Canaccord - November 2023Q3/2023 Recap: Good value but lacking catalysts
We are reiterating our BUY rating and lowering our one-year target price on Neo to C$11.00 from C$13.00 following Q3/2023 results that were in line with our estimates. Neo's rare earth-based advanced materials are well positioned to benefit from the secular shift towards energy efficiency and stricter environmental regulations. After approximately 100 days as Neo's president and CEO, Rahim Suleman reinforced his commitment to the company's plans to expand into sintered magnets via a greenfield plant in Estonia (NPM Narva). On the call to discuss the quarter, Mr. Suleman highlighted the attractiveness of the sintered magnet industry (its very large and growing quickly, in short) and how well positioned Neo is to participate in this growth. There's just one problem, in our view: NPM Narva won't produce its first samples until late 2025 with full ramp-up not likely until 2026/2027. That's a long way off. In the meantime, Neo's business is facing uneven volume trends, margin pressure (albeit potentially abating) from declining rare earth prices, and a significant capex outlay of $100 million next year. All of this appears reflected in Neo's share price, however, with it trading at material discount to peers (discussed below). We see risk/reward as favourable here with the compressed valuation, 5.8% dividend yield, and strong balance all providing downside support, in our view.
Q3/2023 EBITDA was $13.2 million compared to our $13.4 million estimate and the $14.9 million FactSet consensus. This figure increased from $7.0 million in Q3/2022, a soft comp that featured $8 million in inventory write downs. Revenue decreased 7% y/y to $137 million versus our expected $139 million and gross margin of 22.7% remained broadly stable sequentially, but missed our 24.0% estimate. SG&A and R&D expenses of $18 million were behind our expected $20 million. Below the line, $1 million in losses from investments in associates and a 49% effective tax rate drove Adj. EPS of $0.09, up from ($0.04) a year ago and compared to our $0.14 forecast and consensus of $0.11.
Solid results from Magnequench and Chemicals and Oxides (C&O) partially offset lower-than-expected EBITDA from Rare Metals. Magnequench reported $6.0 million of EBITDA, 17% lower y/y, but ahead of our $5.3 million estimate. C&O surprised to the upside reporting $7.7 million of EBITDA, versus our $3.0 million estimate. The Rare Metals segment, however, delivered only $3.3 million in EBITDA, coming in behind our $10.0 million estimate and last quarter's record $17 million.
Neo continues to have a strong balance sheet with $91 million of net cash to fund its strategic growth initiatives. FCF in the quarter was $8 million and $38 million YTD positively impacted Neo's conversion of higher cost rare earth feedstock in inventory. The company has $163 million of available liquidity ($113 million in cash and $50 million on its EDC credit facility). We deem this as sufficient to fund the company's strategic initiatives, which include ~$57 million in remaining capex for its Zibo relocation ($18 million spent so far) expected to be completed in Q1/2024 and ~$48 million for the phase 1 of NPM Narva, expected to be completed in 2025.
We make some model refinements and introduce 2025 estimates. We expect 2023/2024 EBITDA of $45/$47 million from $46/$63 previously and EPS of $0.05/$0.40 from $0.13/$0.67 previously. Our EBITDA and EPS forecasts for 2025 sit at $54 million and $0.45, respectively.
Valuation. We shift to a P/E approach to value Neo from EV/EBITDA previously due to the upcoming capex outlay impacting our EV without an associated impact on EBITDA within our forecast horizon. Neo trades at 12.3 P/E (2024E) versus a loose comp group at 21.4x. We use 17.0x P/E (H2/2024E-H1/2025E) to set our target price (7.25x EV/ EBITDA 2024E previously) before converting it to CAD using $0.73 CAD/USD.