectations.