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Great article, thanks. If this pricing formula estimate is...

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Lbm80

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27/01/19

10:02

Post #: 37236449
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Originally posted by SF@HC ↑

An excellent peice from Rodney Hooper, puts some meat on the bone re Li pricing and how the whole supply chain needs to make profit;

[COLOR=rgba(0,0,0,.9)]Jiangxi Ganfeng Lithium Co (1772 HK) Top investment pick of the "big 4"[/COLOR]

Published on January 26, 2019

[COLOR=rgba(0,0,0,.9)][COLOR=rgba(0,0,0,.9)]Rodney Hooper[/COLOR]
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[COLOR=rgba(0,0,0,.6)]BEE advisory | Commodity investment research and advisory (EV battery metals)[/COLOR]

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[COLOR=rgba(0,0,0,.75)]Established in 2000, Ganfeng has fast become a major player in the lithium world. Whilst it may “only” be the 3rd largest lithium compounds producer it’s the largest producer in the lucrative lithium metals market and as far as mid-stream processing is concerned, given the diverse feedstock it has successfully handled, Ganfeng is the gold standard. Other companies have in house processing skills, but typically they have mastered one single large resource. Greenbushes is the only hard rock mine to date that has consistently produced large scale 6% + spodumene concentrate with low impurities, this will change over time but until then, given the variable quality feedstock currently on offer, processing skills deserve a premium rating. Having recently secured offtakes from Pilbara (stage 1&2) and Altura, thereby further diversifying its reliance on Mt Marion, Ganfeng is on its way to establishing itself as the “clearing house” for unallocated spodumene concentrate in the market.
The investment case for Ganfeng is built on 4 main pillars:
- Volume growth & diversified product / sales mix
- Low expansion costs – capex per ton of installed capacity
- Improved corporate transparency
- Spodumene concentrate input prices falling (improved operating margins)
Industry Overview:
Based on the draft subsidy policy for BEV’s in China, sales of BEV’s should remain solid in 2019 provided car manufacturers continue to produce vehicles with a range of greater than 400kms and the energy density of the battery is greater than 140 (wh/kg). As a result of the shift in policy towards longer range and increased energy density plus the introduction of Tesla in China, the average size of battery packs in Chinese EV’s has increased and could reach an 55 kWh by 2020.

NMC 532 batteries are at 140-160 energy density. Increased usage of NMC 622 lithium agnostic batteries should improve energy density to 180 and maintain subsidies. It remains to be seen whether the energy density subsidy hurdle continues to climb higher year by year making a transition to 811 necessary to maintain a 1.1x – 1.2x multiplier.

Source: BMI
The chart above highlights the planned battery capacity expansion to 2023 and 2028. The Benchmark tracker has a forecast of ~900 GWh to 2023 and 1450 GWh by 2028. Comparing this to current capacity and factoring in the BNEF “learning curve” of 19% per doubling of capacity, we could see sub $100/kWh batteries by 2023 / 2024.
Where do spodumene carbonate 6% prices need to go for Chinese converters to make a reasonable operating margin?
Assumptions:
Lithium carbonate production per ton : 8x spodumene concentrate 6%
Conversion cost: $3,000/t
VAT: 16%
Excludes any funding costs for capex and maintenance costs

The table above gives guidance as to where spodumene concentrate prices need to go to ensure converters can earn a 10%-20% operating margin. Pilbara Minerals Q4 2018 pricing of US$742/dmt looks to be about right if China spot prices were in the US$11,500 – US$12,000/t region. As a number of new spodumene concentrate producers are still ramping up production, with higher strip ratios and therefore higher operating costs, there is likely to be resistance to price falls below the US$600/t level. This should put a floor on carbonate spot prices around the $10,000/t mark. If the China spot price persisted below the $10,000/t level then it’s likely converters would be making a loss and would either stop buying spodumene or force the losses onto the spodumene producers. In any event, if carbonate spot prices were to fall to $10,000/t or below this would discourage further capacity expansions in China until demand drives prices higher and reasonable operating margins can be achieved.
If Ganfeng is so wonderful why has the share price fallen?
In simplistic terms Ganfeng’s share price rallied aggressively when the China chemical spot prices were elevated and well above ex-China, rest of world (“ROW”) prices. Ganfeng has historically sold the majority of its compounds production in China and has relied heavily on Mt Marion for its spodumene concentrate supply. The purchase price of the Mt Marion material (outside of Ganfeng’s equity share) is believed to be linked to the ROW hydroxide and carbonate prices that were trading at a discount to the China spot prices; this meant substantial operating margins for Ganfeng in 2017. During 2018 the China spot price for technical and battery grade carbonate plummeted whilst the agreed prices for Mt Marion’s spodumene concentrate (ROW prices) held up and even increased during some quarters. Under these conditions Ganfeng’s main product line, carbonate, experienced severe operating margin pressure (opex ~$9,000/t+), resulting in the share price losing 2/3rds of its value and now trading at 22 RMB. To make matters worse Ganfeng needed to raise capital offshore in Hong Kong (“HK”), the effective pricing of the US$400m raise was at a ~ 50% discount to the Shenzen share price.

Source: Orocobre

Source: Google finance
Lithium compounds are specialty chemicals that are not straight forward to produce. Despite constant claims in the media regarding the abundance of lithium, it is very apparent that the availability of lithium that can be commercially mined and converted to battery grade / quality chemicals for specialized usage, such as batteries in electric vehicles etc, is limited. Whilst some progress has been made by incumbent producers to improve the quality of their raw materials (spodumene concentrate) and compounds (lithium carbonate and hydroxide), there is still a long way to go. There is also a large disconnect between the amount of spodumene concentrate that is being produced and final lithium chemical sales based on a conversion ratio of 8:1 for carbonate and 7.4 for hydroxide. The bottleneck is in conversion capacity – partly due to financing / development delays, partly due to the scale and magnitude relative to historic capacity and partly due to low quality spodumene concentrate (below 6%) that needs additional processing. This backdrop sets the scene for highlighting the importance of conversion (processing skills), something Ganfeng possesses. From its humble roots in 2000, Ganfeng has grown its effective capacity consistently along with its ability to produce (high barriers to entry) lithium metal, batteries and recycling. The company has proven itself to be adept at processing a range of feedstock of varying quality and complexity. This skill cannot be underestimated. In addition, the company has a projected capex per ton of installed capacity of below US$3,000/t for hydroxide. At current spot prices and operating margins Ganfeng will have a payback of less than 12- months! Many analysts focus on Ganfeng’s operating margins as the reason to ascribe the company a discounted EV/EBITDA multiple relative to vertically integrated (lower opex) competitors. Operating margins are only half the story, when we analyse return on capital, Ganfeng offers exceptional, industry leading returns, especially for hydroxide, the fastest growing segment in the market.

Source: Deutsche Bank
Ganfeng has effectively become the “clearing house” of spodumene concentrate. Recent agreements with Pilbara (stage 1 & 2) and Altura have been struck at far more advantageous terms than the original Mt Marion deal before new competing mines were commissioned. Pilbara’s December quarterly report highlights an average spodumene concentrate 6% price of US$742/dmt, well below the level Mt Marion. As tier 2 and 3 Chinese conversion plants falter or default and existing offtake agreements are reneged on or abandoned, Ganfeng is one of a few, possibly the only company, able to step in and buy the material long term.
Estimated spodumene concentrate offtake pricing formulas with Pilbara and Altura:
65% x China EXW battery grade lithium carbonate spot price
30% x ROW battery grade lithium carbonate price
5% x China EXW lithium hydroxide spot price
Taking into consideration the fact that Ganfeng, through its offtake agreements with Tesla etc, is moving away from the China spot market and more into the export market (ROW prices > China spot and exclude VAT on sale price), these factors should improve its operating margins considerably.
Estimated exports (ROW sales) as a % of lithium chemical production from 2019 onwards:
Lithium hydroxide – 60%-70%
Lithium carbonate – 30%-35%
From a raw materials supply perspective, if my contract assumptions are correct, Ganfeng’s carbonate operating margin is well hedged as it’s likely to sell 65%-70% of production in the China spot market, equal to the pricing formula.
From a hydroxide perspective Ganfeng has lots of operational gearing. Firstly, as can be seen in the table below, Ganfeng’s product mix is moving towards hydroxide, by 2020, the split will be roughly 57% hydroxide up from 26% in 2017. This means the hydroxide division will be paying China spot carbonate related raw material prices and earning China / ROW hydroxide prices. Currently that price spread is as high as ~$4,000/t. How long the hydroxide price continues to trade at a premium to carbonate is an unknown and will largely depend on the evolution of battery cathode chemistries. The longer the transition period from NMC 532 and the lithium agnostic NMC 622 to NMC 811 (hydroxide only) and the quicker the transition to solid-state batteries, the lower the price premium.
Estimated lithium production mix for Ganfeng:

Source: Libull, Company and DB
Ganfeng’s ability to execute volume growth and its diverse portfolio of products, particularly lithium metal, are some of the motivating reasons why the company deserves a 9-10x EV / EBITDA rating. In addition, as the company improves its corporate communication and provides greater insight and market feedback via its HK listing, foreign investors are likely to ascribe a higher valuation metric.
Estimated Ganfeng valuation based on F2020 EBITDA:

Source: Libull
Based on conservative EBITDA estimates to 2020 of between RMB2.8bn – RMB3.0bn and an exit EV / EBITDA multiple of 9.0x – 10x the implied Ganfeng share price is HK$16.58 – HK$19.73. As the company is installing a further 25KT p.a. of hydroxide capacity in 2020 and will still be in the early stages of ramping by year end, plus Cauchari Olaroz (25KT p.a. carbonate) will likely only come online in 2021, an EV / EBITDA multiple of 9.0x – 10.0x appears reasonable.
Risks of investing in Ganfeng:
Liquidity in the 1772 HK share is good with an average daily volume of 1.3 million shares (value US$2m) according to Yahoo Finance. Considering there are only 200 million shares listed in Hong Kong that’s a decent turnover relative to the amount of outstanding shares. However, Ganfeng’s HK market cap is only ~U$325m, the balance of the shares (~1.115bn) trade in Shenzen at a substantial premium to HK and a market capitalization of RMB25.24bn or US $3.71bn. The HK listing trades at an implied market capitalization of US$2.14bn, a 42,3% discount to Shenzen. Therefore, whilst Ganfeng is a material player in the lithium compounds market, foreign traders are realistically limited to the HK listed entity that has a limited market capitalization ($US325m) and daily liquidity (US$2m).
Capital controls in China make it difficult at times for local corporates to execute offshore transactions. This was the motivating reason for Ganfeng to list in HK, however, with Ganfeng’s low HK valuation the company will be reluctant to issue more shares to either raise capital or acquire businesses using script.
Minimum floor pricing in offtake agreements for spodumene concentrate could result in Ganfeng making an operating loss in the event that carbonate and hydroxide spot prices collapse in China and the ROW.
Conclusion:
In summary, whilst Ganfeng cannot currently achieve operating margins equivalent to fully vertically integrated producers the company has the lowest capex per ton of installed capacity and other than in extreme instances of low chemical prices, will achieve an exceptional return on capital. Given that it also has standout chemical processing skills and the likely abundance of spodumene concentrate supply readily available in the future, Ganfeng can grow its volumes faster than any of the other major lithium players without the need to raise further capital. The low market capitalization of the HK listed share (1772 HK) is a detraction for foreign investors, however, as the company continues to perform and the HK share price appreciates, Ganfeng will be in a position to issue more equity on advantageous terms and increase both its liquidity and market capitalization.[/COLOR]

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Great article, thanks.

If this pricing formula estimate is correct (65% china carb spot price,.....)

and if Ganfengs output by 2020 will be 57% hydroxide with some of that being sold to ROW at higher prices,

then PLS should renegotiate the pricing formula based on the larger margins Ganfeng will be getting by converting more spod into hydroxide rather than carbonate
PLS Price at posting: 66.5¢ Sentiment: Buy Disclosure: Held
5 Upvote

0 Great analysis

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