Rare Earth Metals: Impending Supply Squeeze

So we’ve all heard a lot about short squeezes in the stock market recently. In this post, I want to look at a different type of squeeze. I want to look at the supply squeeze occurring in the market for Rare Earth Metals and which stock I think has most the gain from it.

The Basics

If you haven’t read my earlier post on Rare Earth Metals, here’s a refresher on what they are.

Rare Earth Metals (REM’s) are a series of metallic elements which have special properties; such as making great magnets or being heat resistant. They are not hard to mine (like Gold or Silver) but doing so profitably is very difficult because they are spread out along the earth’s crust.

Rare Earth Metals

The two most REM’s elements here are Nd and Pr. These are used to make magnets which power the batteries and motors used for Electric Vehicles (EV’s) and Climate Change Technologies (e.g. Wind Turbines). These also happen to be the two fastest growing end user markets.

Whats the big deal?

What makes Nd and Pr so important is that they are critical components of the products they produce.  The technologies they are used in are very settled, especially the motors which are used in EV’s.

EV Technologies by producer

Above is an overview of the different EV technologies used by car manufacturers. What is apparent is that regardless of producer, the motorization technology is the same, and to produce these components, Nd, Pr are essential.

There is no known alternative to these elements existing in the world today so these are clearly very important components of our lives.

The Problem

There are two fundamental problems here and in both cases investors have a chance to profit.

PROBLEM 1: THE SUPPLY SQUEEZE

The first problem is that demand is outpacing supply, at a considerable rate. You just need to look at EV policies across the globe to realise the scale of the problem. Nearly every major economy in the world has announced some form of EV push to combat climate change and EV vehicle penetration is going to continue to climb as we can see from the below.

EV Policies Overview
EV Growth

If we overlay the demand forecasts for Nd Pr for the EV market, REM supply will not even meet 50% of the forecasted demand for this in the next 10-15 years. This is before demand for Nd Pr from other sectors like wind turbines or smartphones.

This is the hallmark sign of an impending supply squeeze.

PROBLEM 2: EAST VERSUS WEST

The Second problem is that whilst their demand is global, the supply of REM’s is not.

85% of the World’s supply of REM is in China as the Chinese government has made a concerted effort to increase production and relax regulation (through various means).

This is not supposed to be a politically charged article but I think we can all agree that having so much supply concentrated in another country is problematic. What happens if there’s a trade dispute? Or a military conflict? China can and has banned exports to countries like Japan before, and this can severely disrupt supply chains. Just see the price chart of the last squeeze below.

The Trade

The solution is actually quite simple – we need more production and we need that to be in the western hemisphere. As of today, there is only one company operating in this space and that is MP Materials (ticker MP).

Why I like MP Materials Stock?

There are three things I like about MP Materials.

1) MP has a dedicated plan to shore up US manufacturing capabilities

MP has a three stage approach to shoring up US production.

Three Steps to increase US Production

The first stage of MP’s plan is to specialize in Rare Earth Concentrates production. This is the naturally produced concentrate of REM’s. MP has already completed this stage of their plan and they now produce around 15% of the world’s consumption of these REM’s. This is considerably more than what has been achieved at this mine in the past (particularly under previous management, Molycorp).

Stage 1 has been a remarkable success

The second part of MP’s plan is to process this concentrate into refined metals. They are on track to create an onsite refining of REMs in 2022. This will allow MP to be integrated further down the value chain (and ultimately less dependent on China). This is the most important stage for me and I’m optimistic this will be completed on time, as it has the backing of the Department of Defense and is fully funded.

The final stage is to further integrate downstream and to produce the magnets used to make EV Power Trains; also expected to be the fastest downstream market. This would allow MP to sell directly to companies such as Tesla and transition from mining into manufacturing.

2) MP operates in a sector with extremely high barriers to entry

The second thing about this business is that MP’s competitors are significantly behind as they have high barriers to entry. As we can see below, as MP meets Stage II of expansion, it will be at least one year ahead of competition and far cheaper than new Greenfield Sites opening in the US (with uncertain timing).

MP has a natural monopoly in the REM Market outside of China

3) Very strong Financial Position

Finally, I like this business because it has a very promising set of financials. MP forecasts strong growth in revenues as the company expands into refining/end user products. These products also come with higher gross margins of close to 60%. Meanwhile, the capex to fund this associated production will have already been put up by 2021, leaving sizeable Free Cash Flows for investors. Ultimately, this means more Revenues, Cash Flows and EBITDA (projections below).

Conclusion:

MP is doing everything right for me. The REM market is due a serious supply squeeze in the western hemisphere and is vastly under exploited. The only way to publically invest in this space is via MP which is already targeting production growth and will remain ahead of its competitors in a market with huge barriers to entry. Despite very exciting future prospects, the company is still only trading at 13x forecasted 2023 Sales which I think is a good entry point for new investors.

Verdict: Extremely Bullish
Timeframe: 5+ Years

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