Equity Analysis Sample

The rare earth industry primarily produces 17 chemical elements that are critical for producing rechargeable batteries, magnets, computers, cell phones, wind turbines, catalytic converters, military products, and many more. The rare earth supply chain is highly complex and it involves the mining of rare earth elements and then processing them.  The rare earth deposits are concentrated in a few countries. China has around 37% of the world's rare earth deposits, followed by Brazil with 18% and Russia with 15% deposits. The global rare earth production is also dominated by China as can be seen in figure 2. It is followed by Australia with only 7.9% and the US with 3.2%.

As seen above, China controls around 83% of the world supply of rare earths elements. The producers from China are supplying these elements at very low prices and these prices are around 75-80% less than the prices offered by other countries (Daly 2019).  The rare earth is an essential raw material for many new technologies and China has used its control over its supply to its advantage. The concentration of rare earth supply in China has the other nations vulnerable as it is critical manufacturing raw material. The Chinese government has used its control over global rare earth elements to force the manufacturers around the world to move their manufacturing to China by imposing restrictions on exports a few years ago (BBC 2020).  However, on the intervention from WTO, China opened these exports. The ongoing trade world between China and the United States has attracted Chinese restrictions and fixed quotas on the export of these rare earth elements to the US (Amadeo 2020).  The Chinese restrictions and quotas have forced the world to look for other sources of rare earth elements located outside China (Kalantzakos 2018). The recycling of electronic waste is growing around the world as it is also a source of rare earths elements.

2.1 Key players

The global rare earth market size was UDS 2.80 billion in 2018 and it is expected to grow at a CAGR of 10.4% from 2020 to 2025 (Daly 2019).  The production of rare earth elements involves mining as well as processing. The industry is led by Chinese state-owned producers. It's Inner Mongolia Baotou Steel Rare-Earth Hi-Tech Company owns more than % supply of rare earth elements from China. Lynas corporation owns the richest deposits of rare earths and is a significant industry player outside China. The company currently has two projects- Mt Weld mine in Western Australia and the Rare earths processing plant in Kuantan Malaysia. Avalon Advanced Materials Inc. is a Canadian company with the Thor lake project that has the second largest rare element deposit. Molycorp is an important rare earth producer from the US with its mining facility at Mt Pass mine and processing facility in California. Other significant players operating outside China are Greenland Minerals ltd and Iluka resource ltd.

2.2 Lynas position

Lynas holds a unique position in the global supply being the significant producer of rare earth operating outside China. The company produces the most commonly used rare earth elements including- Cerium, neodymium, lanthanum, praseodymium, yttrium, and dysprosium. The demand for the company’s products is largely driven by magnet manufacturing and the automotive industry. Cerium is the most commonly used rare earth element that is used in the catalytic convertors of vehicles, while neodymium & praseodymium are used in the development of rechargeable batteries (Kalantzakos 2018). The company is known for its high-quality rare-earth elements. The company invested in sustainable operations with green approvals in place. Its operations in Malaysia result in low-level radioactive waste which the company stores and reusing various processing by-products for agricultural purposes. The rare element industry faced a huge market threat from cheap imports from China, but the Lynas corporation has been able to survive it through debt restructuring and improved operations. The company has gained significance due to its unique position in the industry. The company has benefited from the increased trade restrictions from China on rare earth and negative market sentiment against China. It is considered an effective alternative source to China my developed nations especially for their requirements in the defence sector.

2.3 Industry Barriers

The rare earth industry has quite high entry barriers which make it very challenging for any new player to enter this industry. It is a highly complex industry with the expertise required in the mining and processing of rare earth elements. The mining process creates various negative implications for society as well as the environment (Kaiman 2014). Rather many developed nations have banned mining activities considering its environmental impact. Thus, mining is a significant challenge for any new player that plans to enter this industry. Another significant barrier for new entrants is the access to the capital. The mining projects and processing plants require huge investments (Kalantzakos 2018). It requires huge capital outlays in the projects that may take quite a long time to yield revenues. The rare earth projects also suffer from political risks as the mines are allocated by the government and are highly regulated (Kaiman 2014). Additionally, the metals and elements required a certain level of quality that a company can manage to attain through experience. The existing companies have established over a long period and have economies of scale which also discourages the new players from entering this industry.

3.0 Going long where China is Ultra-long

The quote made by Andrew claims that the businesses should not compete with China in the areas where it has strong strengths. In reference to the given case, Curtis decided to develop a rare earth mine in 2002 was a contrarian decision. During that time 95% of the supply of rare earth elements was controlled by China. The rare earth elements (REE) became a priority for China during the early 1990s and the state-owned enterprises developed economies and dominance in the industry (Howanietz 2018). Lynas was established as an alternative to China’s rare earth supply.  The company benefited in initial years as China slashed rare earth exports by fixing export quotas.  The prices for REE increased as much as 13 times. The Lynas stock jumped even before starting production as investors look for a secured supply of rare earth elements. The dominance over rare earth made the industry unsustainable.  It encouraged the nations to search for alternatives to China for the supply of REE. This leads to the rise in the stock price of Lynas even before it started production. However, the initial price rise in 2011, the stock price of Lynas move downwards due to various strategies as well as market issues (Mickleboro 2020). Establishing the processing plant meant a significant cost for the Lynas.  The company spent more than AUD 1 billion in its construction by 2013. Additionally, the company faced a strong backlash from society as well as the government due to its negative environmental impact on its project. The company invested further to minimise its environmental impact and gains approvals. Over the years, the cost of Lynas operations went on increasing and was double than its revenues due to which its share was at $0.07 in May 2016. Apart from increasing costs the company also suffered due to falling REE prices. After the interference of WTO, China removed the export restrictions from rare earth elements(REE) resulting in an increased supply of REE and a fall in their prices in 2015 (Dixit, 2015). This added to the woes of already struggling Lynas and its share came down in 2015. The increased volumes of REE, with lower global prices, and competition from China made it economically unviable for Lynas to operate. Thus, during these times Lynas felt that Andrew’s quote was right and it did a wrong thing by going against China.

3.1 Sino-US geological issues

Both the US and China are the two most powerful economies of the world are involved in sour trade relations. The relationship between two nations with contrary political ideologies has become negative in recent years. The geopolitical issues between the two nations have become the paradigm of international relationships during the last two years. The geopolitical issues between the two nations are largely a competition over power, threat perceptions, and politics (Rogers, J, Stringer, D, and Ritchie, M 2019).  The rivalry between the two nations has multiple aspects including- political, economic, and technological. Since 2017, with the economic growth of China, it has been regarded as a strategic competitor by the US government. The US considers the growing Chinese influence in international relations to be a threat. Additionally, the United States is having a trade deficient with China which has motivated the country to impose trade tariffs on Chinese exports. The low-price Chinese goods have dominated the American markets from the past decade. However, in recent years, President Donald Trump began imposing tariffs on Chinese goods to make them unattractive and protect the local industry. These tariffs have ignited the trade war between the two nations as China also reacted by applying quotas to the essential exports to the US (Kalantzakos 2018). Both the countries have imposed tariffs on different goods they import from each other. The US argues that China follows unfair trading practices and intellectual property theft. While China claims that the US is trying to curb the rise of China as a global economic power. Both the countries were in discussion and even reached an agreement last year but the pandemic sharpened the cold war between the two countries.

The pandemic has hit the global economies and all the countries are suffering due to it. The pandemic was started in China and then spread to the whole world. It has tarnished the image of China as they failed to control the virus and let is spiral out to become a global disaster (Amadeo 2020). Rather many politicians in the west have termed the virus as “Chinese virus”.  The COVID-19 has made many countries rethink their existing economic relations with China. The resentment has led many western countries to move their supply chain out of China. This has largely benefited companies like Lynas that use to face strong competition from China. Lynas is the only significant producer of rare earth outside China due to which it has attracted many new contracts such as DoD. Thus, it can be said that Andrew’s quote proved to be wrong in recent times when huge geopolitical issues are existing between the United States and China. Additionally, many nations have turned against China in light of the new pandemic. And after the COVID-19 pandemic, nations are looking for an REE supply that is not dependent upon China.

4.0 Buy Recommendation for Lynas Corporation

We provide a buy rating for the stock of Lynas Corporation for the medium term as the Aussie miner is likely to reap benefit from the current geopolitical tensions.  Lynas is the fully integrated producer of rare earth elements that are used in computers, electric vehicles, magnets, batteries, medical devices, and military equipment. It is the world’s largest producer of rare earth elements outside China. The company possesses a significant rare earth element mine, Mt Weld, in Western Australia and a processing plant in Malaysia (Chanticleer 2020).

Increasing Supply gap

The demand for rare earth elements (REE) is likely to grow post-COVID-19 as it is an essential component in the development of magnets, batteries, and many other products. The global demand for rare earth is forecasted to increase as it is an essential input in the new age technologies. As the countries move towards sustainable development the demand for rare earth rises due to the increased demand for electric vehicles and solar energy. China holds around 85% of the global rare earth supply chain. In recent years it has been observed that China is withdrawing its REE exports to promote its domestic industry. As China withdraws its rare earth exports its prices have also become sustainable for other competitors. For instance, prices for neodymium-praseodymium (NdPr) have increased by 40 %over the past 60 days. However, the current geopolitical trends are expected to remain for the next few years.

Lynas corporation is in a unique position to benefit from the rising demand for rare earth elements as it is the only significant producer of rare earth outside China. Lynas possess the capabilities in exploring, mining, and processing rare earth minerals that are essential for developing new technologies. The developing capabilities in rare earth materials require a lot of investments as well as time. Lynas has managed to develop the same over the last decade. The company possesses economies of scale and operational efficiency. Over the short-term, it is very difficult for a rare earth manufacturer outside China to be able to compete with Lynas corporation. The strengthening of prices and the rise in demand for non-Chinese sources offers a positive outlook for Lynas corporation who started its processing plant in Malaysia some time ago.

Trade war between US-China

In current times of trade was between US-China, not only the US but also other developed countries are looking for supply chain outside China for sustainability. Furthermore, COVID-19 has tarnished the image of China as a dependable supplier. Lynas has managed to attract the US as well as other nations for rare earth supplies. In July, the company managed to secure the development contract of the processing of rare earth by the department of defense of the US. It is a prestigious contract that highlights that the Lynas is only a significant rare earth supplier outside China.

As China restricts its rare earth exports in response to US tariffs it has become a blessing in disguise for rare earth producers like Lynas corporation. The global demand for rare earth is forecasted to increase as it is an essential input in the new age technologies. The company’s association with the defense department of the US is likely to be a big payoff.

Key takeaway

Lynas may be vulnerable to the existing short term volatility in the market but is a good bet for the medium term. However, it holds a significant position in the rare earth industry and will play a crucial role in meeting the supply from increasing demand for electric vehicles and renewable batteries.

References

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