The Aussie miner upsizing its stake in the rare earths space

This article was first published for Livewire Markets on Wednesday 1 February 2023

Global demand for rare earths – specifically, the permanent magnets created from neodymium (Nd) and praseodymium (Pr) – is off the charts. Just 65,000 tonnes of NdPr oxide were produced last year but this figure needs to hit at least 126,000 tonnes annually over the next decade, according to UBS research.

The investment bank sees rare earths prices hitting US$95 a kilogram over the long term, from US$80 currently. With Australia’s wealthiest, Gina Rinehart and Andrew Forrest, collectively tipping more than $200 million into the space in December, the two iron billionaires surely see huge profit potential in joining the net zero bandwagon.

One of Australia’s largest producers, Lynas Rare Earths (ASX: LYC), on Monday reported production of 4,457 tonnes of rare earths oxide during the fourth quarter of 2022, up from 3,500 tonnes in the previous period. 

And having splashed more than $600 million on an expanded production facility in Kalgoorlie, Western Australia, Lynas’ management is banking on further long-term price increases ahead.

Janus Henderson Investors’ Darko Kuzmanovic is confident the company is poised to reap big rewards in the coming years. The senior portfolio manager on Monday discussed his views on Lynas, revealing whether he rates the company a buy, hold or sell based on the latest quarterly result and digging into the detail behind its latest update.

Lynas shares closed at $9.71 on Monday 30 January, ending the day more than 6% higher before settling slightly to $9.50 at the open on Tuesday. The stock has gained 30% since the low of $7.33 on 28 September.

Note: This interview took place on Monday 30 January. The information below should not be considered financial advice. Investors should consult their own financial adviser before making any investment decision.

Daily share prices of Lynas vs the S&P/ASX 200 Materials index (XMJ) over 12 months (Source: Market Index)

Key results for Q2 FY2023

• Quarterly sales revenue of $232.7 million, up from $163.8 million in the previous period.

• Total real earths oxide production of 4,457 tonnes, up from 3,500 tonnes in the previous quarter.

• Closing cash and short-term deposits of $934.2 million, down from $1.02 billion in Q1 FY2023.

• Cash payments for CAPEX, exploration and development of $141.9 million, up from $97.8 million in the prior quarter.

Source: Market Index

What were the key takeaways from the Lynas result? What surprised you the most?

The bulk of the value in Lynas is in NdPr, the neodymium and praseodymium materials. But it was in the lower-value products where they added the most value, with pricing better for these as well. They've been working for a while trying to improve these products for different uses.

The main takeaways were price recovery, volume recovery, and therefore revenue. Volumes last quarter were impacted by access to water because they had some major pipeline issues, which all look to have been resolved.

What was the market’s reaction to this result? Was this an overreaction, an under-reaction or appropriate?

The stock price is marginally up, which I think is partly due to the result. The other reason is that Lynas is undertaking a major capital program in Kalgoorlie, where it’s building a new $600-odd million cracking and leaching facility. That seems to be on track to start up around the middle of the year, which is an optimistic target, but it's a target, nevertheless. The market is recognising this project is fully funded and that it's now just a matter of execution. As that draws closer, the market obviously regards that as a de-risking event.

The stock has already rallied from a multi-period low over the last few months, with the market responding to a couple of things. One is that production is obviously better and the other is that the sentiment for NdPr prices is improving. They took a big hit over the last six months but that's now improving, and the stock has been recovering. I wouldn't say the market reaction is overtly positive – it's in line with what has been delivered.

Would you buy, hold, or sell Lynas on the back of these results?

Rating: Buy

Given where the stock has been and where the underlying commodity prices and Lynas's production volumes are going – they're now targeting about 7,000 tonnes a year of NdPr – I'd say the stock is probably a buy. This is also based on the production rate and the positive news about expected construction completion dates and commissioning. On top of that, management is updating its licence in Malaysia at the end of March. I regard each of those aspects as positive and the stock is a buy on a six- to 12-month view.

What’s your outlook on Lynas and rare earths more broadly over 2023?

It's in the right space, as a producer of key raw materials for the EV transition. These rare earths are core to the production of magnets that are in increasingly high demand. On the earnings call, management indicated they believe demand will grow at 10% CAGR for the next five years, assuming there's no global recession. And I think that's a realistic assumption.

So, not only will price improve, we think, but they also have plans to materially increase production through these capital investment programs. Lynas is becoming a key player in a strategic resource that has growing demand, which I think is a good setup for the company. And it's not particularly expensive relative to the PE multiples at which it previously traded. There's no reason why it won't see multiple expansion as all of these things fall into place.

Are there any risks to this company and its sector that investors should be aware of given the current market environment?

One of the key risks is global economic activity. If we see a big slowdown, demand for these materials will obviously be impacted.

The other issue is that China, as a dominant producer of these materials, can adjust supply. If the price of NdPr increases significantly and impacts China's uptake rate over time, they have the ability to increase production. That's what caused the price to fall from around US$130 or US$140 a kilogram to the low 80s. But overall demand is growing so fast that I think this will become a secondary issue.

There's always the risk of capital blowouts because of this big Kalgoorlie project. But they've already increased the project cost of the last quarter, so I think a lot of that is already baked in. There is uncertainty but I think it's manageable.

The other uncertainty is around permitting, with the licence renewal in Malaysia. But I think Lynas has demonstrated over the last 10-odd years in the country that they're a solid operator and are delivering on what they've said they will, with no major environmental or other issues. But as always, until it's signed and approved, there's that level of uncertainty.

How much value are you seeing in the market right now? Are you excited or are you cautious about the market in general?

On resources more broadly, three months ago, the sector was cheap. If you look at BHP, Rio, and the other majors, they've already had a very good performance and are near all-time highs. So, I think they're probably reasonably fully priced. And looking at the market's forward estimates, for them to go materially higher, we need to see commodity price upgrades by analysts. I think that's going to happen because commodity prices have risen and in some cases are exceeding analyst forecasts.

But I think we need a bit more certainty and to get through the Chinese New Year. Then we'll see more clarity as to the strength of the Chinese and therefore the global recovery for commodity demand. Right now, many companies in the sector remain in a holding pattern because they're reasonably well-priced.

Overall, I'm reasonably optimistic but a little bit cautious because stocks have had a nice little pop. There's always that risk of a slight pullback, which probably would be a buy signal anyway. 

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Darko Kuzmanovic and the team invest in high-quality mining, energy and agriculture companies with the flexibility to invest across the supply chain, taking advantage of price shifts between upstream and downstream sectors and across industries. To learn more, visit the fund profile.