Molycorp Earnings Call Nuggets: Inventory Situation and Heritage Neo Materials Business
Molycorp (NYSE:MCP) recently reported its first quarter earnings and discussed the following topics in its earnings conference call.
Brian Lee – Goldman Sachs & Co.: I guess first off, I was curious if you could talk about any updates on what you are seeing with respect to the inventory situation at your customers especially on the NdPr side in Japan but also anywhere else where you have some additional visibility?
Constantine Karayannopoulos – President and CEO: I tried to address that I guess perhaps a little too superficially in my comments, but we are seeing inventories correcting. This is nothing new what we saw in the first quarter of this year is nothing new, we see it year-after-year primarily by our Japanese customers trying to finish their fiscal year-end at the end of March with as low inventories as possible. We are seeing the improvement in the second quarter we expect our Magnequench business for example, to sequentially increase we also expect sales of neodymium and praseodymium to improve. We are seeing positive signs, but I’m not at a point where I would call these signs a recovery. They are positive the sprouts and that’s why I was saying that they are all pointing to a recovery in the second half, but clearly they’re not reducing inventories any further. So we’re starting to see projections and actual purchasing activity, that’s indicating that the worst is behind us.
Brian Lee – Goldman Sachs & Co.: I guess a follow-up on Japan we’ve been hearing that some of the especially on the auto side some of the manufacturers seem to be bringing production back to domestically given the fluctuations in the yen recently. Any implications for you guys on that potential shift and anything that you’ve already seen some impact from?
Constantine Karayannopoulos – President and CEO: Not really in the short term, I wouldn’t expect to see anything this quarter or next or the one after that. However, long-term I think this is very important. We’re having a number of discussions with Japanese clients of ours who are making the strategic decision to not only produce their cars in North America, but also to repatriate or reinstitute supply chains in North America, which will necessitate increased levels of production and perhaps will mean the eventual return of all these supply chains that have migrated to Asia and elsewhere returning back to the United States. But I wouldn’t hold my breath for anything of this nature to take effect in the next couple of quarters…
Brian Lee – Goldman Sachs & Co.: Last one from me on chlor-alkali quickly. Any status update you can provide on the pricing negotiations there with your EPC contractor and expect the timing of installation, has that changed? Thanks.
Constantine Karayannopoulos – President and CEO: I need to be careful here. On the positive side, the costs have not increased over the last couple of months when we get updates on estimates from our EPC contractor. However, we are getting an update soon, so we expect to see something reasonable from them, let’s put it that way. The target date for completion of construction for the chlor-alkali plant is still end of August, beginning of September and therefore commissioning would be looking at end of September beginning of August. Again, this is based on the latest information we have. Our Board and our senior management were at Mountain Pass yesterday and the day before. We have a tremendously and talented and skilled group running Mountain Pass and especially the group at our chlor-alkali facility. The place looks great, it’s still a hub of activity, but when you look around the chlor-alkali plant, the vast majority of the equipment, piping et cetera seems to be in. So, it’s still something that we need to be very careful on, but it’s looking pretty good actually. So, I’m quite confident that again without promising that the chlor-alkali plant will be fully commissioned by the end of September. I’m very confident that the plant will be up and running in the fourth quarter, and I would expect more so the fourth quarter Mountain Pass to operate with the chlor-alkali plant in full operation. And therefore delivering the cost reductions that we need to see.
Heritage Neo Materials Business
Michael Gambardella – JPMorgan: Couple of questions. One, could you tell us what the EBITDA in the quarter was for the heritage neo materials business?
Michael F. Doolan – EVP and CFO: Hi Michael, it’s Michael Doolan. For the first quarter it would have been about $15.1 million, so down basically split $12.5 for legacy Magnequench division of magnetics, only $1.5 million for rare earth and just over $1 million for the rare metals piece. I think the biggest thing in the rare earth segment is that everybody is well aware of the pricing environment, but both of the Chinese joint ventures haven’t purchased raw material in some time, so notwithstanding, feedstock prices are coming down. We’re not benefit from them yet. Certainly Jiangyin is writing of clays that were purchased probably early summer of 2012. So, at this point unfortunately we’re really suffering that margin compression emerging through high cost raw materials and into a low price selling environment…
Constantine Karayannopoulos – President and CEO: Michael we’re having, as Michael tried to explain, we’re having relatively high cost raw materials and sliding prices and at the same time as you can tell from our volumes we are not back to normal so we are having a bit of a double whammy. On the normalized conditions this business we expected to get back to historical levels with some degree of comfort.
Michael Gambardella – JPMorgan: I think you had said earlier that you expected this business to generate about $150 million in EBITDA more and running at an annual rate of 60?
Constantine Karayannopoulos – President and CEO: Yes, but we explained to you the reasons why we’re running at 60. Again when the volumes are what they have been historically in that business and when the cost of raw materials reflects the cost of our selling prices. The available margin that that business captures should not be that far-off that figure that we have said that the business has historically made.
Michael Gambardella – JPMorgan: So you have to get a recovery in the selling prices basically?
Constantine Karayannopoulos – President and CEO: No we need to get cheaper raw materials reflecting today’s raw material prices and that business should be a lot closer to that figure. But as Michael said we’re using feed materials that were purchased last year at much higher prices than what we would be buying them at today.
Michael F. Doolan – EVP and CFO: With the demand levels its taking us longer to work through them, at more than typical demand. So until we get back to delivery and we are compression.
Michael Gambardella – JPMorgan: I think at the last offering something you said that you thought rare earth pricing was at or near bottom I mean it seems to have gone down more what do you think is wrong – what’s been wrong for the pricing to go down more than you thought back then?
Constantine Karayannopoulos – President and CEO: Well, when you look at the largest producer in China and the world, which is Baotou, I mean their fourth quarter was a bloodbath. To me, that is about as close to the bottom or as close to a level as the Chinese government will allow their major players in this industry that have been tasked with consolidating all the small producers to operate. The bigger problem that in addition to sort of demand being what it is, I think the most fundamental problem that the whole industry faces, and I won’t claim that this is my thought, but I’ve been talking about it for a number of quarters. Su Bo, the Vice Minister of the Ministry of Industry in China last month talked about the two main priorities for the Ministry being the continuing consolidation of the small producers into the hands of big Beijing-based SOEs and the second was the elimination of smuggling. The smuggling is a big problem. You have first of all smuggling of rare earths at easily a 40% lower cost than any legal producer like Molycorp in China has. When we export our products, we pay 25% export duty and 17% VAT and actually the smugglers don’t pay any export duty nor VAT. In addition, smuggling is sort of the last part of a supply chain within China that mines rare earth illegally processes them without production quotas and what that means is that they pay now resource taxes, not VATs and perhaps more worrisome, they do not operate any environmental systems in those facilities. So, as a result they have some very significant cost advantages which means, that they have – their cost of production would be easily 50% of where rare earth prices are today. I’m not saying that prices will have another 50% to go, but I think it’s imperative that the state council in China will take control of this situation. They have been trying for a while, but in fact when you go to the southern borders of China, you see trucks going through the border completely unchecked. So, I think if the Chinese mean what they say in terms of controlling the industry, they will have to put an end to the smuggling and the illegal production, and if they mean what they say with respect to preserving the environment and protecting the resource in china, they will have to deal with this and I don’t think the state council has a lot more patience. So, this is a very long-way of saying that the current way of operating these illegal operations and smuggling the products out of China is not sustainable. So, on a – if we’re talking about illegally producing and exporting rare earth out of China, you know the prices have some more room to go. On a legal basis, no, I think we’re beyond the borrowing as far as the legal Chinese operators are concerned.
Michael Gambardella – JPMorgan: I mean over the past three years, the Chinese Government has been making statements that they are going to crackdown on illegal miners and smuggling activity in this business and they haven’t so why do you think what they’re saying today, which is the same thing they’ve been saying for three or four years now is any different.
Michael F. Doolan – EVP and CFO: It’s not that they haven’t done anything. We have seen people that we know end up in jail while we also knew that they were unlicensed operators and smugglers. You two realize and understand that there is a fairly major battle going on in China, Beijing versus the regions and in the middle they are caught the Chinese citizens who have to live with the environmental implications. The Chinese Government has gone to great lengths to improve the environmental conditions around the cities small and large, clearly what is going on now is not sustainable. So the Chinese when the Chinese Government will have to make a decision whether they need to pay additional heed to what’s going on, again I stress that what we are talking about is the southern borders because we see the bulk of the smuggling going through the southern borders of China and in my view, it shouldn’t be all that difficult. But there’s continuing battle between Beijing and local governments in the south and we have to wait and see who is going to win it. My bet is on Beijing, but I’ve been wrong before. All I can say is that clearly the current situation is not sustainable. The Chinese Government at all levels Chinese Governments have shut down the number of small facilities. They clearly have not intercepted, enough smuggled material but that may be the next step. Again clearly in China you cannot continue to do things illegally for far too long. But I do take your point that they have been talking about this for a long time and don’t forget that their main defense that China has in front of the WTO on the rare earth case is that what they are doing is designed to protect the environment and preserve the resource. And clearly unless they demonstrate that they are cracking down on illegal production and smuggling, that argument will not hold much water…
Michael Gambardella – JPMorgan: One question for Mike. On the write-down, the inventory write-down you had in the quarter, Mike, could you discuss that a little bit more especially the components of it and why you did it at the Mountain Pass, which I think was over $30 million you said?
Michael F. Doolan – EVP and CFO: Correct, $37.2 million. I mean, a lot of it is just that it’s the – given our fixed cost base and the level of production that we have, allocating it to the units production just can’t be sustained with the credit market price. So essentially that just gets write-off to P&L, that’s a good chunk of it. There’s also some inventory on hand at year end that also gets written-down with the movement downward of lanthanum cerium prices. I think the movement has been greater in cerium and lanthanum than it certainly has in NdPr. So the write-downs we’ve taken is predominantly lanthanum than any other materials.
Michael Gambardella – JPMorgan: So by taking this write-down in this quarter, would that in effect be boosting your income in future quarters, because you…
Michael F. Doolan – EVP and CFO: Well, it just really depends on ultimate selling prices. I mean, if selling prices go back up, then yes.
Michael Gambardella – JPMorgan: Well, I’m just saying, aren’t you just getting rid of high cost material that would have been flowing through the income statement in the future?
Michael F. Doolan – EVP and CFO: Yes, but the issue is that it has to be – we’ve (indiscernible) to lesser cost or net realizable value. Right at the moment, net realizable value is just the (governing) factor. So, all those production costs because we have high fixed base over the low volume, as I say most of that gets flushed through the P&L in a particularly quarter. So, until we start to get back up to the Phase 1 rates, it will probably continue to see a little bit of this.
Constantine Karayannopoulos – President and CEO: Mountain Pass, Mike is designed and is staffed to produce a lot more than it is producing today. So, clearly all those fixed costs are getting amortized over smaller volumes and they are resulting in production costs that are clearly above what today’s pricing will sustain. And instead of sort of parking high costs produced materials and inventory, we are expensing those costs as we go along.
Michael Gambardella – JPMorgan: Kind of as an extraordinary item though…..?
Michael F. Doolan – EVP and CFO: Actually to that point, one of the things – no, I guess what we’ve done is the only write-off is there was an additional $2 million of write off at other locations. I will agree that that’s just business and that’s we only try to manage that. The issue I believe at Mountain Pass, why it is unusual is because we have not achieved commercial production as yet. So, we’re not in a normal business phase, so at this point in our evolution, I would suggest that it’s out of the ordinary. Once, we’re up and running and then we have to manage our inventory levels and keep that and keep an eye on the market prices as well. Then we shouldn’t pulling this out as an unusual item for (indiscernible). As it relates to prices I’m not.
Michael Gambardella – JPMorgan: How much interest capitalized in the quarter?
Michael F. Doolan – EVP and CFO: $21 million.