|Shares Out. (in M):||82||P/E||0.0x||0.0x|
|Market Cap (in $M):||5,634||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||-313||EBIT||0||0|
"I think our opinion on that right now is basically that regardless of what production is brought on right now by Molycorp or others, that the gap between supply and demand is going to continue to exist." Mark Smith, Molycorp CEO, 4Q10 conference call
Molycorp (MCP) will be a great short because contrary to what Mr. Smith says the laws of supply and demand also apply to rare earths. The stock is up more than 300% from the July IPO as investors have focused on 1.) skyrocketing prices outside of China due to an artificial supply squeeze caused by a dramatic cut to Chinese export quotas (who produce more than 90% of worldwide supply) and 2.) skyrocketing prices inside of China due to rampant speculation by non-economic actors. Looking forward, massive amounts of new supply are coming online which will push prices to marginal cost and allow MCP to earn a normalized return on capital instead of the 100%+ ROIC implied by sell side estimates. Assuming an $800mm - $1,000mm reproduction cost and a 10% - 12% ROIC, MCP should earn around $100mm on a sustainable basis giving it a market cap of around $1B (down from the current $5.6B).
Supply / Demand: In 2010 demand outside of China was 55,000 tons while supply was roughly 40,000 tons (30,000 from Chinese exports and 8,000 from other ROW players). In 2013, demand is unlikely to grow significantly (see below) from current levels while supply will be close to 100,000 tons (40,000 tons from MCP by end of the year, 20,000 tons from Lynas, 15,000 - 20,000 tons from other ROW sources and 20,000 from exports). Even if China stopped exporting rare earths the market will still be oversupplied.
So why has the stock done so well? Here are some common misconceptions about rare earth:
Myth #1 - Rare earths are rare
Myth #2 - Demand for rare earth outside of China is accelerating
Myth #3 - Rare earths only mines are a good idea
Other interesting points:
Extreme price difference between Chinese and ROW pricing
Rare earths are not in structural undersupply, they are just not being exported out of China.
Some analysts have pointed to increases in domestic China prices as a reason for optimism on MCP. We believe it is nothing more than a speculative phenomenon which is unlikely to last, especially as export prices collapse as MCP and LYC AU come online. This story does a good job of explaining what is happening:
If you don't believe my supply / demand numbers, check out the governments. Even using their generous demand numbers, La, Ce and most likely Nd (which collectively make up >95% of MCP's deposit) will be oversupplied once MCP is online. Also, keep in mind that they are using a 20,000 ton supply figure for MCP instead of 40,000:
You can also look at MCP's numbers which imply that the market will be in oversupply. Check out slide 15 from the link below which does not include MCP Phase 2 and only includes the Lynas supply in a dotted line. Even without Phase 2 the market will be dramatically oversupplied:
Summary: Spot prices achieved during a supply squeeze become irrelevant once a market is oversupplied. As the market tips into oversupply, prices will revert to marginal cost of around $10 kg (Lynas cost) compared to the current $100+ per kg. At that price level, MCP will earn a decent return on capital similar to other commodity businesses as opposed to the current market cap which implies MCP earns high returns on capital into perpetuity in an oversupplied commodity market.