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Khing Oei:
Hello and welcome everyone. I'm Khing Oei, and this is the AlphaSwap Podcast. Every week we'll be discussing a top investment idea from the platform and have an in-depth conversation with the user who posted the idea. You can learn more and join our community at alphaswap.io.
This week we're talking to Daniel Fok. Thanks for being with us today, Daniel. Can you start off by giving us a quick introduction of yourself?
Daniel Fok:
So I started out in high school when I discovered value investing and that was when I, basically, wandered blindly into the markets for the next two years, trying to try FX trading and value investing, all without any success. And so, after those two years, I had a big stroke of luck when I met this really sharp guy who was running a small boutique Google macro hedge fund, and I offered to work for him for free in exchange for him teaching me everything. And so that was how I went from deep value to global macro today.
Khing Oei:
Great. And what is the investment style and philosophy that came with that?
Daniel Fok:
So right now, the framework that I'm using is a top-down thematic macro trading framework, and so I go by themes. And, basically, it's a multi-step process where I go from the super narrative, which is where I view the world headed macro themes, which is the knock on effects of these super narratives. So an example of a macro theme could be the global green movement that we're having. An intermediate step would be macro indicators where we use economic data to track the progression or the regression of either the super narratives or the macro themes.
And so once we've set our eyes on where the macro themes are, then we can find the securities which are mainly affected by it and then we can also find counter securities which could act as a natural hedge, but still have a macro theme behind it.
And finally, when we want to put up trades, then obviously that's the final part of the framework, which is risk management, valuations trading and so on. Yep.
Khing Oei:
Gotcha. So, which stock are we going to talk about today? What's the trade? And is there anything interesting about the context of the investment?
Daniel Fok:
So today we're going to talk about Lynas Corporation, which is a rare-earth miner in Australia. And so I'll use the macro framework to basically bring you through how we arrived with the kind of trade idea. And so for the super narrative, where we're seeing the world going, then there's two things that we're paying attention to, which is the breakdown of the old world order, where the US dominated the global geopolitical stage, and also social uprising. So I'll touch on social uprising first. And so essentially COVID-19 as itself, this pandemic has exposed to the extent of wealth inequality with stocks reaching all time highs and millions still unemployed.
The pandemic has only brought into the spotlight this wealth inequality which was exacerbated by nearly a decade of QE. And so the governments recognize that they can no longer rely on monetary policy to stimulate the economy. And because this effects trickle down to small businesses and main street and they boost the large corporations and widens this inequality gap. And so fiscal has become the name of the game. Right? And governments, they realize that they need to build their way out of this crisis.
And so at the core of many developed economies' fiscal builds is climate change. And the green initiative will be the narrative that essentially undermines the need for unlimited fiscal spending to aid manufacturing and growth. So Europe has their Green New Deal, Biden has the climate change agenda and Japan, they just announced their green themed stimulus bill, and even China has its 2016 carbon neutral goal. So if China, one of the most polluted countries in the world, goes carbon neutral, then you can expect many other developed countries and some developing countries to follow suit as well.
So this narrative is a tailwind for the renewable sector and for the renewable sector, which consists of many things like nuclear, natural gas, not natural gas but clean energy. So the key factors that we're looking at in the renewable sector would be electric vehicles and the wind energy. Right? And these technologies, they use ... the key component, the core component that they use, is permanent magnets, where it's core raw material is neodymium and praseodymium. So it's actually rare earths. And this is where we get to the second super narrative, which is the breakdown of the old world order.
So the rare-earth market is currently monopolized by China. Right? They produce about 70% of the global production. And just months ago, Trump just signed an executive order to make rare-earths a national priority. And with this globalized system breaking down into two, maybe even three, hegemonic zones, then that's where we see the de-globalization taking place. And the key hegemonic zones that we're paying attention to is a pro US camp, which is the Blue Dot Network, which consists of the US, Japan and Australia. And a pro China camp which is essentially the One Belt One Road, and some of Russia and maybe Southeast Asia. So because of this economic decoupling that we're seeing here, that's where we all witness global supply chains make massive shifts.
And where do rare earth's come into this equation? Because of the globalization that we're seeing and also to follow up on the green movement, we're going to see the rare-earth market phase two possible and active supply shocks. The first is the scaling back of trade relations. And so the last time we had a Supercycle in the rare-earths market, that was in 2009, 2008, when China cut off it's exports and, subsequently, the rare-earth market just exploded. And now it still remains to be seen how much more trade relations will be scaled back but we do know that the main rationale for all this getting back of trade relations is China trying to reduce their dependency on the US dollar.
So the second supply shock would be ESG mandates. The process of mining rare-earths is extremely intensive in terms of its environmental impact. So unlocking additional supplies without violating certain ESG mandates will become even more difficult as time progresses. So in the context of de-globalization, you have rare-earth miners and supply chains outside of China who are going to become far more valuable over the next decade. And Lynas Corporation is one of the few companies that are actually producing meaningful amounts of rare-earths outside of China.
Khing Oei:
Great. That's very, very interesting top down. Really, we appreciate that. Is there anything in particular that's interesting anything about the company itself? Anything you want to mention about Lynas?
Daniel Fok:
So Lynas is the only producer of scale of separated rare-earths out of China and which is also the second largest in the world actually. And they also have the world's largest rare-earth processing plant in Malaysia. So basically they are a key supplier outside of China. So when we see the US and Japan pivoting their supply chains out of China, then they're going to look for the next biggest player, which is going to be Lynas.
Khing Oei:
Understood. So you've given a very good expose as to what the Supercycle as you're seeing here. Why do you think the market is not seeing that or, and what do you think the catalysts are for the investment to work out?
Daniel Fok:
So currently, at this point, what the market is ... the market is probably pricing in a smaller probability of this narrative. And what we're trying to do is the bet on the full realization of this narrative. And if we look at the charts of Lynas Corporation, the shares have actually broken out of a channel. They've broken out above a historical resistance so we can tell that the market's actually pricing in this paradigm shift. And what we're doing here is that we're going to position ourselves in Lynas before the entire narrative actually materializes and that whole narrative gets priced into the shares. And as for the catalyst? First of all, really the green movement is sort of like a no-brainer for the developed economies, but it's also debt alone could cause a slow grind up for rare-earth suppliers worldwide because of the higher prices from much larger demand for rare earths. But if we're talking about big price jumps, catalysts, then that would definitely be a breakdown in relations between the US and China, similar to what happened in 2008, 2009, when China restricted their rare-earth exports, yet again.
Khing Oei:
Makes sense. Can you give us a few key metrics on the company? Growth, return on capital, margins?
Daniel Fok:
So for key metrics, we do look at macro and micro. So macro, obviously, we are paying attention to NdPr. Neodymium and praseodymium prices prices, mainly because this is the core component behind the entire theme that we're tracking. As for micro, then we are simply paying attention to the average selling price for Lynas, as well as their EBIT Margins, mainly because we want to see that Lynas is able to achieve scales of economy in order to produce efficiently, and also for their revenues to track their rare-earth prices forward. And as for downside risks, then I'm not overly concerned for Lynas because they do have enough cash to cover for the next five years of debt payments. So in the event where the proverbial rug gets snatched from under their feet in the event of global lockdowns, which I still see a possibility, then Lynas is more or less safe. It's a safe bet to buy on dips.
Khing Oei:
Gotcha. And is there a bit more you can say about valuation of the company?
Daniel Fok:
So as far as valuations are concerned, I usually pay attention to two metrics, which is the return on invested capital and the Q Ratio, which is how much the market is paying for its invested capital. Now Lynas is a relatively fresh company as far as this rare-earth operation is concerned, and they only started generating revenue post 2013 when their Mt Weld mine was finally brought online and started producing rare-earth oxides for sale. So pre 2013, it was basically like a junior mining company whose stock was trading on a buyout prospect by a senior mining company. And so it's not very useful to compare its historical valuations to current valuations. And for this reason, I don't look at Lynas' historical metrics since those conditions are not the same. And to compensate for that, I'm just looking at the largest rare-earth producer, which is China Northern Rare Earth (Group), which is listed on the Shanghai Stock Exchange, ticker symbol 600111.
And so the underlying thesis really is that the US and Japan, two of the biggest net importers of rare-earths, are going to pivot their rare-earth supply away from China to the next biggest supplier, which is Australia, and therefore Lynas. And so the best case scenario is that Lynas will become the China Northern for the Blue Dot Network. And so if we try to overlay the historical performance of China Northern during the 08 to 11 Supercycle, then we could get a rough idea of what kind of valuations Lynas might achieve. And so at the peak of that Supercycle, the market was paying about 15 times China Northern's invested capital while China Northern was achieving 64% return on invested capital.
And so due to the macro themes that we discussed earlier, then I think that's a strong case that the rare-earth oxide market will enter this new Supercycle where it's peak price would either match the previous high or even surpass it. And so, in this case, my target valuation will be about 15 times Lynas invested capital, assuming that they can achieve that economy of scale, assuming that their return on invested capital is satisfactory and which can match that of China Northern. And so this Q Ratio of 15 is our baseline. And, in fact, because I'm even more bullish on the rare-earth market right now, that target could go even higher. And so as far as share price is concerned, and our target is a Q Ratio of 15, then we just need to multiply their invested capital by 15 to get a rough gauge of what kind of market cap that we're trying to target.
Khing Oei:
And what does that amount to? What is the upside in the share price from here?
Daniel Fok:
So currently, as far as their invested capital is concerned, as where it's standing right now, their target is about 14 dollars and 80 cents Aussie. Australian dollars. So, but as far as we know, the management already has more CapEx that's coming in. They have planned for more CapEx and that will obviously be increase their invested capital. So it's a moving target all the time. So our immediate target is about 14.8 Australian dollars, and the more they invest in the company, and if we see return on invested capital growing in relation to the rate of bull market, then their target will get adjusted higher and higher.
Khing Oei:
Gotcha. But in percentage term, what's the potential upside in that case?
Daniel Fok:
That's about a 270% upside from here.
Khing Oei:
So finally, we'd love to get a couple of general investment insights from you. There's three. One is which resources do you use for your research? What's your favorite investment book. And finally, what's the most important investment lesson you'd like to share with your audience.
Daniel Fok:
So as for resources, I don't use any proprietary resources. A lot of my ideas are not original. They are basically borrowed ideas and I take a lot of inspiration from financial Twitter where some of the sharpest guys are at. And once I get a idea, then I drill down on the topic. I just study the narrative that's happening through like Bloomberg news, just dive into the simple SEC filings of these companies and to understand the fundamentals as well.
As for books. My favorite would be Market Wizards by Jack D. Schwager. And the main reason is because it just shows that there are many, many ways that you can make it in this business. So you shouldn't be so hard up on yourself for not being able to execute a certain strategy.
There's really a specific strategy for everyone's personality. And so everyone can do it as long as you put enough time and effort.
And as for the biggest lesson that I've take away is really just how important a framework is, having a framework and mental models for every single segment of your investment process. And if you don't have a framework, then you can't distinguish signal from noise and you're just flying blind into the wind. So really, having a framework just gives you the mental stability to stomach drops and to buy on dips or to know when you just have to take your losses.
Khing Oei:
Makes a lot of sense. Daniel, thanks very much for this very interesting thesis. Really appreciate it. Good luck and speak soon. Of course, anyone who would like to read the full thesis can do so on alphaswap.io, where you will also find a lot of other ideas. Thank you for listening and we look forward to the next episode of the AlphaSwap Podcast.
