An EV Trade That Actually Has Fundamentals

Trading Symbols:                                     NEO

Share Price Today:                                   $15.50

Shares Outstanding:                                37.6 Million

Market Capitalization:                              $580 million

Net Debt:                                                  -$75 million

Enterprise Value:                                     $507 million

Note: NEO reports in USD but I am using CAD in this report

Electric vehicle (EV) stocks have gone through the roof. Everything EV is flying.  

Car companies that have never sold a car are worth billions. 

There are LiDAR companies with a capitalization rivaling big established automakers. 

The battery company QuantumScape (QS – NASDAQ) has an $11 billion market cap and no revenue – and this is after the stock has been cut in half.

Most of these names are doing it on fumes. They are getting rewarded for projections that will happen a decade from now.

Let’s set it straight – no one knows what their 2030 sales are going to be.

The numbers being thrown around are pie-in-the-sky.

But while nine out of ten EV names are rising on hype alone, there is the odd play with some fundamentals behind it.

That is what I am here to tell you about. 

An electric vehicle play that trades at 6x EBITDA and 7x its 2019 free cash flow. 

One with strategic rare earth assets in North America and Europe. And a very real chance that it is acquired at some point.

The name?  Neo Performance Materials (NEO – TSX).

 

Rare Earths and the EV Connection

 

First, a little background on rare earth elements (REEs).

REEs consist of 17 metals on the periodic table that are often found together in deposits in small quantities.

The excitement around REEs comes from their usage in electric vehicle production. 

The reason is magnets. Two REEs, neodymium-praseodymium (shorthand of NdPr, thankfully), are needed for permanent magnets.

Permanent magnets are used in brushless motors. And brushless motors are used in electric vehicles.

On average about 1 kg of permanent magnets is needed for each EV motor. 

According to Bank of America, 10 million new EVs would require around 7,000t of neodymium. That equates to around 24% of global NdPr supply.

That means we are going to see a surge in demand for REEs as EV adoption takes hold.

Bank of America estimates that electric vehicle demand for NdPr will increase from 2kt right now to 17kt by 2030. With that kind of increase, EV’s would account for 31% of the overall NdPr market.

Source: Bank of America Global Research Estimates

A similar forecast has been made by the research firm Adamas Intelligence

Source: Neo Performance Material Investor Presentation

Neo Performance Materials is well positioned for the surge in demand. They own several processing assets – REE separation, magnetic powder production and magnet manufacturing.

Many of their operations are in Europe and North America. They operate the only REE separation facility in Europe.

 

Source: Neo Performance Materials Investor Presentation

REEs have made headlines in the last decade when China has threatened to restrict their export.

China produces around 85-90% of rare earth metals.

In this respect, Neo Performance Materials assets are strategic – they represent REE processing and manufacturing that does not rely on China.

Another REE stock that has been a big winner of late has been the SPAC conversion MP Materials (MP – NASDAQ). MP Materials has seen its stock soar while playing up their non-China production.

MP Materials produces rare earth metals. The company operates the Mountain Pass rare earth mine in California. 

Since announcing the SPAC deal, MP Materials stock has more than tripled off of its $10 list price and now sits at $33.

If one were to take MP Materials and Neo Performance Materials together, the two companies would represent an REE supply chain that does not rely on China. That could be a big plus for strategic buyers and Western governments.

But suggesting such a combination would normally be just wild speculation. 

Except in this case, the assets have hooked up before.

 

The Molycorp Break-up

MP Materials and Neo Performance Materials used to operate together under a single umbrella of Molycorp. 

MP Materials was the mining assets and Neo Performance Materials was the processing infrastructure. 

Molycorp went public in 2010 at the height of the first rare earth boom. At its peak, the stock had a $6 billion market capitalization.

Much like MP Materials, Molycorp started off with just the mining assets – the Mountain Pass mine. In 2012 Molycorp acquired the downstream processing. 

But REE prices fell and Molycorp failed. The two assets were split up after bankruptcy.

The Mountain Pass mine was sold for $20 million to a group in private equity before emerging again as a SPAC in the form of MP Materials this year.

The rest of Molycorp came out of from bankruptcy in 2017. It formed the public company Neo Performance Materials.

Getting the Band back Together?

The synergies of the two businesses are clear. MP Materials owns the mine. Neo Performance Materials owns the processing. 

Source: Neo Performance Investor Presentation

The acquisitive aspirations of MP Materials are no secret. CEO James Litinsky has said that their strategy is to vertically integrate.

Litinsky has also said he would like MP Materials to replace Chinese companies as the “Go-To” for rare earth material supply chain needs. 

In their regulatory S-1 filing, MP Materials disclosed that their long-term mission was to “capture the full rare earth value chain”.

They go on to say that they “intend to explore long-term vertical integration through further downstream processing of our REO into rare earth metals, alloys and finished magnets.”

It is spelled out again in their investor presentation.

Source: MP Materials Investor Presentation

Tale of Two Stocks

MP Materials certainly has the currency for a takeover. The stock has risen 3-fold since Q3 2020.

Even with a recent surge in the stock in 2021, Neo Performance Materials stock has paled when compared to MP Materials. 

Source: StockCharts.com

Part of the reason for the underperformance is COVID.  Neo Performance Materials has a wide variety of end markets for their REE materials and many of those have been hit by the pandemic.

Neo Performance Materials operates 3 business segments:

 

  1. Magnaquench
  2. Chemicals and Oxides
  3. Rare Metals

Magnaquench is a producer of rare earth powders. It produces neodymium-iron-boron (NdFeB) magnet powders. These are used in bonded permanent magnets.  

The segment also manufactures magnets used in electric vehicle motors and small miniature motors (for applications like robotics, pumps and appliances).

Chemicals & Oxides takes rare earth concentrates and turns them into industrial materials. The materials are used in EV’s, catalytic converters and magnetics.

Rare Metals makes metal alloys that are used in aerospace, LED lighting and consumer electronics.

Source: Neo Performance Materials Investor Presentation

While COVID muddied 2020 (traditional REE end-markets like aerospace have been hammered), the long-term outlook is bright. Neo Performance Materials makes products that are used in growth industries like electric vehicles, automation and robotics, and wind power.

 

Neo Performance Materials is not Expensive

 

COVID has taken its toll on the financial performance of Neo Performance Materials.

For the first 9 months rare earth product volumes were down 13%. Revenue was down 25%. EBITDA was down 60%.

It was an ugly year. But those numbers hide the potential. 

From 2017 to 2019, NEO produced EBITDA of $74 million, $83 million, and $80 million respectively.  EBITDA margins over those 3-years ranged from 13-15%.

In 2019, Neo Performance Materials generated over $70 million of free cash flow.

Yes, the stock has gone up like everything else. But even after the recent run-up Neo Performance Materials has an enterprise value of a little over $500 million.

With an average EBITDA of $79 million over the last 3-years, the stock trades at 6.4x EV/EBITDA.  Based on last year’s free cash flow, the stock trades at only a little over 7x.

In this market that passes for cheap.  Certainly not what you would expect from a company tied into electric vehicles.

 

A Number of Ways to Win

 

This stock is not expensive for this market.

There is no question that the stock is being driven by a mania fueled by EVs and SPACs.

But Neo Performance Materials has far less priced in and has more ways to win.

You can win on the back-to-work trade, as their businesses hit by COVID come back.

You can win if MP Materials pulls the trigger and buys them.

And you can win if someone discovers this is an electric vehicle (EV) play.

There’s lots of ways to win—and it has some real fundamentals behind it.

 

 Keith Schaefer