Exactly one year ago, a tiny penny stock was hovering around the dollar level. Actually, it was trading for $1.08 per share. Less than a year later, the stock jumped in value to over $2.00… then $4.00… then $8.00… finally peaking at a value of $10.24 a share!
For those of you quick on the math, that’s a massive 848% win – in less than 8 months!
Why was this one penny stock so successful?
I have two words for you – RARE EARTH.
These days, it seems you can’t flip through a financial magazine, or watch the news without hearing about rare earth… and more specifically rare earth from China.
But what is rare earth… and why is it so valuable?
In the most basic terms, it’s the intersection of advanced technology, and old world mining. See, a whole host of rare earth elements are needed in many of our advanced technologies.
For example, Yttrium is used for Light Emitting Diodes or “LED” lights. Lanthanum is used in Hybrid car batteries.
Neodymium is the strongest permanent magnetic metal. It has a wide variety of uses, everything from military and industrial applications to PC hardware and professional studio equipment.
Europium is used in LED TVs, computer monitors, florescent bulbs, and even has numerous medical uses.
And I’m just scratching the surface.
Every one of us uses these advanced technologies… technologies made possible by rare earth elements. Unfortunately, as technology spreads, the demand for rare earth elements is skyrocketing.
As a result, companies focused on the mining and processing of rare earth have seen huge gains recently… That’s what drove Rare Element Resources (REE) up over 848% in less than a year.
Here’s the crazy thing… REE hasn’t even started mining yet!
Regardless, companies dealing in rare earth – and rare earth like elements – are poised to make a lot of money. And here’s where the China connection becomes so critical.
Eighty percent of rare earth mining operations are in China.
One rare earth mining company I found interesting is China Shen Zhou Mining & Resources (SHZ). They’ve already made some big money for a handful of investors… but I think there’s even more to be made.
Here’s why…
COMPANY OVERVIEW
China Shen Zhou makes the majority of its money from Fluorite.
Now, I know what you’re thinking… google the term “Rare earth” and you won’t see Fluorite listed! Here’s the thing… Fluorite may not be an official “Rare Earth”… but it’s rare enough for the Chinese Government to restrict the exploitation of it.
Why all the fuss?
Fluorite is used primarily as a melting agent. To put it simply Fluorite lowers the melting point for steel and also aluminum. It also makes removing imperfections in the steel easier.
We all know China has one of the fastest growing economies in the world. With annual growth around 10% China has a ravenous appetite for steel.
And right now, almost 88% of the Fluorite produced in China is used domestically.
SHZ operates several mines throughout China. Along with Fluorite, their mines are also rich in Copper, Zinc, and Lead.
The majority of the fluorite comes from the Inner Mongolia mines. The company sells two final products – high grade Fluorite ore used in Steel production and Fluorite powder used for a variety of purposes by the chemical industry.
In 2010 SHZ mined 131,000 metric tons of ore – selling 32,800 metric tons of Fluorite lumps, and 29,000 metric tons of Fluorite powder.
China Shen’s 2011 goal is 60,000 metric tons of the powder and 40,000 of the lumps.
What’s more, there is also a good reason to assume prices will continue to rise. In early 2010 Fluorite was $118/ton, a few months later prices hit $295/ton. If China continues to restrict exploration and exploitation of Fluorite, prices should continue heading higher.
RECENT DEVELOPMENTS
Early this year China Shen Zhou bought 55% of another Fluorite mining operation. In that deal they acquired rights to three additional mines.
Remember, mining operations take time to set up. We haven’t seen any additional revenue from those mines yet. However, down the line they should provide a healthy increase in both production and revenue.
So business is strong, and prices are rising. New mine sites are being acquired, and goals for increased production are set.
Combine all that with a government policy heavily in their favor, and you have what sounds like a winning combination to me!
But before we go too far, let’s take a quick look at the financials…
SHEN ZHOU FINANCIALS
Business prospects are definitely looking up for SHZ. Their revenue jumped 177% in 2010 compared to the previous year. Gross margins rose to over 25%. A big portion of the rebound was due to the Xingzhen mine restarting and Fluorite prices rising.
Revenue was $11.6 million, with the company posting a small loss of $3.3 million.
While the company does have competitors, it doesn’t really matter. China’s growth has created a situation where demand surpasses supply.
Selling all the ore and powder produced doesn’t seem to be an issue.
And that might account for the company’s bright outlook. They provided guidance for 2011 which is quite aggressive. They estimate net revenue will reach $38 million and net income will hit $11 million.
While I have no reason to doubt management projections, if they reach even 80% of those goals it will be a homerun year!
So what’s the stock look like?
SHEN ZHOU’S VALUATION
Shen Zhou is in a very unique situation. The company will be more than tripling revenue this year, and moving into the black.
Believe me, turning a company from a $3.3 million loss one year to a potential $11 million gain is no small feat. Putting up those kinds of numbers deserves a premium valuation…
But that’s not what the company is getting right now.
As I write this, the entire company is valued at roughly $150 million. Based on a projected $11.0 million net income next year the company trades for an undervalued 13.6 forward P/E ratio.
Consider this… the group P/E ratio for many other mining industries is higher… much higher. The average P/E for Silver mines is 44x, Gold mines is 31x, and companies in the Steel and Iron industry have a P/E of 33.5x!
If China Shen Zhou reaches even close to those types of valuations, the stock would more than double. And keep in mind, these numbers don’t even account for future growth. How much more money will the company be making in 2, 3, or even 5 years!?!
ANALYSIS OF SHZ’S STOCK
This stock is volatile. But where there is volatility there is also the potential for profit. We’re well off the 52-week high of over $10 a share… and this gives us a great entry point.
Chart courtesy of StockCharts.com
This stock could be setting up to be a big homerun!
With the stricter controls on mining Fluorite in China, the rising prices, increased production, and revenue & earnings set to skyrocket, SHZ should be a big winner.
ACTION TO TAKE
If you like what you’ve read, do your own research… then Buy SHZ up to $5.25 a share.
Prices as of April 28, 2011
The “Recommended Price” is as of the date and time of the recommendation (adjusted for splits and dividends), you may pay more or less. “Buy-up-to” means don’t pay more than this price for the stock. If you can get it cheaper, then great! “Hold” means hold if you own it, but don’t buy it if you don’t. “Sell” means sell. Remember to consult your investing professional before making any trade or investment. And remember all investments have some risk.