By Chris Berry (@cberry1)
With earnings season winding down and news of vehicle electrification hitting the wires daily, it makes sense to take stock of Q2 results from some of the major players in the Energy Metals space and position as necessary. After all, this is a cycle. There is a great deal of “macro” news I could discuss here, but decided to keep this note short and focused on the producer side of the Energy Metals business.
· Lithium segment results from Albemarle (ALB:NYSE) and FMC (FMC:NYSE) were unsurprisingly strong (Ed note: SQM doesn’t report until later this month, but based on previous guidance, results similar to ALB and FMC can be expected).
o ALB reported lithium segment sales of $244M in Q2 up 55% driven by higher pricing (up 31%) and volume (up 25%). Adjusted EBITDA margins of 47% continued a streak of at least eight straight quarters of +40% operating margins in the lithium segment. The company forecast higher costs going forward due to expansion and exploration expenses and also LOWER average lithium pricing for customers saying that Q3 and Q4 lithium results are likely to match Q1 – perhaps managing investor expectations downwards. The stock sold off hard, falling as much as 6% and is down another 2% as I write this. Given that ALB has returned over 40% in the past year and pundits on CNBC are recommending buying the stock at close to all-time highs, perhaps a pullback was long overdue.
o FMC reported lithium segment sales of $74M up 17% and segment earnings of $24M, up 47% over Q2 2016. Margins here are lower than that of ALB at 32%. While FMC benefited from higher lithium pricing and sales mix (up 20%), disappointingly volume fell by 2%. The company announced plans to spin out its lithium business into a separate company during the second half of next year. Given that lithium is now a minor portion of FMC’s overall business (11% of revenues) and this move has been rumored for some time, it’s not a surprise.
· These strong results bring forth the key issues facing each company in their lithium expansion strategy. Both companies have stated their intention to maintain or increase market share in the lithium space with ALB wanting to have lithium production capacity of 165,000 tpy LCE by 2021 (up from 89,000 t today) and FMC expanding their carbonate capacity in Argentina and hydroxide capacity in China to 40,000 tpy and 30,000 tpy respectively.
o For ALB to achieve this aggressive goal, expansion at La Negra II and III (44,000 t today to 80,000 t) must roll out without a hitch, capacity at Greenbushes must be doubled (40,000 t today to 80,000 t), and conversion capacity at Xinyu (10,000 t today to 30,000 t) and recently acquired Jiangxi Jiangli (15,000 t today with expansion to approximately 35,000 t) must come on stream by 2021 – four relatively short years away. This seems overly aggressive given the time it takes to develop new resources and expand capacity. A lack of customers doesn’t appear to be a problem, but getting everything “right” by 2021 may be.
o FMC’s expansion rests less on the need to raise $250-$300M it has stated it will need to reach their capacity goals (by 2020) but more on the security of supply. The company is currently producing 18,000 t LCE and will add 4,000 t through “debottlenecking” and 8,000 t from an off take agreement with Nemaska Lithium. The remainder will be sourced from third parties which is the “preferred option”. Even if debottlenecking is successful and Nemaska can raise the large funds to commence commercial production, this still leaves FMC short leading to the next takeaway from Q2….
· The majors seem unconcerned by raw material security of supply. This appears to be the major flaw in FMC’s strategy and Joe Lowry has rightly pointed this out for some time. I was surprised to on the FMC earnings call when no analyst questioned the company’s ability to source lithium from third party sources. Accessing third party feed will literally make or break their plans to grow the lithium business by 2020. The only major lithium producer to make significant moves in this regard recently is SQM with their $110M deal for Kidman Resources’ hard rock project in Western Australia. Is SQM, a force in the brine space, overreacting to long term demand trends by forging into the lithium hard rock world, or are ALB and FMC ignoring this critical need for raw material feed for their operations? With lithium demand so strong, organic expansion will only get you so far and so increased M&A in the Energy Metals space is likely over the next 24 months as supply chains continue their evolution. With over $1B raised or committed in the lithium sector YTD for expansion and roughly four times that necessary to meet existing demand by 2025, tight markets and lofty valuations may become the norm. As an investor, understanding the “next wave” of potential lithium/cobalt/graphite/nickel suppliers is key to any value creation strategy at this stage of the Energy Metals cycle.
· Given this interest, large cap miners such as Glencore, Rio Tinto, and BHP now re positioning themselves as companies prepared to participate in the Energy Metals boom is no surprise. Recent announcements from these companies (Glencore with nickel and cobalt, Rio Tinto with lithium, and BHP with nickel sulphate) dictates that the interest (and potential to profit) from the shift in vehicle electrification and energy storage has reached companies who typically overlook niche markets as they don’t “move the needle” on the revenue side. You’ll know their intentions are more than just talk when they start committing significant capital to build out capacity – be it in lithium, cobalt, or nickel. Watch what they do, not what they say.
· So as I said before, the Q2 results from companies along the Energy Metals supply chain points to continued tightness in the markets[i]. But what could go wrong? I spend most of my time ruminating on this topic, but monitoring raw materials prices, EV sales numbers, and advances in battery technologies (larger size or higher energy density) should be the main keys to drive these markets in either direction. Another caveat would be malinvestment. Specifically, looking closely at any deals that are consummated in this sector and really understanding if and where value can be unlocked. With a permanent shift in the lithium cost curve (not so with cobalt or graphite), valuations are higher than historic norms and the rush to get a toe hold in this sector can be tempting. Bad deals are sure to be done and we’ve seen this pattern in previous booms (uranium in 2007, rare earths in 2011, etc). However, to finish on a positive note, pricing remains firm, EV sales numbers have momentum behind them, and significant changes in battery chemistry seem years away, all implying that we have several quarters of continued growth ahead of us. A balanced approach to this small but quickly growing sector is still the best way forward from a risk management perspective.
The material herein is for informational purposes only and is not intended to and does not constitute the rendering of investment advice or the solicitation of an offer to buy securities. The foregoing discussion contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (The Act). In particular when used in the preceding discussion the words “plan,” confident that, believe, scheduled, expect, or intend to, and similar conditional expressions are intended to identify forward-looking statements subject to the safe harbor created by the ACT. Such statements are subject to certain risks and uncertainties and actual results could differ materially from those expressed in any of the forward looking statements. Such risks and uncertainties include, but are not limited to future events and financial performance of the company which are inherently uncertain and actual events and / or results may differ materially. In addition we may review investments that are not registered in the U.S. We cannot attest to nor certify the correctness of any information in this note. Please consult your financial advisor and perform your own due diligence before considering any companies mentioned in this informational bulletin.
The information in this note is provided solely for users’ general knowledge and is provided “as is”. We at the Disruptive Discoveries Journal make no warranties, expressed or implied, and disclaim and negate all other warranties, including without limitation, implied warranties or conditions of merchantability, fitness for a particular purpose or non-infringement of intellectual property or other violation of rights. Further, we do not warrant or make any representations concerning the use, validity, accuracy, completeness, likely results or reliability of any claims, statements or information in this note or otherwise relating to such materials or on any websites linked to this note. I own no shares in any companies mentioned in this note. I am a member of the Board of Directors of Desert Lion Energy. I have no relationships with any other companies mentioned and own no shares of companies mentioned.
The content in this note is not intended to be a comprehensive review of all matters and developments, and we assume no responsibility as to its completeness or accuracy. Furthermore, the information in no way should be construed or interpreted as – or as part of – an offering or solicitation of securities. No securities commission or other regulatory authority has in any way passed upon this information and no representation or warranty is made by us to that effect.
[i] I have neglected to discuss Umicore (to save space) and Glencore (who reports tomorrow) but the strength I discuss above can be extended to these two companies and their businesses as well.