MP Supplies: Flawless Execution And A Brilliant Future (NYSE:MP)

Funding Thesis

After falling 46.54% over the previous 12 months, MP Supplies (NYSE:MP) is undervalued. By changing into vertically built-in they may have the ability to higher serve their prospects and enhance working margins. As well as, present and future provide agreements and authorities help considerably scale back the enterprise danger historically related to commodity firms.

Vertical Integration

In an effort to develop their enterprise and obtain greater margins, MP Supplies has carried out a vertical integration plan that spans a number of years. They discuss with the steps of their plan as “Stage II” and Stage “III”.

In accordance with MP Materials’s most recent 10-Q, Stage II will “reintroduce the oxidizing roasting step which is able to enable MP Supplies to capitalize on the inherent benefits of the bastnaesite ore at Mountain Move, which is uniquely appropriate to low-cost refining by selectively eliminating the necessity to carry lower-value cerium by way of the separation course of”. Stage II will assist them streamline their operations at Mountain Move.

Stage III entails the development of their uncommon earth steel, alloy, and magnet manufacturing facility. They are going to have the ability to use this facility to raised serve their home prospects and broaden margins. Lowering reliance on China can also be a constructive of changing into vertically built-in within the US as by constructing their very own facility MP Supplies reduces the danger of being lower off from processing and refining capabilities.

Q3 earnings revealed the progress of stage II and III. “We reached a significant milestone by starting the commissioning of our Stage II property beginning with the focus drying and roasting circuits. We additionally accomplished the constructing shell of our Stage III magnetics facility in simply seven months,” mentioned MP Supplies Chairman and CEO, James H. Litinsky.

The completion of those steps will enable MP Supplies to create considerably extra worth within the provide chain and enhance income accordingly. They will even have the ability to broaden working margins due to their elevated measurement and by having the ability to carry out manufacturing actions in home as a substitute of paying corporations that they used to export uncooked supplies to.

A serious danger to their vertical integration plans is that if they’re unable to fund the required capital expenditures. Fortuitously, MP Supplies has a powerful monetary place.

Enough Sources to Fund Enlargement

MP Supplies is greater than adequately capitalized to fund their enlargement plans and have a fortress-like stability sheet.

We are able to see that they’ve money, money equivalents, and short-term investments that greater than cowl their complete liabilities. Their debt is comprised of 0.25% fee convertible notes due April 1, 2026. The strike for these converts is $44.28.

Their large money hoard and the character of the debt permits MP Supplies to freely spend money on their operations and enhance capex. In a worst-case situation the place MP Supplies is unable to well timed ramp their stage II and stage III operations, they may possible have the ability to faucet the bond markets once more with out a lot hassle as a result of systemically necessary nature of their enterprise.

Provide Agreements and Authorities Assist

In 2021, Common Motors Firm (GM) and MP Supplies entered a long-term supply agreement.

In 2022, MP Supplies began construction on their Texas uncommon earth magnetics manufacturing facility and finalized their settlement to supply GM with uncommon earth alloys and magnets.

These agreements had been made with the aim of making a totally built-in US provide chain for uncommon earths. Different firms will wish to be sure that they’ve provide of those metals in case China decides to cease exporting them to the US and can possible signal provide agreements with MP Supplies. The corporate ought to have the ability to use their leverage and signal long-term contracts that lock consumers in on pricing and amount. If provide agreements will be structured this fashion, it will give MP Supplies predictable money flows and fewer danger of getting hammered by value declines.

The US authorities has supported MP Supplies each straight with a $35 million contract, and not directly by way of the passage of the Inflation Discount Act. The potential demand increase supplied by the Inflation Discount Act is a close to time period catalyst that might trigger the value of uncommon earths to achieve new highs. As firms start to consider what this laws means for his or her long-term enterprise plans and will trigger them to hurry out and purchase the supplies they want or lock in future provide. This rush to safe uncommon earths (particularly from a home supply) may trigger the value to extend earlier than new provide can attain the market.

The elevated adoption of “inexperienced” vitality requires uncommon earth metals (amongst others), and demand can simply run above provide for years to come back if governments hold introducing environmentally pleasant laws.

MP Supplies has a possibility to place themselves as “too necessary to fail”. Their aim is to construct out your complete uncommon earth mining and processing provide chain. The US authorities doesn’t wish to depend on exporting uncooked materials to China anymore, and corporations wish to safe future provide. Changing into crucial to nationwide safety is necessary as a result of the mining sector is historically uncovered to sizeable growth and bust cycles. By profiting from long-term provide contracts and authorities help MP Supplies is ready to considerably de-risk their firm.

Monetary Efficiency

MP Supplies reported their Q3 earnings on November 3. Their income got here in at $124.4 million and earnings got here in at $0.33 per share on a diluted GAAP foundation. They confirmed rising working leverage of their enterprise mannequin, with income rising 25% 12 months over 12 months and internet revenue rising by 48% over the identical timeframe.

On a year-over-year foundation the outcomes seemed good. The issue is that numbers had been down throughout the board in comparison with Q2, largely as a result of a decline in realized costs.

The corporate appears to be executing properly relating to elements which might be inside their management, and we consider that traders ought to look previous close to time period pricing declines.

Inventory Efficiency

The inventory was down 46.54% in 2022 in comparison with the SPY’s decline of 18.17%. The inventory fell a whopping 26.98% in December because the broader market offered off and recession fears grew stronger. Traders have additionally been forecasting a decline within the value of uncommon earths, which is hindering the inventory within the brief time period.

Valuation

MP Supplies at present trades at a ahead PE a number of of 18.59 as a result of an anticipated decline in realized costs for uncommon earths. The ahead PE of the S&P 500 supplies sector is 16.1. Aluminum, copper, and metal firms are a greater comparability to MP Supplies than the supplies sector at giant as a result of aluminum, copper, metal, and uncommon earths are all metals required to gas the “inexperienced vitality transition”. We are able to see these ahead PEs within the chart under.

On the finish of the day, MP Supplies sells a commodity. They’re positioning themselves to be strategically necessary and are in search of to create extra worth within the provide chain, rising margins and lowering typical commodity danger. We consider that as a result of MP Supplies’ distinctive state of affairs they need to commerce at a premium to different supplies firms. A ahead PE a number of of 21.5 appears greater than affordable, bringing it in step with the typical for copper miners.

Uncommon earths have a much less excessive growth/bust cycle than copper, so it’s attainable that the market rewards MP Supplies with a fair greater a number of than 21.5, particularly if they’ll proceed their margin enlargement and earnings progress. The market may additionally give MP Supplies a premium valuation if traders view them as a play on the “inexperienced vitality transition”. A ahead a number of of 21.5 costs MP Supplies inventory at $28.16, which is roughly a 16.84% enhance from these ranges. That is primarily based on modest expectations for earnings.

Costs for uncommon earths might not decline as a lot as feared. MP Supplies would possibly do an excellent job of retaining enter prices beneath management regardless of the inflationary atmosphere. Because of this, MP Supplies has quite a lot of potential upside if issues go proper, and never a lot draw back if issues go unsuitable due to the character of their enterprise and the way necessary they’re changing into to the US provide chain. It wouldn’t shock us for the inventory value to hit $40 this 12 months if the whole lot goes proper, however we’d fairly be cautious and see how the macroeconomic atmosphere develops and if the corporate can proceed their robust execution.

Dangers/Negatives

MP Supplies could also be compelled to refinance their present debt at a lot greater charges. This could damage margins and enhance the danger of a enterprise failure. They could not have sufficient money to finance their enlargement plans and must borrow extra complete debt. Traders ought to control how MP Supplies’ debt is priced by the bond market to gauge the chance of debt points down the highway.

As a result of nature of the business, commodity firms will be required to speculate some huge cash into their operations. A excessive quantity of ongoing capex will lower the free money circulation obtainable to fairness holders. Because of this, many commodity firms seem cheaper than they are surely, and their ranges of capex are value maintaining a tally of.

MP Supplies has some possession traits that might change into problematic. JHL Capital Group, QVT Monetary LP, and Shenghe Sources collectively personal numerous shares as a result of their roles in creating the entity that may finally change into MP Supplies. JHL Capital and QVT Monetary are institutional traders and in the event that they determined to abruptly promote their place it will put strain on the inventory and might be seen by the market as a lack of confidence within the firm. Shenghe’s possession of MP Supplies may result in an opposed battle of curiosity state of affairs of their enterprise dealings with the corporate. CEO James Litinsky is a significant shareholder and can also be the founding father of JHL Capital. If he resigns or begins to promote inventory it may spook the market, even when he was doing so for a cause unrelated to the well being of the corporate.

Shenghe refines and processes uncommon earths for MP Supplies, and consequently accounted for the overwhelming majority of gross sales as of Q3 2022.

This gross sales relationship is printed of their most up-to-date 10-Q:

I’d encourage everybody to go and browse “Word 3—Relationship and Agreements with Shenghe” within the doc because it describes the earlier business settlement and the brand new “Offtake Settlement”. An important factor to know is the present association between the businesses which will be discovered under:

Whereas this isn’t too out of the strange for a mining firm, this gross sales relationship is barely regarding due to the associated nature of the events. That is extra of one thing for traders to control fairly than a present detraction from the bull case for the corporate.

Conclusion

We consider that MP Supplies is at present undervalued and that it ought to commerce at a ahead a number of of 21.5x PE. This means a price for the inventory of $28.16, which is roughly a 16.84% enhance from these ranges.

MP Supplies has executed flawlessly up so far, they usually have a number of tailwinds that time to a brilliant future. Whereas there are actually dangers to the bull case, we consider that the risk-reward is favorable presently. The corporate has the potential to meaningfully exceed analyst forecasts for earnings within the coming years, so there may be appreciable upside potential past our conservative estimates.

Regardless of the reasonable upside we see within the shares, they symbolize a great way to diversify a portfolio, particularly for traders which have historically shunned commodity firms due to their punishing growth/bust nature. Traders may additionally view MP Supplies as a strategy to play the “inexperienced vitality transition” so this might be an excellent choose for ESG traders as properly.