Investing in the penny stock area of the market can be a risky endeavor. But finding the right market-cap minnow has the potential to turbocharge my portfolio’s performance.
Here’s one penny stock that looks a smart buy to me today. However, it may well take some time for this one to play out. That’s why I’d tuck some shares away for the long term.
Rare earth minerals
Rainbow Rare Earths (LSE: RBW) is a Guernsey-based mining company focused on producing rare earth oxides required to drive the green energy transition. The firm’s projects include its flagship Phalaborwa Project in South Africa and a high-grade project in Burundi. It is also investigating other sites in South Africa and Morocco.
The company is focused on producing four magnet rare earth metals: neodymium, praseodymium, dysprosium, and terbium. These are essential for permanent magnets in wind turbines, EV motors, and much else.
To call rare earth elements ‘rare’ is actually a bit misleading. They’re quite widely distributed around the earth’s crust, but they’re hidden behind other metal and mineral deposits. This makes them difficult to mine because they’re not usually found in commercially exploitable quantities.
If they are extracted, then they have to be processed. Today, that almost always happens in China. In fact, China produces more than 80% of the world’s rare earth-refined products. But Rainbow plans to build its own downstream production facility, which will see it separate rare earth oxides using patented IP and technology.
Alternative supply chains
In 20 years time, the world is expected to need four times as many critical minerals for clean energy technologies as it does today. So the UK government wants to become less reliant on China and establish alternative supply chains for rare earth minerals.
It wants this in place by 2030, when all new vehicles manufactured will be electric.
This is a very supportive backdrop for Rainbow Rare Earths, which is hoping to profit from all this. But how long do we have to wait?
Projects
The company plans to build a pilot plant at the Phalaborwa deposit early this year. This will likely be financed through debt. The company then expects to go into full production in 2026.
Rainbow expects to process 2.2m tonnes of phosphogypsum per annum over 14 years. This will produce 26.208 tonnes of separated rare earth oxides. Based on the average cost today, management claims this will deliver a 75% EBITDA operating margin.
However, its Gakara Project in Western Burundi remains on hold, pending approval from the appropriate mining ministry. Given this is one of the world’s richest rare earth deposits, I do expect the government to ultimately give the nod for this project.
Obvious risks
There is significant risk here. The obvious issue is that production at these mines still needs financing, likely through a combination of debt and equity. But interest rates continue to rise, which adds risk. And selling more shares means diluting existing shareholders.
The company has $4m of cash, so isn’t at risk of going under anytime soon.
At 10p, the stock is down 13% since the company went public in 2017. Overall, I’m encouraged enough to start a small position in this high-risk, high-reward miner in the coming days.
