The Thematic Investor – Molycorp, Inc. (MCP; 52.50)

This morning we are advising investors in MCP shares to take profits, as in our view this risk-to-reward trade off in the shares has shifted given near-term valuation concerns, arguably the near-term best cast scenario for rare earth elements on a political and trade perspective, and the pending IPO lock-up expiration. While we think long-term fundamentals are I place for rare earth elements over the short to medium term, these factors, as well as the meteoric rise in the shares in the last several weeks prompt the shift in our investment opinion. We would look to revisit MCP shares in the coming weeks and months as that reward-to-risk tradeoff approaches a more favorable position.

Since my initial recommendation this past October, MCP shares have climbed an impressive 65%, which was far greater than the 8.7% return in the S&P 500 over the same period. The vast majority of the MCP share price increase came in the last few weeks as China cut export quotas for rare earth elements by 35% in the first half of 2011. Subsequent headlines, along with Molycorp being not only one of a few new sources of rare earth materials in the medium term, but a domestic supplier as well, were the primary drivers in my opinion. Those were some of the reasons why I chose Molycorp as part of my Scarce Resources investing theme. Even though the short to medium-term fundamentals are intact, I find the reward-to-risk profile in MCP shares far more balance at current levels when several things are considered. First, on January 19th President Obama will meet with Chinese President Hu Jintao with the aim of improving the relationship between the two countries. While I do not expect any immediate shift, the subsequent tone and potential policy changes, as they pertain to rare earth element export quotas from China bear watching. Keep in mind, it was the political and trade related aspects of rare earth elements, as well as the scarcity factor that drove MCP shares up over the last several weeks. Any reversal or softening in China's position, would likely pressure rare earth element companies and their respective share prices. Second and more specific to Molycorp, the lock-up period associated with Molycorp's July 2010 IPO expires on January 20th. This risk in my view, given the rapid rise in MCP shares, is that insiders will seek to monetize their positions. Per data from Nasdaq, insiders own approximately 67 million shares, or more than 80% of Molycorp's common share count. Lastly, we have to remember that rare earth element companies at the end of the day are mining companies. As such, we have to consider the valuation when looking at these types of companies on a price-to-peak earnings perspective. Other mining companies have peaked at an average of 12x peak earning over the 2002-2010 period. While factoring in a modest premium to account for scarcity, at the current share price Molycorp would have to deliver peak earnings of $3.75-$4.00 per share. Currently, the Street expects Molycorp to generate earnings per share of $2.60 in 2012. Aside from keeping our eyes on peak earnings potential at Molycorp, we will also keep a watch on new production and capacity increases from other rare earth companies, such as Rare Element Resources, Avalon Rare Metals, Lynas Corp. and others. Once again, this article was originally posted on the

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