"Attractive": Neo Material Technologies

In keeping with my philosophy of investing only in "good" companies with strong balance sheet and solid free cash flow generation, I came up with Neo Material Technologies (ticker: NEM in Toronto, market cap of $149 million @ $1.22/share). Their website is here. Neo is a producer of high-quality rare earth and magnetic powders that are essential in the manufacture of many high-tech products.

The company is an intermediary between the mining company and the manufacturers. It buys rare earths mineral concentrates in China and separates the individual elements, which are then sold. Some of the processes used by Neo are protected by patents (expiring in 2014) and as such, the company enjoys a very high market share in some of its markets. For example, the company sells 80% of the "neo powders" sold worldwide. Neo powder is used to make very strong magnets. Neo's products are essential to the manufacture of various high tech products including: micro motors, computers, optical lenses, mobile phones, display panels and electronic chips. Some of Neo's clients include: Daido, Epson, Panasonic, Hitachi, BASF, Philips, Samsung, Canon, and 3M. Not bad for a small company.

Why invest in rare earths? Rare earths are part of the Minor Metals group, which got its name from the fact that these metals were initially considered of minor industrial importance as compared to Major Metals (iron, lead, copper, etc.). I believe that we have entered a new age: the Age of the Minor Metals. We went through the Stone Age, the Bronze Age, the Iron Age and now we are in the Age of the Minor Metals. Minor metals are essential to our high tech world. While the quantity of minor metals produced will be dwarfed by the quantity of copper, zinc, .... produced , the importance of minor metals should not be underestimated. No minor metals = no iPhone and no flat screen TV.

I believe that, while the cyclical forces currently affecting the global economy will hurt Neo, the secular trend is for continued growth. As such, the current environment could enable us to get a good company at a great price.

At the end of the last reported quarter, Neo had a net cash position of about $32 million (that's $0.27 per share on a fully diluted basis) and the company was generating cash from its operations. In the last 4 quarters, the company reported earnings of $0.30/share and as such, it is trading at 3x to 4x trailing EPS, depending on how you adjust for the net cash. This does not look very expensive but earnings will likely be lower going forward due to the recession. So in the short term, Neo's financial results should be less than inspiring, however, this represents an opportunity for investors with a longer term view.

One of the risks with Neo is that the company relies on Chinese mining companies for its concentrates. China dominates the world's production of rare earths and therefore, it is not surprising that Neo uses Chinese suppliers. As Chinese internal demand for rare earths increases, it is possible that the Chinese government will erect export barriers, making more difficult for Neo to supply its clients. It is something to watch.

Of note, Pala Investments, owner of about 20% of Neo's share outstanding, has announced its intention to bid for up to 23 million Neo shares (representing about 20% of shares outstanding) at $1.40. For the flippers out there, you can buy Neo today at $1.22 and sell your shares to Pala Investments for $1.40 for a quick 15% profit. Sounds good but there is a risk. Neo has a poison pill provision, which states that 50% of the independent shares must be tendered in order for the proposed bid to proceed. Pala has asked Neo's Board of Directors to waive this provision to allow the bid to proceed. I have not insight on what the Board will do but if it waives the provision, the shares should climb quickly to near $1.40 while if the provision is not waived, the stock could go down to where it was before the bid, which is below $1.10.

Pala, a long term investor in Neo, sees value in the company and is, in my view, being opportunistic. As a long term investor, I also see value in Neo and I think that 2009 should offer a very attractive entry point.

CSC

Note: Do your own due dilligence. I am Evil.

Fertilizing your Portfolio: Migao Corporation

If you want to invest in the fertilizing business in Canada, you have a few large cap choices: Potash Corp. (POT-t, market cap: $26.7 billion) or Agrium In.c (AGU-t, market cap: $6.3 billion). You may not know that you also have small cap fertilizer companies that are investable: Hanfeng Evergreen (HF-t, market cap: $338 million) and Migao Corp. (MGO-t, market cap: $231 million). I am particularly interested in Migao because it is a specialty fertilizer company that sells to Chinese tobacco and fruit/vegetable growers. These are high value crops that can absorb high fertilizer prices, as we saw in 2008.


Migao's two main products are Potassium Nitrate (NOP: current capacity of 80,000 t) and Potassium Sulphate (SOP: current capacity 180,000 t). For more details, please see their website at http://www.migaocorp.com/.


In recognition of the quality of its fertilizers, the company has secured a five-year contract with Yunnan Tobacco (a large Chinese Tobacco producer) for the NOP. What is interesting is that Yunnan is increasing its tobacco acreage to deal with the growth in China and to increase its exports. This should be positive for Migao's growth plans. Also, Migao has recently signed a joint venture with Chili-based SQM, the world's largest producer of NOP. The Companies are developing a 40,000 tonne plant (NOP) in China in the form of a 50/50 joint venture.


In terms of growth, in addition to its joint venture with SQM, Migao is working on two 40,000 tonne SOP plants (Shanghai and Zunyi), on a 120,000 tonne Sulfuric Acid plant (sulfuric acid is an input necessary to make its fertilizers) and a new blending facility.


The new blending facility is the most interesting development in my view. The tobacco industry asked Migao to build it. Basically, the blending facility takes the specialty fertilizer from Migao and blends it with more generic fertilizers to meet the needs of specific tobacco growers. Each facility costs about $4.5 million to build and the company stated that it can recover that cost from the first year profit of the facility (payback of less than a year). Also, Migao said that they could end up building 4 to 6 of these facilities, all for the tobacco industry. To put this in perspective, for the last 12 months, the company EBITDA was around $33 million, so these new blending facilities could create significant growth for the company. On the other hand, we have no seen any financial results from the blending facilities so there is risk in these forecasts.

The company has had solid revenue and earnings growth, however, part of that growth came from Migao's policy of targeting 20%-24% gross margin range. When input prices increase, such as in the last few years, the company sees increased absolute revenues and gross profits. If, for example, potassium (KCL) prices were to decrease, Migao would likely see more muted growth for a while.





Last quarter, Migao had about $17 million in cash, $14 million in debt and $78 million in raw inventory on its balance sheet. The company stated that it can achieve its growth plans by using its cash flow from operations and cash on hand: it does not need more financing. I like that the founder still owns about 18 million shares (40% of the company). Of note, Migao's revenues, costs and profits are in Chinese Renminbi that are translated in Canadian dollars for reporting purposes. So, if you feel that the value of the Renminbi will change dramatically versus the Canadian dollar, you must consider this in your due diligence.


For the fiscal year ending September 2009, the consensus EPS estimate is around $1.10 (last year, its earnings were $0.63, with the last quarter of the year at $0.31). With the shares trading at $5.49, you have a 5x price to earnings ratio. Under a similar valuation approach, Agrium trades at 5.9x and Potash trades at 7.4x.


Migao seems to have quality products and solid growth prospects while trading at a low multiples. Even if potassium prices were to decreased substantially, thus affecting the company's absolute earnings, the company would still be profitable and growing with a solid balance sheet. I think it is worth considering.


NOTE: This post is not a recommendation, do your own due diligence. I may or may not own this stock so please keep this in mind.

Riding the Wave - Ruggedcom Inc. (Ticker: RCM in Toronto)

Have you heard of The American Recovery and Reinvestment Act of 2009? In the next few weeks, the U.S. Congress will consider this Act, which could have very positive effects on a few small cap companies with exposure to the U.S. market. One of them is Ruggedcom. The focus of the Act is to modernize the U.S. infrastructure, including creating a smart grid. Ruggedcom has designed products and technologies that are the communications backbone of the smart grid and the company has been successfully selling to electric utilities for past few years. I could go on and on about the various products offered by Ruggedcom but I think the best way to educate yourself is to visit their website (http://www.ruggedcom.com/).

Ruggedcom has been riding a wave of investment in rugged communications. Last quarter, its revenue was up 54% year-over-year and 13% quarter-over-quarter, with most of the growth coming from sales to electric utilities. The other segments (Transportation, Industrial and Military) have also shown some limited growth.

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Profitability has also exhibited strong growth but with some volatility. This volatility in earnings could potentially provide an entry point into the stock if the company were to report a "bad" quarter.

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In addition to the fact the Ruggedcom is in a good industry to benefit from infrastructure investments, I also like the company because it does not need financing. Ruggedcom has over US$45 million (that's US$3.60 per share) on its balance sheet with no debt and it is generating cash. So the company has staying power.

For the fiscal year ending in March 2009, the consensus estimate is around US$.82. The shares are trading at around $14.50 putting the P/E multiple at 17.6x or 13.3 (x-cash). While this is not cheap considering current markets, I think that this is a good company that is well positioned to take advantage of infrastructure spending.

NOTE: This post is not intended as a recommendation but it is aimed at generating a discussion about the company. I may or may not own shares in the company mentioned. Do your own due diligence. Do not solely focus on the potential profit but make sure you understand the risk of any investment.