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Date : 28/02/2023

Lynas Rare Earths

ASX :

LYC

Market Cap : $7.69 Billion

Buy

52 Week Range : $7.28 - $11.59

Share Price : $7.97

The short-term volatility presents an opportunity for long-term investors. We recommend a 'Buy.'

Company Analysis

Lynas Rare Earths (ASX: LYC) has built up incredible momentum within the firm, reporting a strong profit for 1H23, following a record 1H22 and FY22 results. Market conditions were stable during the period, and demand for Lynas products remained strong during the half year.

Lynas saw an increase in sales revenue to $370.0m, up 18%. This contributed to a Net Profit Before Tax (NPBT) of $170.1m, an 8% increase on the 1H22. Underlying profits remained flat at $189m. This result was achieved despite significant production challenges due to water supply issues in the first quarter and the start of the second quarter and rapid cost increases, particularly for chemical inputs.


Source: LYC

Production Rebounded in Q2

These operational hiccups from Q1 are now behind Lynas, evidenced by Q2 operations rebounding. The water supply issues were resolved in October 2022, allowing strong production during the December quarter. Lynas’ production volumes were higher in 1H23 compared to the prior corresponding period despite the effects of water supply issues. This is the result of particularly strong production volumes late in the half year.

The average China domestic price of NdPr decreased from US$124.0/kg in June 2022 to US$87.0/kg in December 2022. The good product mix and the good price obtained for SEG and new La-Ce speciality products improved the average selling price despite market pricing remaining flat until early December.

Lynas has an excellent reputation as a reliable supplier of quality products. Lynas has focused on developing strong customer relationships with strategic customers, primarily outside China. Lynas is the leading supplier of the NdPr family of products to the Japanese market. Demand from key customers has consistently increased over the past few years, with accelerated growth in the past 12 months.

The demand for the company’s products, particularly for the NdPr product family, remained strong throughout the period. However, there was an increase in the cost of sales has been driven by an increase in chemical prices, utility tariff rates, employee costs, and royalty costs.

Two Reasons why the Lynas share price is under pressure

The headwinds ensured Lynas’ result was slightly below consensus. Markets had priced $397m in revenues and $200m in underlying profit. This weighed on the share price following the result. However, with operations already back on track from Q2, the slight miss in earnings is not the biggest concern for investors.

The LYC share price has been under pressure lately due to license renewal issues in Malaysia. This began earlier this month, and Lynas is now bracing for possible supply issues from Malaysia. Lynas received notice from the Department of Atomic Energy that the Atomic Energy Licensing Board (AELB) prohibits importing and processing lanthanide concentrate after 1 July 2023. Malaysia opted to outlaw cracking and leaching of rare earth mined in WA on its shores despite lobbying from Australia, the US, Japan, and the European Union to give Lynas more leeway given the importance of rare earths materials in electrification, electronics and defence applications. However, the fact that the process leaves behind traces of low-level radioactive residue has led Malaysia to take this step.

Lynas is now building up inventory ahead of the ban as a complete shift of its Malaysian operations to its Kalgoorlie facility is not possible by July 2023. Lynas says that its inventory should assist in meeting key customer requirements during any transition period.

Lynas is Progressing Well on All Fronts

Construction activity on Lynas’ Kalgoorlie Rare Earths Processing Facility accelerated during the half year. Recruitment of the Facility’s operational leadership team is complete and focused on completing construction and preparations for commissioning and ramp-up. Feed on at the Kalgoorlie Rare Earth Processing Facility is targeted for Q4 FY23.

The Kalgoorlie Facility is important for business continuity as well as growth. Its importance is now even more pronounced, given the events in Malaysia. All other activities in Malaysia will go ahead as usual. Therefore, construction is underway on facilities to receive the mixed rare earth carbonate (MREC) feedstock from the Kalgoorlie Facility and the equipment needed to integrate the new facilities with downstream processes at the Lynas Malaysia plant.

The Mt Weld Expansion Project is progressing well, including Detailed Engineering Design, procurement of long lead time items and award of packages. The bulk earthworks contractor mobilised in January and has commenced site works.

Applications for the two major environmental approvals for the project have been submitted, and subject to relevant regulatory and stakeholder approvals, full operation is planned for 2024. Lynas continues to progress with its deliverables under the previously announced contracts for developing a U.S. Rare Earths separation facility. A proposed site in an existing industrial area on the Gulf Coast of Texas has been identified, and the activities associated with site acquisition are nearing completion.

Outlook & Valuation

The Lynas 2025 plan is going to schedule. The strategy will see the company’s production go from 7,000 tonnes annually to 12,000 tonnes. Rare earth prices should remain well supported despite a recessionary backdrop due to its critical nature, particularly among Western Governments. Lynas also has a strong balance sheet with a cash balance of $934.2m.

Given that Lynas’ productions are ramping up amid favourable rare earth pricing and strong demand from Lynas’ customers, market expectations are high. For FY23, the mean consensus forecast for revenue is $938 million. Over the next 5 years, Lynas is expected to grow its revenues steadily to $2.4 billion. Markets have also priced in EBITDA of $538 million and an EPS of $0.47 a share for full-year FY23.

While Lynas did not provide guidance, it’s important to note that Lynas has a history of being transparent to its shareholders. Therefore, while the hiccup in Malaysia is not ideal, the company has added that they are boosting inventory to mitigate any production impact as Lynas gears up to move its cracking and leaching operations to its Kalgoorlie facility.

Valuations also show that Lynas is not trading at exorbitant multiples. LYC shares are currently priced at 17x FY23 P/E and just 9.5x FY25 P/E. With the Lynas 2025 strategy in place and favourable rare earth prices expected to continue in the short and medium term, the estimates should be achievable for Lynas.

Technically, LYC’s share price continues to consolidate in the range of $7.30 to $10.00 (the two horizontal lines on the chart). As such, we think prices near the bottom of the range at $7.30 are attractive for new buyers. Short-term traders can take profits next time the share price gets closer to the top of the range at $10.00, and stop their losses in the case of a confirmed break below the bottom of the range at $7.30. We recommend long-term investors remain exposed to LYC shares and collect dividends in the next couple of years as the company ramps up production and increases its free cash flow.

Recommendation

Lynas’ 1H23 results were mixed. The first quarter was spent mitigating the water supply issue in Malaysia, which reduced production. However, production has recovered in Q2, and Lynas is back on track. The company is tracking well on all fronts in its ‘Lynas 2025’ strategy, and production is set to significantly ramp up in the medium to long term. This will yield considerable free cash flow and open up the potential for a dividend policy.

In the short term, Lynas shares are under pressure as there are licensing headwinds arising out of Malaysia. However, Lynas is expected to mitigate production impacts by stockpiling inventory prior to the ban and then moving its affected operation to its Kalgoorlie facility. We think the price volatility is an opportunity for long-term investors and reiterate our ‘Buy‘ recommendation.

 

 

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