Lithium Is Hot, But Here’s What You Need To Know Before Investing In The Trend

April 19, 2018

Lithium Is Hot, But Here’s What You Need To Know Before Investing In The Trend

  • Is the current decline a lithium buying opportunity?
  • We’ll analyze the sector, and the key factors to watch in the industry.
  • I’ll use a bottom up approach and discuss the company Lithium Americas.



Introduction

We all know the story about lithium and the expected surge in demand coming from the electric vehicle boom. However, some stocks haven’t performed as many expected in the last few months, and I want to look at what’s going on to see whether it’s a buying opportunity or if we should still stay clear of lithium miners.

Today, I’ll use a bottom up approach to discuss Lithium Americas (NYSE: LAC). By analyzing the company, we will see how it fits in the lithium environment and what we have to seek out when analyzing investments as there is a high likelihood that lithium will be the place to be over the next 10 years due to its lightness. 

Lithium Americas

At the end of November 2017, LAC reached a high of $10.95 only to steadily decline to $5 since then. It’s at $5.3 as I’m writing this. When something in a positive structural trend drops 50%, I like to look at what’s going on.

Figure 1: LAC’s price in the last 6 months. Source: CNN Money.

LAC has a joint venture with Chemical & Mining Co. of Chile (NYSE: SQM) on the Caucharí-Olaroz lithium project in Argentina where a definitive feasibility study was recently completed that supports operating costs of US$2,495/t with 40-year project life. The company has also secured financing of $285 million in equity and credit from Ganfeng Lithium and Bangchak to fund Caucharí-Olaroz Stage 1.

Their hope is to start producing lithium by 2020 and with a $425 million CAPEX.

The project shows interesting economics and shows a net present value of $803 million at lithium prices of $12,000, operating costs of $2,500 per lithium ton, and there is also the potential to double production if economically viable.

Figure 2: Caucharí-Olaroz’s key economic data. Source: LAC.



Now, one would look at the economics of the project and say that given the price of lithium is above $20,000, this should be a stellar investment. Not so fast, there’s a big difference between South American and Chinese lithium prices ($13k vs. 20k).

Figure 3: The lithium spot price is above $20,000, but long-term contracts are around $13,000. Source: LAC.

This is also the main problem with lithium miners as it seems like a race between tortoises and hares. The tortoises are the big producers that will supply huge amounts of lithium when the economics are beneficial over the long term, while the hares are the up-and-coming producers that are trying to take advantage of temporarily higher prices. Before looking deeper into the lithium environment, let’s talk briefly about the second project LAC owns.

The second project they own is the Lithium Nevada project where a pre-feasibility study is expected in Q2 2018. The project will produce lithium form clay-stone. One should compare the current resources with other similar projects to see what the value could be, but that’s beyond the scope of this article.

Fundamentals

The company has $73 million in cash and a fully undrawn credit line of $205 million. The largest shareholders are Ganfeng Lithium, Bangchak, and the management. The major shareholders also own the loan of $205 million at an interest rate from 8% to 9.5%, and they will also take 100% of the production in the 20 producing years.

So it looks like the project will go on and SQM is also interested given that it will increase its 2020 production by 25%, or 12.5% pro rata. Let’s look at the lithium environment and the risks for the net present value of $800 million for the project, which by the way is $400 million for LAC and still below the current market cap.

Lithium Environment

Morgan Stanley came out in February and splashed cold water on the lithium sector saying that lithium prices will be 45% lower by 2021 based on insufficient demand and a slower increase in electric vehicle production.

The new additions in production threaten to add 500,000 tons by 2025 which is 10 times more than the current production capacity of SQM, which is 23% of market share. The bank expects huge surpluses from 2019 onward which will lower the price of lithium to $7,000.

Figure 4: Morgan Stanley’s prediction about lithium. Source: Business Insider.



In order to clear the market, electric vehicle sales would have to be 13.6% of the market by 2025, thus 7 times more than the current 2%. Morgan Stanley’s penetration expectation by 2025 is 9%.

What we can also learn from the Morgan Stanley report is that the marginal cost of production, thus the most expensive ton of lithium in 2025, is expected to cost $7,000. Therefore, to invest in lithium producers, we have to find those with all-in sustaining costs well below $7,000 to see stable long term profits.

Now, given LAC’s economics, even with a lithium price of $7,000, there would still be some value there. Just extrapolating from LAC’s data gives me a net present value of around $50 million with ` a 10% discount rate, but around $600 million with a 6% discount rate for the complete Caucharí-Olaroz project at a $7,000 lithium price. If lithium prices stay around $14,000, the NPV becomes $2 billion, thus $1 billion for LAC.

Figure 5: LAC’s net present value sensibility. Source: LAC.

So, there is definitely risk there, but there is also potential so you should expect volatility but if you are looking for a volatile play to trade on the lithium trend, you could keep an eye on LAC.

The Industry Doesn’t Agree With Morgan Stanley

Ken Brinsden, CEO of Pilbara Minerals, said that Morgan Stanley is underestimating the difficulties in bringing all those projects to life and operating profitably.

Paul Graves, CFO of FMC, the fourth-biggest lithium producer, said that the industry has repeatedly failed to bring on its supply in the way it predicted by always being late and always more expensive to operate. Something to keep in mind about the lithium sector, but also before investing in a stock.

Back to the production, Albemarle sees lithium demand at 800,000 tons by 2025, thus a 60% higher level than Morgan Stanley projects.

Further, there is something Morgan Stanley forgot about, and that is a trend called energy storage. We all think about cars, but storage might be the next trend that might displace, not even disrupt, the way we consume and produce electricity.

Figure 6: Drivers of lithium growth. Source: Albemarle.



Albemarle also sees a much higher EV penetration rate than Morgan Stanley while others see even higher rates.

Figure 7: Penetration rate for EV, various expectations. Source: Albemarle.

Conclusion

Is the lithium trend going to stick around? Yes, given all the developments going on and technology improvements in energy storage. Therefore, one should keep an eye on what’s going on and start slowly exposing one’s portfolio to such an investment. However, always keep in mind that the sector will remain volatile forever, so rebalance accordingly especially in the next recession.

I’m going to finish today with Morgan Stanley’s lithium stock outlook which will give you fresh ideas for where to look and what to expect.

Figure 8: Morgan Stanley’s lithium sector stock ratings. Source: Business Insider.