Galaxy stock price is down 20% in the past month, but recovering now.
3 methods of valuation are considered.
A brief look at risks, near term catalysts and competitors.
I wrote previously about Galaxy Resources (ASX:GXY) (OTCPK:GALXF) about 2 months ago, when I rated them as an excellent buy. You can read the article here. I will try here to not repeat myself from that article, except where I wish to emphasize key points.
Since the recent stock price drop I have had many Seeking Alpha readers ask me, "what is happening with Galaxy?" This article will help answer that question, as well as reaffirm the reasons to buy the dip.
A brief history of Galaxy Resources
Galaxy Resources (("Galaxy")) are an Australian emerging lithium producer. Galaxy have 3 lithium projects (100% owned) - Mt Cattlin (producing spodumene), James Bay (DFS expected late 2016, spodumene production no timeline yet), and Sal De Vida (SDV) (awaiting an updated net present value (NYSE:NPV) for their updated DFS, brine production expected around 2019-2020).
Galaxy Resources 100% owned James Bay Canada spodumene project Source What has changed in the past 2 months
The biggest change has been to Galaxy's stock price which has fallen from AUD 0.48 to AUD 0.395, or down around 18%. The US listing GALXF has fallen from USD 0.386 to USD 0.304, or 21%. I believe this was mostly due to the August 9 Macquarie report that downgraded many of the top Australian lithium miners, including the Galaxy target price to AUD 0.41. I believe this downgrade was unwarranted, and their forecasts are too conservative. I will discuss this further in the valuation section.
During this time Galaxy has completed their friendly takeover of General Mining (GMM) without a problem. This diluted their equity (as expected by the market), but increases profit going forward to 100% of the 3 lithium projects. Due to this the Sal De Vida NPV update has been delayed, but is expected shortly.
The only other Galaxy news is Paradise Investment Management ceasing to be a substantial shareholder. Galaxy Resources (ASX:GXY) 6 month chart Click to enlarge
Source: Bloomberg Valuation of Galaxy Resources - 3 methods
1) Earnings Multiple valuation
My model forecasts 2017 earnings for Galaxy (coming only from Mt Cattlin selling 150kt of spodumene at USD 700 per tonne) of AUD 62m (based on 1USD=1.3 AUD). Using a PE multiple of 15, my price target for end 2017 is AUD 0.52. Remember this really only allows for first stage production ramp from ONLY Mt Cattlin.
2) Sum of the parts valuation
Strachan analysts performed a sum of parts valuation before the General Mining takeover, and using the old Sal De Vida NPV. Their conclusion was Galaxy was worth 0.64. In my previous article I calculated an updated sum of parts valuation based on a low and high estimate for the NPV of Sal de Vida. The range for Galaxy's value was between AUD1,382m and AUD 1,979m. If we take a loose middle point and call it AUD 1,500m. Current market cap of Galaxy is AUD 706m, less than 50% of the updated sum of parts valuation. Or put another way, once the updated NPV for Sal de Vida is made public, the stock will have a value about 100% higher, or around AUD 0.80 per share. NB: Managing Director Anthony Tse stated the new NPV for Sal de Vida could be expected to be "north of a billion dollars." (link is to a video with Anthony Tse). Strachan analysts see AUD 1.2b as possible.
3) Discounted cash flow (DCF) valuation
When I modeled a DCF for Galaxy based on 15 years of future projected cash flows (including all 3 lithium projects), using a 10% discount rate, my model came to a valuation of AUD 1.785b or AUD 0.99 share.
Summary of valuations with 3 different methods
Column 1
Column 2
Column 3
1
End 2016 (AUD))
End 2017 (AUD)
2
Earnings multiple (Mt Cattlin only)
0.52
3
Sum of the parts (all 3 projects) - based on Strachan analysis with my updated SDV NPV estimate
0.80
4
DCF (all 3 projects) - my estimate of future cash flows
0.99
Click to enlarge
NB: Strachan analysts forecast is 0.64, based on April 29, 2016.
NB: I have used LCE selling prices of USD10,000/tonne, costs of USD 2,500/tonne. Spodumene selling at USD 700/tonne, and costs of USD 205/tonne.
Given the most accurate way to forecast a stock with rapidly rising earnings is using DCF, the AUD 0.99 target can be considered the most accurate. Off course reaching the cash flows would require all three projects to reach production. To get there my model allows for USD 369m (AUD 480m) Sal de Vida project start up CapEx raised from a AUD 100m (25% off-take) partner, AUD 100m debt funding, and, and 280m retained earnings from Mt Cattlin to end 2019). For James Bay start up CapEx of say AUD 200m, Galaxy may raise AUD 100m of equity, and AUD 100m of debt, or if delayed to 2020 can use retained earnings. These are my best cautious estimates, but are comparable to other lithium miners experience and projected costs. The fact Galaxy now has strong earnings coming in from Mt Cattlin that will help them to reduce the need for any further equity raising.
Management has said it prefers not to dilute equity and an equity partner in Sal de Vida may take a larger stake. Mt Cattlin will also be spinning of around AUD 62m of cash in 2017, and increasing beyond that.
Strachan summarizes quite well, " Strachan Corporate expects that the stock will continue to be re-rated as cash flow from Mt Cattlin is established, along with reduction in the technical and funding risks at Sal de Vida and James Bay, through a clear path to start up using a development funding partnership". And, "the company has begun to move towards attracting a development partner who might also be an off-take partner. Galaxy has the capacity to attract a buyer for ~40% of the project with funds thus released, supporting the equity component for its retained 60%. Strachan Corporate believes that a processing plant could begin development at Sal de Vida with the aim of commencing production by late 2018, after a 15 month ramp-up period from early Salar cell development."
Risks/Catalysts and Competitors
This was all covered in my previous article on Galaxy linked at the beginning of the article. Briefly the main risks involve lithium price falls due to market oversupply, financing issues for starting SDV and James Bay, political risk (SDV is in Argentina), and market liquidity risk (best to buy on ASX). Galaxy has binding off-take agreements in place covering most (120kt) of the 150ktpa forecast 2017 production, reducing selling risk. They also have very strong contacts with Chinese buyers.
The main near term catalyst expected any time now is the updated NPV for Sal de Vida. Investors are reminded that an increase in NPV does not always translate to an immediate stock price increase. Other near term catalysts are the late 2016 DFS for James Bay, increased earnings from Mt Cattlin, and in time a possible off-take partner announcement for Sal de Vida.
The table below shows Galaxy's competitors that are racing towards production. Add to this the existing lithium producers of SQM (NYSE:SQM), Albermarle (NYSE:ALB), and FMC Corp. (NYSE:FMC)).
Lithium X (TSXV:LIX) (ROCEF) (OTCQB:LIXXF), Bacanora Minerals (TSXV:BCN) (OTC:BCRMF)
Click to enlarge
Conclusion
Galaxy Resources was a good buy 2 months ago at AUD 0.48 before the Macquarie "unfair" (in my view) downgrade pushed the stock 20% lower. I say unfair as my valuation section above gives values much higher than the current stock price.
My forecasts are based on reasonable expectations of lithium demand based on a rapidly growing electric vehicle and energy storage market lead by BYD Co (OTCPK:BYDDF) (OTCPK:BYDDY) and Tesla (NASDAQ:TSLA). To view more about my demand versus supply forecasts for electric vehicles ((EVs)) and lithium you can click here and here.
For those investors that want a leading future lithium miner, diversified across brine and spodumene, diversified across 3 countries, and with very strong Chinese buyer connections, strong off-take agreements to 2017, I would suggest looking at Galaxy Resources.
At the current depressed price with an NPV upgrade imminent, I believe Galaxy is an outstanding buy.
I am not currently working as an analyst, however I have the academic training. Investors should do their own research and due diligence.
As usual all comments are welcome.
Disclosure:I am/we are long BYD CO (1211:HK), OROCOBRE (ASX:ORE), GALAXY RESOURCES (ASX:GXY), PILBARA MINERALS (ASXLS), LITHIUM AMERICAS (TSX:LAC), LITHIUM X (TSXV:LIX), NEMASKA LITHIUM (TSX:NMX), ALTURA MINING (ASX:AJM), CRITICAL ELEMENTS (TSXV:CRE).
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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LS), Nemaska Lithium (TSX:NMX) (OTCQX:NMKEF)
