Good Concept, But Bad Timing? Rare Earth Producer JL Mag to List in HK

The state-owned maker of high-performance rare earth materials will complement its A-shares with a new float in Hong Kong

Key takeaways:

• Rare earths producer JL Mag plans to raise up to $650 million through a Hong Kong IPO by selling shares at a discount of up to 39% to its A-share price
• Analysis suggests U.S.-China trade frictions may limit the stock’s post-IPO upside potential

By Jony Ho

Rare earths, a collective name for 17 metallic chemical elements, are widely used in a range of important fields, from defense to communications and machinery. But their scattered nature in the earth’s crust means they aren’t easily mined, making them difficult for most countries to make locally.

One such producer, JL Mag Rare-Earth Co. Ltd. (6680.HK; 300748.SZ), launched a second listing in Hong Kong IPO last Friday to complement its existing A-share listing in Shenzhen. It will close the books on the deal this Friday (Jan. 7), raising up to HK$5.06 billion ($650 million), which it will use for building new production bases and expanding its global industrial chain. The company is a state-owned producer of high-performance rare earth permanent magnetic materials.

As a supplier of materials used in many high-tech goods, JL Mag has benefited from global trends towards devices that can save energy and reduce emissions. But it also faces risks associated with selling to just a small group of customers. The potential for trade restrictions or sanctions from the west, coupled with weak overall stock market sentiment in Hong Kong, has led the company to price its soon-to-be-listed new H-shares on the conservative side.

So, what exactly are the rare earth permanent magnetic materials that are JL Mag’s specialty? Such materials are alloys of some rare earth and other metals, which are then magnetized. Neodymium-iron-boron permanent magnetic materials produced by JL Mag can be used in new energy vehicles, wind turbines and energy-saving inverter air conditioners. According to third-party data quoted in the company’s prospectus, JL Mag ranks first in the world with a market share of about 14.5% in the production of high-performance rare-earth permanent magnetic materials.

Increasing demand

JL Mag said demand for rare earth permanent magnetic materials continues to increase, with global consumption growing from about 146,000 tons in 2015 to 210,000 tons in 2020 and expected to rise further to 305,000 tons by 2025. The company’s revenue has risen in tandem, from 1.28 billion yuan ($200 million) in 2018 to 2.29 billion yuan in 2020 and 1.77 billion yuan in the first half of last year alone. Its gross profit has been growing, while gross margin has remained stable in the 21.1% to 24.3% range for the past three and a half years.

High barriers to entry have helped JL Mag and its peers maintain customer loyalty. But such loyalty is a double-edged sword, creating high dependence on a small number of such loyal customers. In the three and a half years through the first half of 2021, the company’s top five customers accounted for 67.6% to 73.4% of its sales, with the largest accounting for nearly 30%. JL Mag openly admits a loss of any major customer could deal a big blow to its business.

The company has moved beyond China to address that vulnerability, including its signing of a supply agreement with electric vehicle giant Tesla (TSLA.US) in September 2020. That agreement is expected to boost its operating results and diversify its customer base.

But diversification through exports carries its own risk. JL Mag currently operates overseas subsidiaries in the U.S., Europe and Japan, even though its overseas revenue has only accounted for 10% to 20% of the total in recent years. But that part of the business could be vulnerable to international economic and financial sanctions, which have grown in frequency as tensions grow between China and the west.

Along those lines, the U.S. Commerce Department recently announced it would initiate a Section 232 investigation to determine the impact of imported permanent magnetic materials on U.S. national security, which could eventually result in future tariffs or restrictions on goods imported from companies like JL Mag.

The U.S. is already taking steps to reduce its reliance on China, which is the world’s largest rare earths producer. The U.S. and Australia said last year they are committed to developing the industry, and Australian Prime Minister Scott Morrison said the country will actively contribute to a reliable and competitive rare earth supply chain. The U.S. defense and energy departments have also funded rare earths research since 2019, and are funding allies to enter the industry.

Looking to shore up its own sector, China responded last December by announcing the establishment of a central enterprise, China Rare Earth Group, directly under the State-owned Assets Supervision and Administration Commission (SASAC), which oversees China’s largest state-owned firms. The new entity will integrate market resources, increase investment in scientific research and enhance the added value of rare earth products, to build a globally competitive first-class rare earth giant.

In the face of such risks, JL Mag has given a conservative IPO price range of HK$33.80 to HK$40.30, representing a discount of up to 39% from last Friday’s A-share closing price of 44.89 yuan.

Modestly valued

At its current rate of profitability, the company would record a full-year net profit of about $440 million for 2020. At that level its H-shares would command a price-to-earnings (P/E) ratio of about 48 times if its shares priced at the middle of their IPO price range at HK$37. Using the same metrics, the company’s only Hong Kong-listed peer, China Rare Earth (0769.HK), has a much higher P/E ratio of about 95 times.

ZH Mag (300224.HK), WKXT (000831.SZ) and North Rare Earth (600111.SH), which are all listed in China, currently trade at P/E ratios of 47 times to 109 times. That compares with a 64 times ratio for JL Mag’s A-shares, ranking them toward the lower end of their peer group.

Despite pricing comparatively cheaply and receiving support from big names like China Resources Group, CITIC Prudential and Hillhouse Capital Group, JL Mag’s new H-shares have received a relatively lukewarm response. The shares attracted HK$200 million in margin financing subscriptions over the first two days of the IPO, representing only 40% of the retail tranche.

Many may worry that the U.S. will impose more restrictions on rare earth imports, with companies like JL Mag getting caught in the “eye of the storm,” said Francis Kwok, vice chairman of the Hong Kong Institute of Financial Analysts and Professional Commentators.

“A-shares have a long history of trading at premiums over H-shares. But even if JL Mag’s IPO pricing is conservative, it does not mean there is room to narrow the gap”, Kwok said. He pointed out that recent weak sentiment in Hong Kong, coupled with increasing local infections of the Covid-19 omicron variant in the city, could make investors more pessimistic, to the detriment of new IPOs.

Kwok added he believes that JL Mag shares will price the low end of range and could fall below their IPO price on their first trading day, as many won’t consider the stock a good speculative short-term play.

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