Paradigm Capital - November 2023
Q3 Mixed; Large EBITDA Growth from Traction Motors
Investment Thesis. Neo Performance Materials (NEO) is the largest producer of neodymium permanent magnet powders on a global basis. The company benefits from a proven and seasoned management team capable of paving a path to take EBITDA to over $150M over a 3–5-year period. We are of the view that the shares offer uncommon value at these levels and should benefit from a multiple expansion along with the higher profitability as a strong participant in the EV growth curve.
Event
NEO reported Q3 financials which were below Street expectations.
Highlights
Q3 Lighter Than Forecast | NEO reported Q3 revenue of $136.6M ($135.5M in Q1; $176.1M in Q2), adjusted EBITDA of $13.2M ($0.8M in Q1; $19.5M in Q2) and EPS of $0.09 (vs. a loss of $0.23 in Q1; profit of $0.05 in Q2). We were looking for $165.5M, $18.5M and a profit of $0.14, respectively.
Segment Data | NEO’s Magnequench (MQ) experienced higher revenue, operating margin and EBITDA than in Q2. This was achieved even though the revenue per kilogram was at a new low ($39/kg) as the tonnage was 1,389, up 33% over Q2 (Figure 1–3). Chemicals and Oxides (C&O), despite lower revenue over Q2 ($54.9M vs. $75.3M), had higher operating margins and EBITDA. Rare Metals (RM) was lower in all three measures after a very strong Q2 owing to Hafnium prices.
Prices Stabilizing | Over Q3, neodymium/praseodymium (Nd/Pr) prices stabilized in the $65–$70 area and are still holding there.
NEO Minimizing Lead Lag Impact | To minimize the impact of Nd pricing volatility (when it occurs), NEO is implementing processes to minimize the holding period and increase inventory turns. These changes will probably take 1–2 quarters to gain traction. In the meantime, Nd prices have stabilized.
Magnet and CAT Demand Tepid | The demand for magnets and catalytic converters has been slow to respond as the Chinese economy is only slowly returning working its way back from the harsh COVID shutdown of 2022. To help stimulate the vehicle market, the provincial Chinese bodies are implementing vehicle purchase incentive plans.
Strong Balance Sheet Can Fund Capex | NEO has $113.4M in cash and another $50M in undrawn credit from its EDC loan, and debt of $23M. Capex for this year will be about $90M with $8–$10M going to maintenance capex, ~$16M for the sintered magnet (traction motor) expansion at Silmet (Estonia) and ~$65M for the new plant at Zibo.
EBITDA Positive for Five Years | Despite working in a very volatile price and volume industry, NEO has managed to be EBITDA positive every quarter for five years. This is a strong validation of very good, quick-to-respond management.
Traction Motor Magnets Can Double EBITDA | NEO can generate about $75M in EBITDA, and participation in EV traction motors could take that to $150M, in our view. The opportunity for NEO in BEVs could be between $150 and $200/vehicle versus $15–$20/ICE vehicle.
Valuation & Conclusion
NEO’s traditional business lines are normalizing quickly, and we have adjusted our 2023 forecast to reflect this. The Estonian Traction Motor Magnet facility is reflected in our 2025 and 2026 forecasts. Our 2026e EBITDA is $114M (unchanged). We use 8x EV/EBITDA (unchanged) and a 10% discount rate (unchanged) to value NEO. We maintain our $16.00 target. Note we are using a 4,000-tpa sintered magnet scenario in 2026. We reiterate our Buy rating.