September 20, 2011 (Source: J.P.Morgan) — J.P. Morgan turned its analytical eye once again toward Molycorp and the REE sector this week, moving the Colorado-based company’s rating to a neutral hold from overweight and lowering both earnings per share and share price targets.
Headline quote: “Downgrading to neutral on recent uncertainties with pricing speculation and demand reduction – lower EPS and PT…to reflect the recent drop in rare earth prices following a sharp increase over the April-July time frame, ” a September 20th, 2011 note states.
New end-2012 price target? $66. Previous target? $105.
Molycorp closed Monday at $53.01 share, moving as low as $22.41 and as high as $79.16 each in the last 52 weeks. Share price at 10am EST Tuesday morning? It’s down 13.9%, or $7.33, to $48.68.
Think of the investment house as you would a MACD share chart, one that looks at recent trends and momentum.
The note said rare earth prices have taken a downward step but are still elevated, especially the Chinese domestic prices, which have held up better.
“We would note, however, that export prices are still roughly equal to or above their 1Q 11 averages,” it said.
A price drop means an earnings estimate drop here, so 2011E EPS is dropping to $1.75 from $2.44, 2012E to $3.15 from $6.10; and 2013E to $11.20 from $14.55.
The next two quarterly earnings reports? 3Q11E EPS is lowered to $0.70 from $0.86. 4Q2011E EPS falls to $0.56 from $1.10.
Here comes the investment thesis: “We continue to believe that most announced rare earth supply projects beyond Molycorp and Lynas will not enter the market on schedule or if ever due to financing and permitting hurdles,” J.P. Morgan states. “That said, we are neutral on the stock given the lack of clarity on the impact that recent speculative buying potentially had on rare earth prices and the recent downgrade of rest-of-world 2011 demand forecast from IMCOA to 40,000 tonnes from 60K tonnes.”
J.P. Morgan said the still-elevated rare earth prices should support MCP’s stock and push it higher as investors get a better understanding on the impact high RE prices have on various MCP valuation levels. The investment house said the recent uncertainties arising from the news of Chinese speculation as well as recent reduction in demand forecasts lead it to be more cautious on the stock in the near term until the uncertainties are resolved.
“While MCP has committed to building out its Phase II capacity that will allow it to produce at 40K tonnes per year, we believe that MCP will be disciplined with its production and only bring on what is needed,” the note states. “
Here are J.P. Morgan’s perceived risks to its rating and price target:
- China has taken action to restrict the supply growth or rare earths, so a further crackdown or unexpected easing would have a significant impact on prices;
- The on-time, on-budget completion of its fully-integrated Mountain Pass project in late-2012 is closely intertwined with MCP valuations;
- Given that Molycorp is a relatively small and specialized mining company, the departure of key executives or a disruption in the Mountain Pass facility could hit sales and earnings expectations;
- Demand growth for rare earths is being driven by the increased adoption of new technologies; if these don’t grow as expected or are supplanted by alternatives, then guess what? That’s right, you got it.
The “important disclosures” bit of this exercise isn’t a surprise: J.P. Morgan has, in the past 12 months, acted as lead or co-manager in a Molycorp debt or equity offering; and had Molycorp as a client, in both an investment and non-investment banking capacity, meaning that, yes, Molycorp has paid or will pay the investment house for various services rendered in the past 12 months.