Lynas Corp (ASX: LYC) – It’s one of the top performers in the ALL ORDS over the last six months. An attractive growth trajectory. Henry’s been onto this one for a while. About time we put it through the BHS filter. LYC is the world’s second largest producer of separated Rare Earths, and the only significant producer outside of China. The company has turned itself around since the ‘debt-laden’ mess it was labelled in 2014. What’s the deal with rare earths? Funnily enough, they aren’t actually that rare. Apart from being used in electric vehicles, green technologies, consumer electronics, robotics and medical device, rare earths are also a key component in many pieces of specialised military equipment. For example, each F-35 Lightning II aircraft – one of the world's most sophisticated, manoeuvrable and stealthy fighter jets - needs ~417 kilograms of rare-earth materials, according to a 2013 report from the US Congressional Research Service. The issue is, China accounts for almost 95% of global output and the US relies on the Asian nation for ~80% of its rare-earths requirement according to a research piece last year in the SMH. You might see where this is going. The table above highlights the supply risk for rare earths as calculated by the European commission. Not surprisingly they are in the ‘Very High’ category. Late in the September quarter, Trump announced an Executive Order to build reliable and resilient critical minerals supply chains for the US economy. The European Union also identified the need for a diversified and sustainable supply chain. With China becoming increasingly volatile on the trade front, global heavyweights are not surprisingly looking to other solutions/providers. The focus for the business recently has been expanding its product suite and its Heavy Rare Earths (HRE) separation capability. In July it signed a deal with the US department of defense for work on the proposed US-based HRE facility. At the end of November, exploration results from Mt Weld showed promising outcomes. Quarterly production revealed a ‘good’ start to the new financial year. Total Rare Earth Oxide production was 4,110 tonnes, compared to 2,579 tonnes in the previous quarter. Sales revenue was $87m during the September quarter, up from $38m in the previous quarter. LYC also completed a $425m capital raising which will help fund projects like its Kalgoorlie processing facility, which is expected to be operational by mid-2023. The operation will assist in de-coupling reliance on its Malaysian operations which are exposed to a level of sovereign risk.

Main observations:

• One the top-10 performers in the ALL ORDS over the last three months, and the last six months.
• ROE of 8.6% not terribly exciting, behind the average return of the ALL ORDS. Forecast to improve substantially in FY2 and FY3.
• EPS in the last financial year no doubt hurt by the capital raising. Financial performance in FY0 was less than pleasing, weighed down by progress on its growth phase. But that’s in the past now.
• EPS is expected to massively outpace revenue in the next couple of years. A solid indication the business is focused on driving efficiencies.
• A PE of 69.5x is relatively expensive. Expected to move to far more palatable levels in future periods. 21.9x and 14.3x in FY2 and FY3 respectively. ALK sits on 26.5x.
• Of the five brokers that follow the company, 80% have a BUY or STRONG BUY rating.

WHAT SORT OF INVESTMENT IS LYC?

There is no avoiding the fact that LYC is a mining play, and like any mining company, it doesn’t matter what secret herbs and spices you add to your intrinsic value calculation. The only thing that matters is the value of the underlying commodities that it processes and sells. With China having the monopoly in the market, prices are at risk of manipulation. The sector is notoriously fraught with risks. One commentator noting China can, “turn on the taps, flood the market, the price of dysprosium crashes, a new entrant is washed out, and then they’ve re-established their monopoly.” What is pleasing to know is that LYC has held its own. The only producer in the last two decades to successfully ramp up, not just preliminary processing of rare earths, but right through to separated oxides. What is also encouraging is that production of rare earth has increased significantly through the decades as technologies require more of the magnets, catalysts and metal alloys that can only be produced with rare earths. Back on the commodity front, November saw the prices of all major Chinese-sourced rare earths spike, but especially those used in magnets. In particular, neodymium (shown in the chart below), which is up more than 30% since early in November and over 70% year to date. As mentioned before, the EU and US are trying to separate themselves from reliance on China and supporting demand.

BROKER STUFF

Ord Minnett has a BUY recommendation, mulling the growth options beyond LYC’s 2025 project scope. Paying close attention to the multi-year high commodity prices and a significant war chest, the broker considers the company well-placed to capitalise on some incremental growth options post-2023. UBS sees LYC well positioned to benefit from EV demand. Views the company’s assets as ‘very’ strategic. Both target prices see the company fairly valued.

TECHNICAL VIEW

A nice-looking chart, almost the perfect bottom left to top right (BL2TR) configuration. We have spoken before about putting the balance of probability in your favor. LYC passes the BL2TR test. Up an impressive 324% since the March low. RSI has been in overbought territory since mid-November but has just started to tick lower. 3MA compliant as well. For an explanation of the 3MA technical indicator, click here. A short-term top appears to be forming. If support around 400c evolves, that could prove to be an attractive entry point.

TOP INVESTORS

A notable skew to buying. Macquarie in August picked up almost 40m shares. Challenger and Greencape more recently offloaded 10m shares each.

SHORTING

Short interest peaked in August, around the time of the equity raising. From quite a significant level, just below 7% interest has fallen rapidly. Now at 0.98%. The move arguably validating LYC’s growth trajectory with bears wanting to get out.

CONCLUSION

Right now, it doesn’t look like a bargain. But in a years’ time, will that assessment be proven wrong? The commodity tide driven by demand from the US and Europe is an attractive backdrop. The growing level of production and need for rare-earths another pleasing consideration. LYC’s progress on its 2025 growth vision is also encouraging. Projects that will likely add to business efficiencies and increased capabilities. Partnerships with the US, Malaysian and domestic governments adding confidence to its 2025 vision. Despite seeing it fully valued, the commentary from the brokers is largely positive and speaks to a level of future optimism. On the technical front, it is 3MA compliant although, there is a small indication the trend might be slowing down. The steady decline in short interest another factor helping its investment case. Fundamentally the numbers are solid and expected to improve in the next few years. The question is how much of that has already been priced in? While difficult to know, the balance of probabilities does appear to be weighted to the upside. If support were to form around 400c, that could provide an opportunity to add the stock to a growth portfolio.