Neo Performance Materials Inc. (TSX: NEO) is engaged in the innovation, development, processing, and manufacturing of rare earth and rare metal-based functional materials. The group’s operating segments include Magnequench, Chemicals & Oxides and Rare Metals.

Key Investment Rationale:

• Leader in Magnequench Segment: Within the Magnequench segment (represents ~49% of FY21 income), NEO produces industry-leading permanent magnetic powders used in household applications like vacuum cleaners, refrigerators, hairdryers, air conditioners and residential heating & cooling circulation pumps along with several industrial activities. Notably, the group uses its proprietary process to manufacture the powder using a blend of various inputs. In the recent past, NEO focused on key macro growth trends that are yielding positive sales volume growth in areas like compression magnets and electrified-automotive applications, including traction motors & pumps. Notably, the company reported its adjusted EBITDA of USD 48.0 million in FY21, which increased 60.4% on y-o-y basis.

• Positive Long-term Outlook: The company’s products are expected to be used for several new-generation businesses like Electric vehicles, Water Purification, Energy Efficient Homes & Factories etc. Notably, the company’s neodymium-iron-boron (NdFeB) magnets are likely to be used for Electric Vehicles and Heavy Electric Vehicles models, which is the future of the automobile industry. As per a recent study, demand for NdFeB Magnet is likely to grow at CAGR of 23.3% from 2022 to 2030. We believe the company is highly poised to take advantage of the growing demand coming from the industry. 
  

• Tremendous growth from the Rare Metals segment: In FY21, the company’s Rare Metals segment reported a strong performance (revenue at USD 83.6 million, up 40.1% y-o-y) driven by the growing traction from the magnetic elements used in the leading technologies like electrification vehicles and other environmentally sustaining technologies. Moreover, continued demand recovery within the aerospace space coupled with fresh demands from newly added customers also supported the performance growth. The company is also planning to expand its customer base and would push several value-added products for its customers. This is likely to support the company’s overall margins and cash flows. Notably, in FY21, adjusted EBITDA stood at USD 9.1 million v/s an adjusted EBITDA loss of USD 2.1 million in FY20.

• Surge in Dividend Payment: Despite the ongoing sluggish economic growth, the company reported a higher dividend of USD 12.7 million in FY21, compared to USD 11.2 million in FY20. This is impressive as most of the companies are lowering their dividend distribution in order to retain liquidity.

• Healthy Balance sheet: The company is virtually debt-free and reported a lower debt-to-equity (D/E) ratio of 0.02x in FY21, as compared to the industry median of 0.78x. This will help the company to use its cash flows for alternative projects, while the lower leverage will help the company to outpace its peers during the rising interest rates environment.

• Ample Liquidity: The company has a prudent working capital management and reported its quick ratio and a current ratio of 1.35x and 2.88x, respectively, in FY21, as compared to the industry median of 1.30x and 1.91x, respectively. This indicates that the company’s short-term liabilities can be easily funded by its current assets.

Risks associated with the investment:

The company’s operations might be hindered on account of a lower level of activities from the end market due to several reasons like semiconductor chip shortage, lower corporate order book, sluggish demand for technology and related products etc.

FY21 Financial Highlights: (in thousands USD)

FY21 Income Statement Highlights (Source: Company Report)

• Robust Sales growth: NEO announced its FY21 result, wherein the company posted an income of USD 539.2 million, significantly higher than USD 346.6 million in FY20. The surge was driven by solid growth from all three operating segments on the backdrop of economic recovery. Notably, the group reported 21.4%, 18.3% and 33.3% y-o-y growth from Magnequench, Chemicals & Oxides and Rare Metals, respectively, in FY21.

Source: Company Report

• Higher Gross profit: Despite a higher cost of sales, the group posted a higher gross profit of USD 150.5 million, as compared to USD 80.3 million in FY20, thanks to the higher income as mentioned above.

• Decline in total expenses: The company curbed its total expenses to USD 90.6 million, as compared to USD 135.9 million in FY20. This was primarily due to a lower impairment of assets (USD 0.121 million v/s USD 59.0 million in FY20), partially offset by higher selling, general & administrative expense and elevated research & development expense. Due to the above reasons, the company reported an operating income of USD 59.8 million, as compared to an operating loss of USD 55.6 million in FY20.

• Net income v/s net loss: The corporation posted a net income of USD 36.0 million, as compared to a net loss of USD 60.0 million in FY20. This is due to a higher operating income as mentioned above, partially offset by higher net finance costs and an increase in other expenses.
  

Top-10 Shareholders:  Top ten shareholders of the company together hold approximately 51.62% stake, Oaktree Capital Management, L.P. and Mawer Investment Management Ltd. are the major shareholders in the company with an outstanding position of 24.28% and 12.66%, respectively.

Source: REFINITIV, Analysis by Kalkine Group

Valuation Methodology (Illustrative): EV to Sales based\

Analysis by Kalkine Group

*% Premium/(Discount) is based on our assessment of the company’s NTM trading multiple after considering its key growth drivers, economic moat, stock's historical trading multiples versus peer average/median, and investment risks.

Stock Recommendation:

In FY21, the company has shown significant volume recoveries from the prior year as COVID-19 related issues continue to diminish, which is encouraging. Hence, in FY21, the corporation reported robust growth from all its operating segments, which has resulted in strong performance metrics. Notably, consolidated adjusted EBITDA was recorded at USD 81.9 million, which soared from USD 28.8 million in FY20. The company has long standing relationships with industry leaders and OEM’ clients, and offers value proposition for them, which would continue to support the company’s upcoming order-book as well. We have valued the stock using the EV to Sales based relative valuation method and have arrived at a double-digit upside (in percentage terms). For the said purposes, we have considered peers like SNC-Lavalin Group Inc, 5N Plus Inc etc. Considering the aforesaid facts, we recommend a ‘Buy’ rating on the stock of NEO at the last closing price of CAD 15.87 on March 25, 2022. Markets are trading in a highly volatile zone currently due to certain macro-economic issues and geopolitical tensions prevailing. Therefore, it is prudent to follow a cautious approach while investing

One-Year Technical Price Chart (as on March 25, 2022). Source: REFINITIV, Analysis by Kalkine Group

*Recommendation is valid on March 28, 2022, price as well

Technical Analysis Summary

Disclaimer

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