Nice plug in the AFR this morning:The lithium stocks bestplaced...

Nice plug in the AFR this morning:

The lithium stocks bestplaced to capture price boom

Fund managersfavour established lithium producers, rather than explorers, given they’re morelikely to capture soaring prices.

The powerful rallyin lithium stocks is not sustainable for all companies in the sector, strategistswarn, meaning investors will need to become more selective if they wantexposure to one of the hottest pockets of the local sharemarket.

The price oflithium, a key ingredient in batteries, has exploded in the past year as tightsupply has been met with booming demand fuelled by the transition to electricvehicles.

Demand for lithiumhas soared amid the transition to electric vehicles.

Prices forspodumene concentrate, which is mined by most Australian lithium producers andsent to global battery manufacturers, were fetching $US3262 ($4630) a tonne bythe end of March, up 504 per cent from a year earlier.

Although investorshave flooded into the major lithium producers, including Pilbara Minerals,Allkem and Mineral Resources, there has also been a rush to less establishedminers. Exploration companies have posted some of the most impressive gains,despite not yet being in production.

Shares in CoreLithium, which is building its Finniss lithium operation in the NorthernTerritory, are up 400 per cent over the past year. The share price of freshlylisted explorer Lithium Plus Minerals skyrocketed 180 per cent on its ASX debutlast week.

All boats lifted

But strategistsare cautious about the sustainability of such returns, warning even though somepre-production assets will perform well, others will not.

“The surge inprices has lifted all boats in the lithium sector, and in terms of explorationassets, you’ve only got to say that you think there’s lithium and you’regetting material re-rates,” says Ben Cleary, who runs the Tribeca GlobalNatural Resources fund.

“So of course,when lithium prices do eventually pull back, there are going to be some fairlybig pullbacks in some of these exploration assets.”

This means Tribecais more heavily exposed to the big producers. Mineral Resources has the largestposition in its natural resources fund, and Allkem is the other major holding.

“The incumbentsare generating a lot of cash flow for retail investors, so you’d expect to seepretty significant shareholder returns, and dividends and buybacks, whichyou’re not going to get with exploration companies,” Cleary says.

“The existingproducers still look pretty cheap on current spot prices, but the key questionis where do long-term prices land?”

Realising lithium’spotential

Although movementin the price of lithium is positive for the sector, UBS says a company’sability to actually capture, or get close to, selling the raw material at spotprices is crucial in picking a winner.

“We think theability of a producer to realise prices closer to a rising spot is a key factorin picking relative outperformance in the sector,” UBS analyst Lachlan Shawsaid in an April note.

There is often adifference between spot prices – the current price of an asset – and therealised price a producer receives. A key factor is how the miner’s order bookis compiled in terms of the proportion of sales done on a fixed priceagreement, compared to those that reference the spot market.

Like othercommodities, there is a timing component too, where sales reported by producersreflect realised prices from the previous period.

“This meansrealised prices lag spot pricing when spot is rising, with the differenceaccentuated when the spot market is moving quickly,” Shaw said.

UBS expects theindustry to gravitate closer to spot pricing and noted some producers aremoving towards this to capture current prices.

The brokerunderlined Allkem, which recently moved annual contracts that previously hadfixed prices to those using indices, to set realised prices with an averagebimonthly adjustment.

Mineral Resources’lithium processing plant at Wodgina in Western Australia.

Transition of power

It means there isa shift in terms of pricing power from those purchasing lithium to the majorsuppliers of the raw material, as they attempt to accelerate the pace of theadjustment between contract and spot prices.

“The raw materialsuppliers are in a very strong position to negotiate, particularly if they cangrow production over time because the people they have offtake agreements withare scrambling for resources and are more likely to deal,” says David Franklyn,portfolio manager of Argonaut’s Natural Resources Fund.

Franklyn agreesthat sticking to the major producers is the best way to capture surging lithiumprices, and the fund has large positions in Pilbara Minerals, Mineral Resourcesand Liontown Resources.

“We look out forlarge companies that are in tier-one locations, have a large resource base, arein production and also have the ability to further grow production,” he says.

“The guys whomaximise the benefit of those higher prices are the ones that are in productiontoday and don’t have everything locked away in long-term contracts because youneed to be able to sell near spot.”

The realopportunity is over the next three to five years when market dynamics meansupply can’t respond quickly enough to the pace of demand, which should keepprices elevated.

“In the mediumterm, there will have to be a point when supply will catch up to demand andprices will clearly soften,” Franklyn says.

“The question iswhen that happens because there are many moving parts, but the way to try andmitigate risk is to go with the bigger, more established producers.”

Macquarie says itspreference for Australian-based lithium producers is Pilbara Minerals becauseit offers strong near-term production growth.

The broker has an“outperform” rating on Allkem, Pilbara Minerals, Liontown Resources and MineralResources.