Summary:
- The prevailing mood in the lithium share market is bearish, courtesy of negative perceptions around potential "oversupply" based on corporate future nameplate capacity wish lists and falling Chinese spot market chemical prices.
- It remains my view, that in order for the participants of the Paris agreement to meet CO2 emission targets, the adoption of electric vehicles ("EV's") & other battery applications (buses, energy storage etc) are non negotiable. China is at the forefront of EV adoption, and will, where necessary, adjust its regulations & subsidy formulas to ensure the reduction of its reliance on imported oil & cars.
- Historical research performed by Orocobre & others highlights the harsh reality that actual current output is well below previously targeted production - processing techniques will improve but the oversupply camp is pricing perfection.
- Central to the oversupply thesis, following a settlement between SQM & Corfo, is an increase in production from the Salar de Atacama to 400ktpa (216ktpa SQM) by the early 2020's. SQM, by spending US$525m, is theoretically able to add 132ktpa of capacity by 2021.
- The facts:
SQM's Q1 output of 10kt was 18%
below 2017 Q1, both SQM & Albermarle have had to reduce brine pumping in the east of the Salar - Q2 results - due on the 22nd of August, will confirm if SQM is on track to achieve
55kt for 2018. The CEO has just resigned & the company still faces allegations of bribing a previous economics minister.
Albermarle is facing similar problems, its Le Negra II ramp up is behind schedule & the Chilean GM has recently been replaced.
Local communities (environmentalists & unions) aren't happy about increased activity, resulting in Wealth Minerals Ltd withdrawing its drill rigs until further notice.
Following the substantial rise in royalties linked to chemical prices, SQM's opex,
including the lease payment, are ~
US$6,000/t at US$15,000/t Li2CO3 -
2nd quartile at best - at worst
3rd.
Given the above, there may be some merit in market commentary suggesting that SQM is feeding the oversupply camp the narrative it needs - resulting in temporary negative industry sentiment giving itself time to ramp up production before juniors & competitors can at lower all-in production costs. At US$20,000/t Li2CO3, SQM's opex of $8,000/t makes it closer to being the marginal producer - competitors are claiming $3,000 - $5,000/t. In short, SQM is only at the low end of the cost curve if prices are low - not an enviable position longer term - they need to diversify for many reasons.
In my opinion the Salar's
localized issues (water / environmental / communities) will prevent
both SQM & Albermarle reaching capacity targets - my forecast for
2025 is ~160ktpa for both companies combined,
well below 400ktpa.
- In the absence of a liquid futures market for hedging purposes & limited institutional investment exposure, lithium shares are vulnerable to targeted short selling. Shares have corrected substantially over the past 6-8 months and are priced for failure, despite ex China lithium chemical prices rising (LAC chart).
- During the past 6-8 months investors have paid substantial school fees, the learning curve has been steep and expensive, however, the silver lining is that mid to long-terminvestors can now buy de-risked, fully funded / commissioned / producing projects at low P/NAV & EV/ EBITDA valuations & can avoid marginal (& almost all) juniors. Mid sized, financially de-risked companies are currently being priced as juniors so there's little incentive to look beyond them.
- It will be interesting to see investment demand & pricing for the listings of Livent (FMC lithium) & Ganfeng in Hong Kong - investors should take note that these listings will reduce the pool of available funds for lithium companies in general unless new participants are found.
- Incumbent hard rock producers continue to refine spodumene concentrate grades (targeting 6%) & brine producers remain below nameplate capacity.
- Financing for juniors is more difficult than ever, further delaying future project supply (2025 820ktpa forecast). Without credible JV / off take partners, many junior companies are unlikely to survive. Some will, until a project is fully funded, permitted & under construction I don't add it to the supply estimate.
- In order to attract those partners a new project needs a substantial resource, scalability of production & consistency in the quality of its output (not to mention low cost, safe jurisdiction etc). My 2025 risk adjusted supply forecast suggests the top 8 companies / projects will account for ~76%-80% of total production.
- Almost all quality projects are spoken for, there are only a few potentially large scale, economically viable prospects located in safe jurisdictions left (My picks are Mineral Resources for hard rock, Neo Lithium & Lithium Power International for brine, LAC for clay(?)).
- Demand continues to grow as applications widen (2025 1MT forecast), Benchmark Minerals is tracking 41 "megafactories"set to produce 998GWh in 2028.
- Where will the chemical prices (Li2CO3, LiOH) settle? That's the question everyone is trying to answer. Based on rising demand & supply issues in the form of delays in ramp ups (production & conversion capacity), junior financing problems & environmental issues, it's going to be a while before a stable price band is maintained. Joe Lowry has previously guided US$12-$14k/t - levels I agree with - high enough to encourage new production, low enough for battery manufacturers to cut costs. He's also mentioned that, over the long term, prices should settle slightly above the high end of the cost curve. Based on long term 6% spodumene concentrate price estimates, capital costs per ton, conversion capacity (in)efficiencies & a reasonable return on capital - $12-$14k/t makes sense - this could change with improved efficiencies or successful new technologies.
- My model portfolio has been constructed to be overweight the 3 largest hard rockresources & undervalued mid sized companies on the premise that chemical prices will remain stable off the back of robust demand growth. In my opinion, the largestincumbent producers face some legal, regulatory, environmental & political risks that need to be factored in. I will be changing the portfolio weights monthly as there is likely to be significant corporate action in the future.
- Mid term, my expectation is that once companies have reach full steady state production, they will trade at 7-8x EV/EBITDA multiples.
As an example of value, below is an overview of Nemaska ($NMX) to 2022/2023:
Target price is
CDN$2.01 - $2.57 assuming
75%-80% of nameplate production is achieved. This model assumes no debt repayment prior to 2022 / 2023 and in the event that opex costs are above forecasts due to reduced production there is still substantial upside potential in the share price versus the spot price of 67c.
Conclusion:
- Outside of China chemical prices continue to rise.
- Actual production remains well below nameplate capacity, there are a number of factors responsible & these are unlikely to change in the mid term - construction, commissioning and ramp up takes 5-years plus.
- There are only a few large scale, economic projects available for JV's or buyouts.
- 76%-80% of future production will come from the top 8 companies / projects.
- Unless a company is fully funded and permitted by 2019/2020 it will not make a meaningful contribution to total production by 2025.
- For those who feel aggrieved that I've missed some of the smaller companies or have been too conservative, please bear in mind that my 2025 supply estimate of 820ktpa is well below my demand estimate of 1MT leaving plenty of room for improved / additional production & still result in a balanced market.
- In the short & possibly the medium term, various factors can influence lithium share prices, over the longer term however, quality will prevail. Evaluating the risk / return proposition has been a difficult task, current valuations are compelling. The Lithium Podcast has knowledgeable industry guests on its show & Joe Lowry shares information he receives from industry contacts that is invaluable. Orocobre (Tara Berrie) & other companies, through reports & presentations, also offer excellent industry insights.
(20min delay)