MP - MP Materials: This Major Catalyst Won't Slow The Growth

2023-03-30 01:47:46 ET

Summary

• MP Materials just posted its Q4 earnings report and the company crushed the expectations for both revenue and earnings per share.
• However, just a couple of days later, a major catalyst happened when Tesla announced its new permanent magnet that requires no rare-earth oxides.
• Let’s look at earnings, free cash-flow, capital expenditures and risks to find out how sustainable the growth is for MP Materials.

Investment Thesis

MP Materials ( MP ) is one of the few (SPAC) deals that offered consistent returns for its shareholders. This came as a result of a flawless execution, corroborated with its unique position withing a crucial US industry. Still, Tesla recently made an announcement that impacts MP Materials. Let’s see how MP Materials executed and what are its key drivers for future growth. And we're going to start with its financials.

Revenue & E arnings

The first thing that we need to address is the slowdown in revenue. Although MP Materials sold 11% more rare oxide compared to 1 year ago, the price dropped around 16%:

Additionally, the production cost grew 26% YoY, mostly because of headcount growth related to the Stage 2. As a succinct reminder, MP materials operates in a unique industry with 3 main business stages:

Stage 1 – rare earth concentrate production; MP Materials currently operates at Mount Pass and mines a rare earth concentrate that represents 15% of the global supply. The concentrate is an intermediate product that is currently sold exclusively in China.

Stage 2 – refining (separating the rare materials into individual oxides); the company is currently building the biggest refining facility in the world. Refining is the next step after mining and allows turning the intermediate product from stage 1 into separate rare earth materials at a significantly lower cost. Upon completion of Stage II, MP Materials expects to be a low-cost producer of NdPr. The separating process is set to begin in the second half of 2023.

Stage 3 – production of NdPr magnets; once stage 2 is finished, the company hopes to be able to produce NdPr magnets in the U.S. It is estimated that stage 3 will begin in 2025.

As a consequence of the lower NdPr price, in conjunction with unfavorable changes in the foreign exchange rate, the total revenue for Q4 2022 dropped 6% YoY. However, the company still managed to surpass the estimates as it now surpassed earnings expectations for 9 consecutive quarters:

Moreover, even if margins slightly decreased, the GAAP net margin remained around 50% mostly because of an $11 million interest that MP Materials gained on its short-term investments. For Q4 2022 I’ve eliminated the impact of a one-time tax credit of around $20 million, which would make the GAAP Net margin hit 71%.

While the operating margins dropped, I expect MP to keep solid margins throughout 2023. Still, this will be a period of expanding aggressively, with investments that will affect the Income Statement, while the volatile price of NdPr will add uncertainty for the top line.

Free Cash Flow

Regarding free cash flow, defined as Cash from operations minus capital investments, the company’s activity has been generating cash consistently:

However, MP Materials is planning to invest a total of $700 million of capital expenditures for its Stages 2 and 3. Since MP can’t deliver NdPr yet its market remains very limited. However, it is expected that starting with the second half of 2023, the company will be able to deliver NdPr to other markets, for instance in Japan, where the company signed an agreement with Sumitomo Corporation for delivering refined NdPr .

Luckily, the Stage 1 is generating high amounts of cash from operations so the funding came almost exclusively from the cash generated so far:

Balance Sheet

The company has enough cash to where its long-term debt is not an issue. I also want to point out the low amount of stock-based compensation ((SBC)) that MP Materials paid in recent years. For 2022, the SBC was only around 6% of revenue, which is a great trend that I want to see continuing.

Demand for NdPr

As I mentioned before, the demand for NdPr was lower in Q4 2022 and as a result, the price was 16% smaller than 1 year before. At the same time, production cost grew 26% for MP Materials, mostly because of the upfront investments related to Stage 2:

As a consequence, the gross margin per ((MT)) of rare earth oxide dropped to 77% in Q4:

The upfront costs related to Stages 2 and 3 will be notable in 2023, around $300 million and these, in conjunction with the fluctuations in the NdPr price will lead to volatile margins for MP Materials. Still, the company executed really well as the management reiterated that it will keep the spending within the $700 million total budget allocated when the long-term plan was sketched.

Demand for NdPr and Tesla's announcement

Recently Tesla announced at its Investor Day 2023 that it will produce its permanent magnet which requires no rare-earth oxides:

While we didn’t get any information related to its characteristics or when this permanent magnet might be available, if Tesla can deliver a high-quality permanent magnet that doesn’t use any rare earth oxide, other manufacturers will surely follow.

Adamas Intelligence expects that the replacement for NdPr magnets is a ferrite-powered magnet. Studies have shown that while a ferrite magnet can match or exceed the performance of a NdP magnet for one or more parameters, the ferrite magnets are also 30% heavier, which is a massive weight penalty. As a result, the switch towards ferrite has been unattractive in the past and there’s no evidence yet that it will be successful for Tesla.

However, if successful, the transition would be a serious catalyst for MP Materials since the demand for NdPr might decrease significantly. Still, Adamas Intelligence estimates that NdPr will remain one of the most sought for rare oxides in the next decade.

“NdPr consumption value is expected to see the greatest rise over the forecast period, increasing 11-fold by 2035 compared to 2020”

Electric vehicles and wind energy applications will be the most important sources of upside for the NdPr demand as the world transitions from a fuel-intensive system to a mineral-intensive one.

However, besides electric vehicles there are many other areas where permanent magnets are crucial:

As a result, Adamas Intelligence estimates there will be a 68 thousand tonnes NdPr shortage by 2035 because of lack of primary and secondary supply sources, in conjunction with the inability to increase output at the rate of the demand growth. Right now, the price of NdPr sits around $80/kg, which is significantly lower than when I last wrote about MP Materials, in August 2022, when the price was around $110/kg:

To conclude, I do expect the price to remain volatile in the future and I want to see MP Materials maintain good margins in spite of it. The most important factor will be the cost of production and how much upfront cost will MP Materials incur for its Stage 3 project. So far, the execution has been really thoughtful and I expect it to continue in the same way.

Valuation

Since MP Materials reiterated it will continue to invest heavily into 2023, this will affect its Free Cash Flow. As a result, I believe it might be better to value the company in terms of EBITDA or earnings per share. MP Materials is trading around 14X NTM Enterprise Value / EBITDA and 25X NTM Normalized Price / Normalized Earnings.

While MP Materials trades at a significant premium as compared to the industry, I believe that its unique position within the US supply chain, in conjunction with a 23% compounded annual growth rate expected between 2022 and 2026 make the company really attractive.

Moreover, the high margins, the low level of US competition and the immense current demand for its minerals are additional reasons why MP Materials deserves to be trading at a premium. The company proved its ability to invest its earnings and get a high Return on Invested Capital and it looks like it will continue to execute well.

Risks

Innovation. The main risk is that new technologies will require less rare earth oxides or no oxides at all. Luckily for MP Materials, NdPr is used in many verticals like electric vehicles, robotics, consumer electronics and green energy. Another significant risk is the sudden drop in price for its most important material, NdPr as the result of lower than expected demand. However, as long as the cost of production per MT doesn’t increase substantially, there’s room for the margins to slightly decrease. Lastly, another risk is related to the global macroeconomic environment. If a recession materializes, MP stock might be severely affected and might provide subpar returns.

Final thoughts

I do believe that MP Materials will do well in the long run. The company is uniquely positioned within the US industry to where it is almost forced to succeed. I believe that the demand for NdPr will remain strong and the recent catalyst following Tesla’s announcement will prove to be a good short-term opportunity for shareholders.

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