Members of our Inner Circle service often ask about technology stocks. Recently, I replied to this question concerning a Canadian stock that processes materials that have been in the news frequently these past few years, rare earth elements.

Q: Hi Pat: Could you give me your opinion on the following stock: Neo Material Technologies? I appreciate the advice! Thanks.

A: Neo Material Technologies Inc., (symbol NEM on Toronto; www.neomaterials.com), buys rare earth elements and processes them into neodymium-iron-boron magnetic powders and zirconium-based engineered materials. Toronto-based Neo Material makes its products at plants in China, Thailand, Germany and North America.

Neo’s Performance Materials division supplies 67% of its sales. This division makes oxides and salts out of rare earth elements. These materials are then used in catalytic converters, compact fluorescent lighting, computers, television display panels, optical lenses, mobile phones and electronic chips. Neo’s clients include Epson, Panasonic, Hitachi, BASF, Philips, Samsung and Canon.

The company’s Magnequench division accounts for the remaining 33% of its sales. This division makes magnetic powder, which is used to make small, strong, lightweight magnets that are used in electronics, particularly small motors that run computer hard drives, copiers and CD and DVD players.

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Technology stocks: Acquisitions add to Neo-Material’s product base

In the three months ended June 30, 2011, Neo’s sales jumped 172.9% to $216.1 million from $79.2 million a year earlier (all figures in U.S. dollars). The company earned $56.6 million, or $0.44 a share. A year earlier, it earned $16.4 million, or $0.13 a share. These gains were mainly the result of higher demand for the technology stock’s specialty metals.

In August 2009, the company bought Peterborough, Ontario-based Recapture Metals Ltd. for $15.3 million U.S. in cash and shares. Recapture produces gallium, indium and other rare metals, mainly from discarded electronic and industrial equipment. It sells its metals to a wide variety of manufacturers, including makers of cellphones, solar panels and computer screens. Recapture is now a part of Neo’s Performance Materials Division.

In 2010, Neo paid $5.2 million for 50% of Buss & Buss Spezialmetalle GmbH, a German company that recovers and recycles rare metals. The company also paid an undisclosed sum for 19.5% of privately held Atlantic Metals and Alloys, LLC, a Connecticut-based metals-trading company.

This technology stock’s strong balance sheet gives it plenty of room to make more acquisitions or increase its research spending (it currently spends about 2% of its revenue on research). It holds cash of $295.9 million. Neo’s long-term debt of $196.1 million is a low 18% of its market cap.

Technology stocks: Plants in China give company a competitive advantage

Neo should continue to benefit from the trend toward tougher energy efficiency and environmental regulations, as well as rising interest in recycling old electronics.

Higher demand for energy-efficient motors, hybrid vehicles and high-efficiency lighting should spur its sales, as well. Moreover, the company’s patents and long-term relationships with its main customers help protect it from competition.

Neo’s plants in China also give the company a competitive advantage. China accounts for around 95% of global production of rare earth elements.

From time to time, China imposes export restrictions or quotas on rare earths (including a recent 72% cut in export quotas for the second half of 2010) to boost prices internationally and ensure enough supplies for Chinese companies. But because it has plants in China, Neo enjoys both steady supplies and lower domestic Chinese prices.

Neo Material Technologies is okay for aggressive investors to hold.