Valuation
NEO currently trades at 4.9x EV/EBITDA, which is below their past 5-yr average of 6.0x
• Using lower end of management’s expected incremental revenues in the range of $135-160 million following the completion of Phase I of the Estonian REE sintered magnet manufacturing capacity in 2025 (just began construction) + Magnequench’s historical average EBITDA margin at around 13% + FY22 EBITDA (no growth in all other segments) + 6.0x EV/EBITDA yields 3-year TP of C$19.1, IRR of 28%.
• Assuming Phase II of the Estonian REE sintered magnet manufacturing capacity is fully operational by 2027 (doubles Phase I capacity) and with the same set of assumptions, this yields 5-year TP of C$22.3, IRR of 19.6%.
ESG Considerations (Most Material)
1. Environmental (E) – Waste and Water Management
The REE industry is notorious for waste contamination and wastewater pollution. In this regard, NEO has been exceptional in its environmental management of existing operating facilities, with 0 non-compliance associated with water quality permits, standards and regulations in 2020 and 2021. Some awards of their operating facilities include:
• Estonia REE and rare metal processing facility + Thailand REE magnets production plant awarded Gold Medal from Ecovadis for 2021 sustainability program (top 5% of all facilities globally)
• REE magnet production plant in Tianjin China awarded silver medal from Ecovadis for 2021 sustainability program (top 25% of all facilities globally)
2. Environmental (E) – GHG Emissions
Processing and production of REE related products is energy intensive, and in this regard, NEO has been a standard setter in incorporating renewable energy sources into its production processes. For instance, the Estonia plant obtains 78% of its energy needs from renewable sources, with more than half of their total operational energy consumption in 2021 being obtained from renewable sources (28% steam/ other heating + 27% renewable)
3. Governance (G) – Compliance with Laws and Regulations
Given its diverse operational footprint and how diversified operations stand at the heart of its “mine to magnet strategy”, compliance with laws and regulations is critical for NEO to expand operations and gain new permits. NEO has a legal team in place that frequently assesses the risk of administrative or judicial sanctions for failure to comply with environmental laws and regulations. It recorded no instances of non-compliance with laws and regulations in 2021. Testament to their clean record is the speed at which the grant was given for the construction of the Phase I facility in Estonia.
Key Risks [Mitigation]
1. Geopolitical and Supply Chain Risks
As things stand currently, 30% of NEO’s LTM revenue is derived from China and more than 45% of the workforce is in China, which houses their only REE bonded magnet manufacturing facilities. Naturally, this points to the risk of supply chain concentration, in an industry that is prone to REE weaponization from Chinese dominance. Moreover, its operating Estonian plant gets most of its REE feedstock from a Russian supplier, which could lead to disruptions if sanctions pertaining to the war are expanded. [As the main business strategy of NEO continues to develop and play out, supply chain risk will naturally be mitigated as NEO is already the industry’s undisputed leader in carving a supply chain out of China’s REE monopoly, particularly in value added post-mining segments. They are also participating in additional REE feedstock initiatives – Greenland’s Sarfartoq Project, Australia’s Yangibana and Koppamurra Projects]
2. End Market Concentration
More than 50% of NEO’s revenue should be tied to the automobiles end market, given the use of magnetic powders in various small motor applications in ICE/ Hybrid/ EVs + substantial use of their Chemicals & Oxides product in auto emission catalysts. Such effective sectorial concentration results in high volatility of sales as the cycles turn. [NEO is working on better inventory management to reduce the lead-lag effect on their earnings, and with a more diversified supply chain and an establishment of their “mine-to-magnet” strategy, inventory management should improve with greater visibility across their sources and markets, helping to mitigate the follow-on effects of auto cycles.]
Conclusion
NEO’s business at current valuations looks very attractive, with short term underperformance impacted by aggressive inventory destocking in the key end markets which are experiencing cyclical downturns compounded by a weakening Chinese macro-outlook (automobiles and to a lesser extent, semiconductors, and industrial automation). Moreover, the lead-lag effect due to their inventory management exacerbates the effects of this cyclical downturn and may have contributed to further market mispricing, on top of minimal coverage. However, the medium to longer term prospect looks very bright for an already cash generative business. NEO are in the parallel processes of entering and establishing the first “mine-to-magnet” vertically integrated business based in Europe, which fits into the broader themes of supply chain diversification and de-globalisation (near-shoring of manufacturing capacity especially within the Western bloc EU/US), while its other products serve end markets with secular growth trends (eg. enhancing energy efficiency across multiple advanced technological applications).
*Do note that all of this is for information only and should not be taken as investment advice. If you should choose to invest in any of the stocks, you do so at your own risk.
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