Why now might be a good time to buy ASX lithium producers
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Why have Australian lithium producers missed out on a global sector share price rally? Supplied
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by
Tess Ingram
Pun-laden headlines about the "super-charged" lithium sector would have you believe Australian lithium stocks have been on a tear.
That was certainly the story in 2016, when many of the local miners and hopefuls recorded triple-digit share price gains. But so far this year, the spark has been missing.
While global lithium players have surged, Australian lithium producers have been relatively stagnant.
Of the three key Australian lithium companies in production,
Mineral Resources is the best performing, up about 25 per cent since the beginning of January (and it is important to note the Chris Ellison-led company also has a significant mining services business and iron ore mines).
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Argentinian-focused Orocobre's share price has returned to its January base, after dropping nearly 40 per cent in March, while West Australian-focused Galaxy Resources has lost about 9 per cent.
The share prices are still strong compared to where they were 18 months ago, but considering these companies have kicked off and de-risked projects during a period when lithium prices increased about 30 per cent, they should arguably have performed much stronger.
The same holds true for a number of the lithium hopefuls developing the next phase of Australian production – investors shrugged as strong sales agreements were inked or construction milestones reached.
The performance is especially jarring when compared to the rally global lithium producers have enjoyed in step with the rising prices and a string of positive demand indicators for the metal, which is used in the lithium-ion batteries that power electric vehicles and energy storage systems.
Of the five major global lithium producers, US-listed Albemarle, FMC and SQM are up between 50 and 100 per cent while Chinese-listed Tianqi Lithium and Jiangxi Ganfeng Lithium are up more than 100 and 200 per cent respectively.
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Lithium-ion battery cells being inserted into a battery pack. Investment in battery capacity has increased dramatically over the past few years. Bloomberg
One portfolio manager told Due Diligence he and his team had been "pulling our hair out".
"We were sure we were right but then not many of our lithium stocks were doing what we thought they should be doing," he said.
So why are Australia's lithium miners the global laggards?
Investors, analysts and company executives say there are a few dynamics behind the unusual disconnect.
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Mineral Resources has a 43.1 per cent stake in the Mount Marion lithium mine in Western Australia. Supplied
Scale, shorts and sentiment
For one, the global lithium producers are all much bigger than the Australian players.
Albemarle, FMC, SQM and Tianqi all have market values in excess of $US10 billion, with Ganfeng at about $US9.5 billion.
By comparison, Orocobre, Galaxy and MinRes have market caps of $920 million, $1 billion and $2.9 billion respectively. Pilbara Minerals is the largest developer with a value of $830 million.
The Australian miners are only just making ground in an industry that has long been an oligopoly. They are competing against large, well-established producers that have the scale and liquidity to attract significant institutional or index-focused investors.
But this may be beginning to change, with the likes of BlackRock and The Vanguard Group dipping their toes in Down Under. BlackRock is now Galaxy's biggest shareholder with about $70 million worth of stock. Pilbara isn't in production yet and already both funds feature in its top 10 shareholders.
Then there's the fact the global producers produce a more refined lithium product.
The Australian producers, except for Orocobre, produce a concentrate from spodumene, a lithium-bearing mineral.
The concentrate is
then converted into end-use battery chemicals, including lithium hydroxide and lithium carbonate.
Orocobre and the global producers produce lithium chemicals.
Given the significant short positions in the Australian stocks, another theory is that some US hedge funds have taken long positions in the larger US stocks and short positions in Australian producers. About 16 per cent of
Orocobre's shares are held short and about 10 per cent of Galaxy's.
And lastly, it could come down to how Australian investors think.
Our strong tradition in resources may be doing us a disservice in this instance, numerous sources suggested to Due Diligence.
"The same argument some Australian investors have made about the near-term uncertainty around supply and demand can be made for Albemarle, SQM and FMC and yet their share prices have gone up," Canaccord Genuity analyst Reg Spencer says.
"And that tells me the investors in those markets are thinking about this in a much longer term fashion than the resource-focused guys here, who are thinking more cyclically."
Buying the disjoint
But not everyone is thinking that way. Tribeca Investment Partners portfolio manager Ben Cleary says the disjoint has created opportunities.
"More than half our portfolio is in North America – as we are global investors – but all of our lithium exposure is via Australian listed stocks because they represent far better value on most metrics but particularly on an enterprise value [EV] to production tonnes basis," Cleary says.
Tribeca's analysis pegs MinRes's 2018 EV to production tonnes at $US50 a tonne, with Galaxy at $US38 a tonne and Orocobre at $US49 a tonne. By comparison the global producers are on a much higher "premium" – SQM at $US338 a tonne, Ganfeng at $US565 a tonne and FMC at the top of the bunch at $US779 a tonne.
"We see this dislocation between Australian and international peer valuations as short term and believe it's a great opportunity from the long side," Cleary says.
There are of course many that would disagree and argue the Australians' valuations reflect the risks the companies face entering a market dominated by powerful majors that could ramp-up supply and alongside tens of other new entrants racing to bring on new projects.
Plenty think the rapid price acceleration has echoes of previous mineral sands and uranium price booms which rapidly collapsed, burning investors.
There's no doubt plenty of the ASX-listed lithium aspirants' projects won't ever see the light of day. Terra Capital's Matthew Langsford said it is all about identifying "those very low on the cost curve or in production soon – that's going to be a good place to make money".
But for Cleary, and others, the long term draw card is the one that has grabbed headlines – the super-charged demand growth.
The Chinese demand case
Battery costs are continuing to decline, traditional
carmakers like Volkswagen and Mercedes-Benz are accelerating their EV strategies and regulators across the world are pushing for a transition to electric cars.
In July, the United Kingdom and France advised they would ban the sale of petrol and diesel engine vehicles by 2040. China followed suit earlier this month with a commitment to
switch all car sales to electric vehicles, but without setting a firm date.
This would be a significant driver given China is the world's largest auto market. In terms of electric vehicle sales, China's BYD is bigger than Tesla.
China's major cities are some of the most polluted in the world and the government wants 5 million EVs on the road by 2020 as part of its plan to clean up.
As China's strategy evolves, it has wound back subsidies for electric vehicles. But a range of disincentives forced on consumers that continue to opt for petrol and diesel cars continues to drive sales of EVs.
The confidence in a positive outlook is reinforced by the slow response from the supply side - mines are not being built as quickly as battery manufacturing capacity is being brought online.
This dynamic has been exacerbated by lithium miners' difficulty securing traditional bank finance. Miners have said the metal's lack of price visibility and hedging made banks skittish.
And it's not just lithium - last week Syrah Resources, which is developing the world's largest graphite deposit, ended months of debt talks with an equity raising after not securing a facility on terms it was comfortable with.
"The capital being deployed into the sector is still not in tempo with the rate at which supply needs to grow just in order to meet demand, let alone exceed it," Galaxy Resources managing director Anthony Tse says.
"And looking at the customs data we have seen lithium prices go up very healthy double digits since the end of last year. But at the same time you have a noticeable increase of raw materials into China – mainly spodumene and some lithium carbonate and chloride - based on our calculations for the first seven months of the year that's already up almost one-fold.
"You are looking at a one-fold increase in raw materials and the price has still gone up double digits and that tells you something about the demand side of the equation. So even we as industry insiders are still trying to get our heads around it but the general feeling is we have all underestimated demand levels."
It seems the ASX lithium stocks have some catching up to do.
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Assuming the trend continues, at some stage this company is gonna go bang based on the above....
(20min delay)