Buy, Sell, or Hold: Molycorp

When considering any stock for your portfolio, don't be swayed by just the positives. Examine its pros and cons, and decide whether it's possible upside outweighs its risks. Let's take a look at Molycorp (NYS: MCP) today, and see why you might want to buy, sell, or hold it.

Based in Colorado and with a market capitalization recently near $1.25 billion, Molycorp is a small producer and seller of rare-earth oxides, metals, alloys, and magnets used in clean energy technologies, defense applications, water treatment technology, and multiple high-tech uses. Over the past year, its stock has plunged about 78%, leading some to steer clear and others to wonder whether it may be a bargain now.

Buy
One reason to consider buying the stock is this: It has fallen sharply and over the long run, there will be ongoing demand for rare earth minerals. Molycorp's valuation seems attractive. Its price-to-earnings ratio was around 10 in 2011, well below the S&P 500's 15. Its forward P/E of 5 is less than half of the S&P 500's 14, and its five-year expected PEG ratio is 0.35, suggesting it's very undervalued. (Its price-to-sales and price-to-cash-flow ratios are considerably higher than those of the overall market, though.)

The company sports some attractive growth rates, with revenue exploding recently, from $35 million in 2010 to $397 million in 2011 and $460 million over the past 12 months. Earnings per share went from being in the red to being solidly in the black in 2011, though over the past 12 months, it has fallen sharply.

Here's another reason to consider buying Molycorp -- though it could be a reason to sell, too: It's heavily shorted, with close to a third of its float sold short as of mid-July. That means a heck of a lot of investors are betting against it. They might be right, but if they're wrong and the stock starts a steep ascent, they'll eventually have to cover their positions by buying shares, which will send the share price up on the "short squeeze."

Sell
One reason to consider selling Molycorp is the main reason that its stock has fallen so hard: The prices of rare earth minerals, which were rather high not so long ago, plunged, taking Molycorp and peers such as Rare Earth Resources (NYS: REE) and Avalon Rare Metals with them. The prices can keep falling lower, though the long-term prospects are promising. Meanwhile, Molycorp has been contributing to the problem, as have some peers, by upping their production and adding to the supply of the minerals.

Then there's the ongoing dilution of its shares. The number of shares outstanding has gone from about 39 million in 2009 to roughly 100 million recently. Imagine a pizza being cut into more and more pieces -- your allotted slices will become smaller and smaller. Similarly, Molycorp shares will each have a smaller and smaller claim on the business.

By selling more shares, the company has generated more cash, some of which it has used to buy downstream businesses such as Canadian rare earth processor Neo Material Technologies, for $1.3 billion. In order to pay for the purchase, Molycorp took on a lot of debt. The buy will give Molycorp more exposure to China, though, which is the world's top consumer of rare earth minerals.

My colleague Travis Hoium isn't impressed with this acquisition strategy, but being vertically integrated can sometimes help buffer a company during rocky periods. Steel giant ArcelorMittal (NYS: MT) , for example, has been pursuing vertical integration by buying mines. This way, it can supply its own steel factories instead of having to buy ore from others.

Molycorp's free cash flow has been negative for several years in a row, and cash flow from operations has been mostly negative.

The stock is also, clearly, very volatile, with an eye-popping beta of 3.92. (Anything higher than 1 suggests that a stock is more volatile than the overall market.) If you're risk-averse and the possibility of sharp drops alarms you, perhaps steer clear. If you're OK with that, keep Molycorp in mind.

Hold (off)
Given the reasons to buy or sell Molycorp, it's not unreasonable to decide to just hold off. You might want to wait for the rare-earth prices to rise, or for the company to start reporting a string of net earnings, as it pays down its debt.

You might also want to look at some other mining companies. Cliffs Natural Resources (NYS: CLF) , for example, produces mining iron ore and metallurgical coal used in steel production. The company has been pressured by China's slowdown and also by rising production costs. It's priced rather low, though, and will eventually see rising demand. Freeport McMoRan (NYS: FCX) , meanwhile is a copper-mining giant also pressured by China, and also seemingly undervalued, with strong prospects.

The verdict
I'm holding off on Molycorp for now, but everyone's investment calculations are different. Do your own digging and see what you think. Molycorp may perform spectacularly in the future, but remember that there are plenty of compelling stocks out there.

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The article Buy, Sell, or Hold: Molycorp originally appeared on Fool.com.

Longtime Fool contributor Selena Maranjian, whom you can follow on Twitter, holds no position in any company mentioned. Click here to see her holdings and a short bio. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold and ArcelorMittal. The Motley Fool has a disclosure policy.We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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