Lithium: A dark corner in a bright stock market

An industry with a promising future that is currently struggling with cyclical headwinds.

While some investors are celebrating the latest investment themes generating marvelous returns, others are still cleaning up the aftermath of previous ones that flamed out badly. One of those is the clean energy bubble of 2020/21. EV manufacturers and lithium miners are among the worst performers YTD. Albemarle ALB 0.00%↑ and SQM 0.00%↑ are down 24% and 33% respectively.

They are suffering from sharp commodity price declines due to supply/demand imbalances. From a supply perspective, the promise of an all EV future has created large investments and a lot of production capacity has come online. From a demand perspective, there is a clear slowdown in EV adoption due to saturation of certain market segments and due to reduction in government subsidies in some of the key markets.

But aside from this growth pain, it’s in my opinion actually not in question whether or not individual ground transportation will be mostly electrified eventually. It seems obvious considering our emission targets and clearly favorable cost curves from scaling the technology.

The potential is huge. Battery raw materials will be needed in almost unimaginable quantities to enable EV manufacturers to deliver on their production targets. This begs the question whether there will eventually be a buyable dip in some of these names. In this article I will take a closer look. It will be mostly an industry research article. But towards the end, I will touch on the two largest players in the US: Albemarle ALB 0.00%↑ and Sociedad Química y Minera de Chile SQM 0.00%↑.

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TLDR Summary

• The lithium price boom of 2021/22 was fueled by speculation that battery demand prospects would cause shortages due to long lead times of new mining and production facilities. It turned out that it was indeed just that: speculation. So far, these shortages have not materialized as the supply response is outpacing demand growth. This is exacerbated by an apparent slowdown in EV demand caused by saturation in certain market segments and phase-out of subsidies. This has created excess supply in the global lithium supply chain. By cutting into the cost curves of producers, markets are enforcing its rebalancing.

• However, it seems that this is a temporary moment of pain. In the long-term, the proliferation of EVs seems a done deal due to our emission targets and clearly favorable cost curves from scaling this technology. Most of individual ground transport will be electrified eventually and lithium-based cell chemistries still are and will continue to be superior solutions from a cost and performance perspective.

• The current supply response has likely been facilitated through dormant capacity in existing mines and production facilities. There will eventually be limits to that. Once EVs are being produced in sufficiently large numbers, new facilities will be needed. These are already in the making, but they require 10 years or more to come online. The supply/demand gap will likely start closing next year and a deficit will likely open up towards the end of this decade. It’s possible that current woes will amplify this deficit as producers might cut back production plans due to unattractive economics and possibly financial distress.

• The two largest lithium players listed in the US are SQM 0.00%↑ and ALB 0.00%↑. Together they account for more than a third of global lithium production which puts them into a strong bargaining position. Both are currently trading at unambitious valuations which makes them attractive BTFD candidates.

• However, a near-term turnaround of their EPS trajectory appears unlikely as commodity price changes are hitting their financials with a lag. Consensus estimates appear elevated both from a revenue and from a margin perspective. If there is further income statement consolidation ahead, simple valuation metrics may send the wrong signals. They would be classic value traps, at least in the near-term.

• In the long term, I consider the value proposition of these stocks quite attractive. We will learn more on Feb 15 (this coming Thursday) when Albemarle reports their 4Q23 earnings. SQM will follow on Feb 29.