Canada Connection: Neo Material Technologies

Paul Rolfes | Oct 09, 2007 6:20am EDT | Comment

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The vast natural riches of Canada remain mostly untapped, whether it’s oil, precious metals or other resources. In response, some of the nation’s best-performing public companies have focused on the exploration, processing and sale of natural resources found not only in Canada, but around the world.

Canadian-based Neo Material Technologies, Inc. (TSE: NEM) has found its place in delivering the rare earth elements that the world needs—with many of them coming from the untapped wealth being unearthed in China. For small-cap investors, Toronto-based Neo Material has remained mostly a hidden gem.

Founded in 1993, Neo Material finds and processes neodymium-iron-boron magnetic powders, rare earths and zirconium-based materials—substances required in many high-technology products ranging from catalytic converters to computers and consumer electronics, to precision motors. Its strength includes firmly holding onto proprietary manufacturing technology that it has successfully protected through the patent process.

Neo Material operates through two business divisions—Magnequench, a former General Motors Corp. (NYSE: GM) spin-off that focuses on magnetic technology, and AMR Performance Materials, which includes a neodymium production facility in Thailand. GM invented neo powder technology in 1982 and founded Magnequench to commercialize it. The two entities combined in 2005 through a reverse takeover of AMR to form the current Neo Material.

Neo Material, with some 1,300 employees deployed in 10 countries, was something of a pioneer in China ventures. AMR acquired stakes right out of the gate after its founding in 1993, with two joint ventures in existing rare earth facilities. It launched its neo powder manufacturing facility in Thailand in 1997.

Why rare earth materials? They’re becoming more important as technology becomes more complex. Rare earth materials are used because they typically offer a weight advantage over alternative, more traditional materials, provide tremendous energy efficiency and often are needed to meet environmental regulations.

Delivering these necessary materials puts Neo Material in a sweet spot of having the mining sources and manufacturing facilities in a growing field with unforeseen demand. Analysts covering Neo Material have a highly favorable outlook for this growth company.

Neo Material, which claims the title of the world’s largest producer of neo magnetic powder and second-largest producer of specialty rare earths, has a market capitalization of $392.12 million. Neo Material shares have been publicly traded since 1996.

In its summer release of an annual Investor 500 tally of Canada’s publicly traded companies, Canadian Business ranked Neo Material as the 42nd best, with a respectable five-year return of 20.4%, but a stronger 97.9% return for the previous year.

One key factor in Neo Material’s growth prospects is its exclusivity. This summer, Neo Material announced the successful negotiation with Hitachi to maintain its exclusive licensing of a key patent through 2014.

In updating his coverage of Neo Material in a Sept. 10 report, Fraser Mackenzie analyst Ian Prittie outlined why he’s expecting the company to continue to deliver pleasing results for investors. “A key factor in understanding the growth opportunity presented by Neo Materials is an appreciation of the true scale of the increasing use of rare earth materials in a number of multibillion-dollar end markets,” Prittie wrote. “Consumption of these materials is being driven by research and development activities in areas as diverse as hybrid electric vehicles and laptop computer hard disc design.”

For 2006, Neo Material reported earnings of $27.8 million, or $0.33 per share fully diluted, compared with a 2005 loss of $5.5 million, or a loss of $0.13 per share. Revenue grew to $162.6 million from $98.5 million the year before.

Neo Material has done quite well in 2007, with share price about doubling since January, and is starting to pick up more interest from investors. Shares have a 52-week Toronto trading range of CAD$1.73 to CAD$5.50, and most recently have traded around CAD$5, closing Friday at CAD$4.90. Neo Material started the year at CAD$2.63.

The company reported that in the quarter ended June 30, net income grew 18.8% to $7.6 million, with earnings per share rising a penny to $0.09. Revenue increased 59% to $61.5 million. In the March quarter, net income rose to $6.4 million from $5.3 million, while per-share earnings were flat at $0.06; revenue grew by nearly one-third to $50 million.

Ahead of the Aug. 9 release of Neo Material’s second-quarter results, the company completed the issuance of 17.6 million shares of stock, a public offering priced at CAD$4.60, putting about 20% more shares into play. Proceeds were used to retire debt.

In a late-September report, analyst Frederic Bastien, of Raymond James Equity Research – Canada, raised his expectations for Neo Material. Putting it at “strong buy 1” and a target price range of CAD$6.75, Bastien wrote to clients that Neo Material “is a promising growth company that boasts an experienced management team, enviable industry positions and a proven, low-cost business model. Our view is that these combined forces will allow AMR to capitalize on market share gain opportunities and enable Magnequench to drive rapid growth in the global Neo powder market.”

Back in June, Bastien had an “outperform 2” rating on Neo Material and a CAD$5.25 price target. Following a 2006 P/E ratio of 15 times, Bastien raised his P/E outlook to 14.8 times this year and 12.7 times in 2008.

That optimism is shared by Yuri Lynk, materials analyst for Laurentian Bank Securities, who initiated coverage of New Material Technologies in midsummer with a “buy” rating and CAD$5.60 price target, but with a “high risk” rating. In the Laurentian Small Cap Outlook released in August, Lynk boosted the target price to CAD$6.

Citing the company’s “low cost/high return growth opportunities,” the Laurentian analyst is expecting $0.26 earnings per share this year, rising to $0.38 in 2008 and $0.44 in 2009.

Clarus Securities analyst Youssef Abboud drew similar conclusions in his Aug. 15 note to investors, rating Neo Material at “buy,” but with a 12-month price target of CAD$5.70. Abboud did boost his EPS estimate for 2007 by $0.04 to $0.31, while keeping his 2008 estimate at $0.36.

“Despite short-term concerns regarding higher raw material prices,” Abboud’s note said, “the Company will continue to capitalize on the growing trends of energy efficiency, miniaturization and stricter environmental standards. All these bode well for the Company’s advanced material applications.”

Analyst Daniel Kim of Paradigm Capital also has Neo Material at “buy,” but with an even more optimistic price target of CAD$9.75, telling clients in his summary that “we believe the shares are vastly undervalued.” The Aug. 23 report concluded “the shares make an extremely attractive investment” because of the potential for accelerating cash flow.

Fraser Mackenzie’s Prittie labels Neo Material a “strong buy,” with a CAD$7 price target. His Sept. 10 report also noted that attempts are being made to diversify the sources of many of these rare earth materials to places outside of China, including Australia and other countries.

In its report of 2006 results, Constantine Karayannopoulos, president and chief executive of Neo Material, said: “Fiscal 2006 tested the 2005 combination of AMR and Magnequench and our abilities to manage the combined companies effectively. Given current market trends, our success with new applications and the continued strengthening of our balance sheet, there is a good basis for optimism about the future of the company.”