Can Molycorp Sail Straight With a New Captain?
After a consistent slide in its stock price that was finally reversed in mid-November, shares of Molycorp are back under pressure. The company announced on Tuesday that CEO Mark Smith was unexpectedly leaving the company. Reuters reports that various analysts see the move as a positive for the company, particularly given the pending SEC investigation that is looking into the accuracy of some of the company's financial disclosures. Clearly the market has not agreed, having taken the stock down nearly 10% since the announcement. The only thing investors like less than uncertainty is... an SEC investigation that questions the integrity and trustworthiness of management.
Ultimately, while the sell-off may prove to be an attractive buying opportunity, the stock should be considered a highly speculative play that is best considered with a very long-term view. Molycorp carries a beta of 3.84 relative to the S&P 500, meaning that it is nearly four times as volatile. While I still like the long view for Molycorp, and rare-earth producers as a whole, this stock is not for the faint of heart.
The state of the rare earth
Molycorp, along with competitors like Avalon Rare Metals , Rare Element Resources , and Australia's Lynas Corp., faces supply and demand issues and significant involvement from China, the world's largest producer of rare-earth materials. JPMorgan analyst Michael Gambardella commented in a note to clients: "We remain very concerned about what will happen as new supplies from Molycorp and Lynas totaling 57k tonnes hit up against a ROW (rest of the world) demand estimated at 40k tonnes in 2011."
The interplay between world supply and demand is a subject of concern given the importance of some of these materials to many products. Ed Crooks of the Financial Times explains: "Rare earth metals such as neodymium and praseodymium are essential for many products and industrial processes, from smartphones to cruise missiles. China's control of world supply - it has accounted for about 95 per cent of global output - has fueled concerns about its dominance and excitement about the prospects for rival suppliers such as Colorado-based Molycorp."
The China question
As more supply begins to come online from other producers, it is difficult to predict how China will respond. A catalytic event that occurred at the end of November was the announcement by China that it would begin offering subsidies to its domestic rare-earth producers. The news helped to drive the price of Molycorp from the $8 range to over $11 per share. The Chinese move, an effort to help stabilize prices, was reported by AFP: "Rare earth miners would receive a subsidy of 1,000 yuan ($160) for every tonne of rare earth oxides they produced, while smelters would get 1,500 yuan ($240) per tonne, China's finance ministry said in a statement."
Over the past several months, the Chinese government has made clear that it intends to target illegal mining operations as well as attempt to stabilize prices. Many remain of the belief that Chinese mismanagement of these resources has led to demand destruction as a result of sustained high prices. Where some consumers of these materials have continued to look for alternative sources of supply, others have sought redesign options to minimize reliance on these substances.
The way forward
The first order of business for the newly appointed interim CEO Constantine Karayannopoulos will be securing additional financing to help it complete its Mountain Pass project. The operation remains in phase 1 and is already significantly over budget and past initial deadlines. While the company specifically denied that there was a connection between the SEC investigation and Smith's departure, the involvement of a more trusted steward should ultimately bode well for Molycorp.
Adam Graf, an analyst at Dalman Rose, gave an explanation of the management change in a note sent to his clients: "Mr Smith's departure is tied to Molycorp's recent weaker-than-expected performance, driven in part by falling rare earth oxide price, but also by disappointing operating results, unexpected additional capital expenditures and aggressive acquisitions." While the company was very reserved in making any comment, the reality of the departure may well have involved each of the above reasons.
Moving forward, it is hard to believe that demand for these materials will completely dry up. Given their broad industrial applications, it is more likely that global supply and demand equilibrium well settle over the next few years. As operators like Molycorp come online outside of China, some of these issues should resolve themselves. If the company's new CEO, a tested industry veteran, is able to weather the immediate storm, which I believe he can, the company will come out alright. In the meantime, the stock is likely to be volatile and not ideal as more than a long-term speculative play.
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