The only thing rarer than a rare earth metal is a cheap rare earth stock.

With all the hype surrounding rare earths we suggest a long position in Neo Materials Technologies Inc (NEM.TO).  Unlike REE and MCP which have no current operations nor earnings, NEM is trading at less than 10x our estimated run rate EPS, on $320m revenue ($90m Ebitda), has ~$55m of net cash on its balance sheet ($.45/share) and has been buying back its own stock. For a more detailed background on NEM's business model we refer you the November 2006 VIC write-up by miser861.

For those not following the geometric pricing growth in rare earths due to China's reduced export quota's, we have outlined below some price moves:

NEM produces and processes rare earth materials used in smartphones, electronics, optical lenses and various solar components.  NEM operates two divisions:

AMR - this division sells rare earths and certain rare earth finished goods.  AMR purchases rare earth concentrate in China and processes it into separate rare earth components.  In China, it is the export license that is 'rare' not the rare earths and AMR is a licensed exporter under Chinese quota laws (however, the process from concentrate to rare earth is itself complex - which could delay the production of rare earths from any start-up mines).  AMR derives ~25% of its revenues by selling rare earths to customers outside China, where pricing has skyrocketed and should boost company profits.  We believe this could add ~$.10/share in run rate EPS from the current $.50/share level with additional opportunities mentioned below. 

Magnequench - this division makes Neodymium (Nd on the table of elements) into neo magnets.  Neo magnets are crucial for hard disk drives, electronic motors (think Prius), and other electronics. Chinese overproduction of rare earths allowed neodymium (and other rare earths) to become staples in everyday products; hence, many customers are now committed to using neo magnets and cannot easily switch to alternatives.  Magnequench purchases Neodymium from its AMR division and while prices have risen, Magnequench has been able to pass higher cost (75-100%) onto customers.  While the cost recovery tends to lag, we have seen numerous price increases this year and expect to see another in Q4.

The tightened quota and higher rare earth pricing will lead to stronger earnings - we believe NEM could report Q3 EPS of $.15/share going toward $.20/share per quarter in 2011.  The sell side is currently at $.12/share and we expect they may raise estimates before the company announces Q3 earnings in early November.  Additionally, NEM has the opportunity to gain new customers as they have finished goods facilities in China that are not subject to quotas whereas certain competitors only finish goods in Europe. 

Finally, the market is giving NEM no credit for its strategic relationship with a Brazilian mine that has discovered rare earths. NEM thinks the mine could wean them off its dependence from China and eventually supply much of its rare earth needs.  News from Brazil has been encouraging and management should give an update on its next conference call.  NEM could receive rare earths from the mine as early as late 2011.

In summary, we believe NEM is a rare, profitable Rare Earth's company which should benefit from the tightness in the rare earth market.  NEM easily deserves a 11-12x multiple on 2011E EPS of ~$.70/share.  This plus credit for their cash would create a $8-9 stock.  However, a move to $15 is possible if the REE/MCP crowd discovers NEM and begins to extrapolate future growth or gives them credit for its relationship with the Brazilian mine.