By Chris Berry (@cberry1)
The Trump-induced reflation trade has been a popular one on Wall Street with the major equity indices such as the SPX at all-time highs and up slightly YTD (+5.57), the US 10 Year Government debt market and the USD both range bound.
Whether or not President Trump’s planned economic de-regulation plans can sustain this remains to be seen (this is likely fodder for another note).
The mining sector has also benefited from this idea of a reflation trade, with this sense of optimism and de-leveraging from major mining companies translating into strong gains in recent months. Glencore (GLEN:LON) up 87%, Anglo American (AAL:LON) up 65%, BHP Billiton (BHP:NYSE) up 26%, and Rio Tinto (RIO:NYSE) up 37% over the past six months respectively.
Lithium names have also benefited here and are continuing plans to increase production capacity to maintain and increase market share.
SQM (SQM:NYSE) aims to generate $1B in EBITDA by 2020 (the company reported roughly $238M in Q4 2016) and will invest $300M to achieve this target. The joint venture with Lithium Americas (LAC:TSX) will comprise the bulk of this but the company stated it plans to invest $100M in 2017 for expansion. Even in a bull market, return on invested capital (ROIC) matters and it appears that SQM’s investment in a major cash flow driver for its business is an obvious and sound strategic move.
Orocobre (ORE:ASX, ORL:TSX), despite posting reasonable financials, continues to struggle, again lowering its production guidance to 12,000 -12,500 t from 15,000 t. The company still plans to double capacity to 34,000 tpy Li2CO3 by the end of 2018, but has yet to reach their original stated capacity of 17,500 tpy.
Albemarle (ALB:NYSE) reported Q4 and fiscal year results yesterday and continued its relative dominance of the lithium space with yet another quarter of 40%+ margins. Volume and pricing growth were up 18% and 14% respectively, though there are many, including Joe Lowry, that question this conservative pricing strategy in a raging bull market for lithium. The company reported a 31% YOY increase in lithium sales to $669M and a 34% increase in adjusted EBITDA to $286M. The company’s efforts at deleveraging have left it with $1.4B in cash and a debt/EBITDA ratio of 2.2x. This is balance sheet strength and flexibility is exactly what the company needs as it embarks on its aggressive expansion plans.
ALB did forecast an additional $60 to $70M in costs on 2017 to its lithium business, but the continued strong demand acts as a buffer here. Higher pricing of 10 to 15% should also be beneficial. On the call, CEO Luke Kissam commented that the company’s stated goal is to generate a return double that of their cost of capital. Investing in their lithium business is the clear drive to achieve this goal.
More broadly, the themes of project-level investment and consolidation will continue with Nemaska Lithium (NMX:TSX) a likely next beneficiary due to its solid location and de-risked profile. Given their success in raising $70M from the institutional investor community, the composition of the investor base and structure of the financing here should be an interesting data point.
The Lithium Americas (LAC:TSX) financings were a seminal event in the current lithium cycle as it showed a belief from multiple strategic partners that the demand story is real. With LAC, NMX, Galaxy Resources (GXY:ASX), Neometals (NMT:ASX), Pilbara Minerals (PLS:ASX), and Altura Mining (AJM:ASX) among those forecast to add to lithium supply by 2020, and the need for the equivalent of one new lithium mine to come on stream every year between now and 2025, many are looking at which companies may comprise the “next wave” from 2020 onwards.
On the hard rock side, WCP Resources (WCP:ASX) has focused its efforts on hard rock pegmatite exploration in North Carolina, where I recently returned from a site visit. The history of lithium mining is well known in this part of the world and though it’s at an earlier stage, the company plans on executing a drill program to better understand the pegmatite zones on its project and producing a scoping study this year.
Reflation or not, the bull case for lithium remains intact. Even ALB, who constantly tries to talk the market down, referenced the need for 20,000 tpy LCE in their demand models during the earnings call. While I still think that execution outranks exploration in terms of value creation, a reasonably positive macroeconomic environment, low interest rates, and voracious demand for next generation technologies imply that deal making in the lithium space will continue.
The argument for security of supply around lithium and associated raw materials will only grow louder as the dynamics around energy generation and storage continue to evolve.
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