Neo Performance Materials (TSX: NEO) is Canada based specialty mining and minerals company, which is engaged in the manufacturing of advanced industrial materials, magnetic powders and magnets, specialty chemicals, metals, and alloys, which are critical to the performance of many everyday products and emerging technologies.

Investment Rationale

• Manufacturing Essentials for a Wide Range of Industries: The company is the world leader in the production of permanent magnetic powders used in bonded and hot-deformed, fully dense neodymium-iron-boron magnets, which has applications in a variety of industries like vacuum cleaners, refrigerators, hairdryers, air conditioners and residential heating and cooling circulation pumps, industrial and other sensors, motors used in various automotive applications for hybrid, electric, and internal combustion engine vehicles.

• Virtually Debt Free Balance Sheet: The company’s Debt/Equity ratio at the end of June 2021 stood at 0.02x, and long-term debt as % to total capital stood at 0.6%. Moreover, at the end of the quarter, the company holds a net cash positive position, which implies negligible balance sheet risk.

• Robust Liquidity Position: The company’s current ratio at the end of the June quarter stood at 3.34x, which improved from 2.85x reported a quarter before. The company holds a significantly better liquidity position compared to its peers as the industry median stood at 2.12x.

• Consistent Improvement in Bottom line: The company has consistently improved its financial performance over the past four quarters. On the back of robust performance of all three operating segments, net Margin bolstered to 9.4% in the second quarter of FY21 from negative 0.5% in the third quarter of September 2020.                     

• Solid Performance in Q2FY21: The company reported another outstanding quarter that exceeded the management expectations with record topline numbers, strong profitability and more importantly, the plants operated near-record output (higher capacity utilization). Revenue during the second quarter jumped by ~99.5% to USD 135.1 million, and net income was recorded at USD 13.02 million against net loss reported in the same period of the corresponding financial year.

• Reported Organic Growth in Each Business Segment: All three operating segments of the company reported an increase in revenues due to higher pricing and volumes. Further, all three segments demonstrated strong growth in volumes and profitability compared to recent (pre-COVID-19) historical periods. With revenue of Magnequench segment nudged by 124.3% on a YoY basis and volumes in the segment witnessed a continued rebound and strong growth on a Y-o-Y basis. Revenue in the C&O segment surged by ~106.4% to USD 52.3 million, and Adjusted EBITDA was USD 8.7 million vs negative numbers reported a year before. Revenue in the Rare Metals segment soared by 48.4% to USD 20.1 million, and adjusted EBITDA bolstered by 554.8% against the same period of the previous financial year.

• Macro Tailwinds Driving Growth in Rare Earth Segments: Despite organic growth witnessed in all the operating segments, the significant macro tailwinds boosting the entire rare earth sector, and a number of strategic growth opportunities on the radar, which makes the management confident in the sustainability of the company’s long-term vision and growth strategy. The group is continuing to diversify their sources of rare earth feed materials to include material sourced from North America for their European-based rare earth processing facility in Sillamäe, Estonia, which would strengthen the company’s ability to meet growing demand from their global customers.

• Stable Dividend Distribution: Amid a lower interest rate environment, finding a yield that can protect against the prevailing inflationary pressure is quite tough and increasing tolerance of debt troubled businesses is posing a lot of risks in the bond market. Therefore, it is good to stick with companies that are yielding higher with a track record of consistent dividend payments. NEO is offering a dividend yield of ~2.3%, which is higher compared to the yield on the investment grade government and private bonds.  

Dividend History (as on September 24, 2021)

• Gaining Technical Strength: After a recent downtrend in the stock, on the daily price chart, NEO shares registered a bullish engulfing candlestick and ended the bear trend with strong volume as well. Further, CAD 16.05 is a crucial support level, and the demand zone and stock prices are hovering above it. Further, 14-day RSI is also taking support near 40, which indicates that stock is no more in a bearish trend at the current level.

Source: REFINITIV, Analysis by Kalkine Group

• Taking Support at Rising Trend Line: After taking steep correction from the higher levels, now the NEO stock prices are hovering around the rising trendline support zone on the weekly price chart and prices are sustaining above the trend line support zone. Moreover, the prices are trading above the trend-following indicator 50-period SMA which may act as a crucial support level for the prices. Furthermore, the momentum oscillator RSI (14-period) is trading at 48.38 level,  which indicates the possibility of recovery in the stock from the current levels.

Source: REFINITIV, Analysis by Kalkine Group

• Risk Associate to Investment: Neo’s sales and profitability are determined principally by the pricing of the advanced industrial materials. The prices of the rare earth products are influenced by the price and demand of the end products that Neo's products support, including automotive, electronics and clean energy technologies. A significant decrease in the global demand for these products may have a material adverse effect on Neo's business. Neo does not have hedging contracts for revenue and costs in place.
  

Financial Highlights: Q2FY21

Source: Company Filings

• During the second quarter under consideration, the company’s topline grew by 99.5% on a YoY basis to USD 135.14 million against 67.73 million reported in the same quarter of the previous financial year.
• Topline growth was mainly driven by robust performance of all three segment, with revenue in the Magnequench segment was USD 67.9 million, up 124.3% on a YoY basis, revenue in the C&O segment was USD 52.3 million (up 106.4%), and revenue in the Rare Metals segment was  USD 1 million, up 48.4% against the same quarter of the previous financial year.
• The group’s reported volume for the second quarter of the 2021 was 4,063 tonnes, which improved by 59.6% YoY.
• The company’s reported operating income was USD 18.2 million vs operating losses reported in the same period of the corresponding financial year, driven by robust growth in operating income reported in each of the operating segments.
• Operating income of Magnequench segment was USD 12.6 million, which saw a continued rebound and strong growth compared to prior periods operating income of USD 3.4 million.
• Chemical and Oxide segment reported operating income of USD 7.9 million compared to an operating loss of USD 37.7 million.
• Rare Metals segment reported an operating income of USD 1.8 million vs an operating loss of USD 24.7 million in the same quarter of the previous financial year.
• The company’s Cash balance at the end of Q2FY21 stood at USD 59.6 million after distributing USD 3.1 million in dividends to shareholders.
• The board has declared a quarterly dividend of CAD 0.10 per common share on August 11, 2021, for shareholders of record at September 20, 2021, with a payment date of September 29, 2021.

Top-10 Shareholders

Top-10 shareholders together holding approximately 55.33% stake in the company, with Oaktree Capital Management, L.P. and Mawer Investment Management Ltd. are the major shareholders with an outstanding position of 32.95% and 10.22%, respectively. 

Valuation Methodology (Illustrative): EV to Sales Based Valuation Metrics

Note: Premium (discount) is based on our assessment of the company’s growth drivers, economic moat, competitive advantage, stock’s current and historical multiple against peer group average/median and investment risks.

Stock Recommendation: NEO is engaged in the manufacturing of bare essentials, which is the building blocks of many modern technologies that enhance efficiency and sustainability. The company’s advanced industrial materials, magnetic powders and magnets, specialty chemicals, metals, and alloys, are critical to the performance of many everyday products and emerging technologies. More importantly, the company has strategically positioned itself as a leading commercial partner to some of the world’s largest customers in the semiconductor, automotive, specialty chemical and advanced electronic industries. As a result, the company is well-positioned in markets that are estimated to record robust, long-term growth driven by multiple global macro trends, such as vehicle electrification, industrial automation, consumer electronics, energy-efficient lighting, air and water pollution control, and superalloy.

Further, Neo’s robust financial health with a virtually debt-free balance sheet and strong liquidity position increases investor’s confidence in the company.

Hence, based on the aforementioned rationale and valuation, we recommend a “Buy” rating on the stock at the closing price of CAD 17.21 on September 24, 2021.  

*Depending upon the risk tolerance, investors may consider unwinding their positions in a respective stock once the estimated target price is reached.

Technical Analysis Summary

1-Year Price Chart (as on September 24, 2021). Source: REFINITIV, Analysis by Kalkine Group

*The reference data in this report has been partly sourced from REFINITIV.

*Recommendation is valid on September 27, 2021, price as well.

Disclaimer

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