Lithium Americas Stock Price Has 1000% Upside But There Are Risks

  • Lithium Americas stock price is trading at a 90% discount to the combined net present value of the two lithium projects it owns – the Cauchari Olaroz brine asset in Argentina and the Thacker Pass claystone asset in Nevada
  • The key when analyzing Lithium Americas is to know it is a junior miner. Junior miners have only equity as their currency and might easily over promise to push their stock prices up.
  • Lithium Americas expected production costs in Argentina are 30% lower than Orocobre’s current production costs on what is practically the same asset.

Lithium Americas (NYSE: LAC) is developing two lithium projects, the Cauchari-Olaroz brine asset in Argentina and the Thacker Pass claystone asset in Nevada with very interesting economics. The net present value at a 10% discount rate (current value of future cash flows minus cash outflows) is $1.1 billion for the Argentinian project of which LAC owns 50% and $2.6 billion for the American project owned 100%.

1 cauchari olaroz

Source: Lithium Americas

The combined net present value for LAC’s projects is $3.15 billion or $35 per share. Compare that to the current market cap of $318 million and you get a discount of 90%. Whether it is justified or not will be discussed in this article.

2 Lithium americas stock price

Cauchari Olaroz should be up and running in 2021 and Thacker in 2022. However, a decision has still to be made for Thacker despite the extremely positive pre-feasibility study.

2 thacker pass

Source: Lithium Americas

I’ll first discuss the risk and reward of the two projects and then end with a valuation and investment thesis for the stock.

Argentinian brine project adjacent to Orocobre

The Cauchari- Olaroz plant is close to Orocobre’s (OROCF) plant so we have an indication of the project’s potential and profitability.

3 orocobre litium

Source: Cauchari Olaroz Technical Report

Orocobre is already producing there with strong margins above 50%, even with the currently subdued lithium prices.

4 orocobre margin

Source: Orocobre presentation

However, LAC is expecting even better margins from what I see in their pre-feasibility study. LAC’s expects  $300 million in revenue, around $150 million after-tax profits, and $225 million before interest and tax. This means that the cost of sales should be around $3,000 per lithium ton sold or 30% below Orocobre’s current costs. On top of that, current lithium prices are not at the expected $12,500 per ton but below $10,000.

5 cash flow

Source: Cauchari Olaroz Technical Report

If I adjust lithium prices to $10,000 and cost of sales to $4,300, like it is the case with Orocobre’s plant, the operating margin should be $6,700. Add the 35% profit tax applied in Argentina and what you are left with is a $4,335 profit per ton. Plus, there are other taxes, like a 1% royalty, VAT, local taxes, and there might be more taxes in Argentina given that the political environment might change after the October elections. My estimate is that LAC will hardly reach the expected profitability on the project.

If I add other related costs and assume after tax free cash flows of $3,500 per sold ton, the average cash flows per year should be around $87.5 million and not $150 million as the technical report estimates.

6 cash flows cauchari olaroz

Source: Cauchari Olaroz Technical Report

Consequently, my net present value calculation differs significantly from what the company presents. It is actually 50% lower. It is a big risk for investors as there will always be operating issues, delays and unpredicted things happening when developing such a project.

Table 1. LAC’s technical report cash flows and my estimated cash flows (2019-2061)

lac cash flows

Source: Author’s estimations

The net present value of Cauchari Olaroz should be around $600 million based on higher operating costs and lower margins. If you add the usual discount for undeveloped projects of around 30%, or even 50%, depending on lithium prices, you soon fall to a NPV of $300 million or $150 million for LAC’s stake.

Lithium Americas – Thacker Pass Project Nevada

The Thacker Pass Pre-Feasibility Study says it is not precise and that estimations can vary 25% on the upside and 20% on the downside. An investment decision has not yet been made to develop the largest lithium source in the US.

A significant risk is the application of a new lithium recovery process. “A process flow sheet that uses conventional leaching and purification technology has been developed, and replaces the roasting/calcining approach that was considered in a previous technical study (Tetra Tech, 2014).”

This is a good place to comment on the fact that LAC quadrupled the number of outstanding shares over the last half decade. Therefore, all estimations are likely to be stretched towards the positive as the company’s success depends on the stock price for capital raises.

7 thacker process

Source: LAC – Thacker Technical Report

As we don’t have comparable production numbers from Thacker like plants, I will focus on the company’s estimates.

8 thacker pass

Source: LAC – Thacker Technical Report

The net present value of the project is highly sensitive to lithium prices. If lithium prices remain at current levels, the present value of the Thacker Pass project is just $1.2 billion. This doesn’t include financing and we know LAC doesn’t have the $581 million required to develop only the first phase of the project.

9 costs phase 1

Source: LAC – Thacker Technical Report

On top of operational risks, another big risk for investors are even just temporary lower lithium prices. LAC might not be able to issue equity at favourable terms to finance their projects. It is also hard for a company with a $318 million market capitalization to issue shares to get to an amount of $581 million necessary to develop the Thacker Pass, even if half of the amount could be collected by issuing debt. A 50% dilution would lower the NPV per share from $35 to $22 and therefore lower the potential upside for investors.

It is also always possible that somebody buys the projects or the whole company at a 25% premium on the subdued stock price. This would limit your investing upside while the downside risks remain equal.

Further, when it comes to developing mining projects, it is really rare that something is done under budget. Plus, when you take a look at sensitivity charts, those always focus on only one variable. The combination of lower lithium prices, higher initial capex, operational issues, possible higher taxes or whatever, significantly changes the initial net present value and internal rate of returns.

12 prices

Source: LAC – Thacker Technical Report

At current lithium prices, the IRR is already very close to 20% which is usually a mining threshold that you don’t go under.

However, with higher lithium prices and no operational issues, the Thacker Pass Project might become a highly profitable project with yearly cash flows of above $500 million per year from 2025 onward.

10 cash flow

Source: LAC – Thacker Technical Report

Lithium Americas Stock Price potential

LAC is an extremist an investment. If all goes well, it could deliver a 1000% investment return over the next 5 years. However, if they need to issue many shares to develop the Thacker pass, enter into joint ventures and there are operational issues alongside lower lithium prices, the future potential value quickly drops.

So, this can easily get complicated. I would say there is just a 10% chance that all works well, a 50% chance we see higher lithium prices and the stock returns to where it was, and 40% chance things turn south due to one of the mentioned risks.

10 lac final table

My conclusion is that LAC is worth around $7 per share but there is also significant potential for permanent loss of capital which excludes this from my personal investing world.

For example, Albermarle (NYSE: ALB) offers similar upside with less downside. Here is the article on ALB.

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ALBEMARLE – Lithium Stock Offering 4x Growth Up To 2025

Albemarle business overview

Lithium Albemarle investment thesis

Lithium cost curve

Current analysis of Albemarle + the growth story

Albemarle – Bromine & Catalysts

Investing risk

Conclusion – expected investment returns

I am researching the chemicals sector as there are many stocks with low PE ratios that look valuable at first sight.

The below is part of my list, I am looking at one by one, writing up short overviews, and at the end of the process, I’ll see what are the best businesses to watch over time and perhaps even buy when cheap. I’ll write up deep reports on the most interesting businesses.

1 list overview

Source: Stock Market Research Platform

Albemarle (NYSE: ALB) is a very interesting business creating a strong buzz with its lithium segment. The stock is down but the business looks strong, it is time to make a deep dive into the lithium sector.

2 albemarle stock price

On a side note, the above chart perfectly describes the biggest benefit of value investing versus growth investing is. During 2017, with high lithium prices, investors where extrapolating staggering growth rates for ALB and expecting lithium prices to grow forever. In such an exuberant environment few even consider the risks, but at some point, the growth has to slow down and when that happens, the situation gets ugly. It gets ugly for those that have chased growth, of course.

Value investors on the other hand, avoid hot stocks due their high risk. As seen in the above chart, growth stocks can easily fall 50% and more. However, this doesn’t mean anything. Value investors actually look at companies when there is usually a lot of negative sentiment while the fundamentals still offer attractive business returns. By buying businesses, with an attractive business earnings yield in relation to the price paid, you buy with a margin of safety. Thus, you don’t lose money, which is the key when it comes to investing!

Disappointed growth investors often create the best buying opportunities. When it comes to hot stocks, the excitement usually vanishes quickly and when that happens, one has to look at the fundamentals, estimate earnings with and without exuberance to see what is the investing risk and reward. This report will focus on that.

Albemarle business overview

Albemarle is a diversified business and there are 3 sectors to discuss: Lithium, Bromine and Catalysts. All sectors have different sector environments that make this an interesting, diversified business.

3 albemarle business overview

Source: Albemarle investor relations

The market capitalization is $7.7 billion and the net income is $695 million for a price to earnings ratio of 11. We have to see about the trends and earnings for each specific sector so that we can make a forward-looking earnings model.

The lithium segment is the growth one while bromine and catalysts will be good if maintained at current levels.

3 albemarle business segments lithium

Source: Albemarle investor relations

The company has been good at rewarding shareholders with a 26 year dividend increase record and strong buybacks of $500 million. Combining the buybacks and dividend gives a yield of 9%. The lithium environment also offers excellent growth opportunities.

4 albermarle buybacks growth

Source: Albemarle investor relations

All of Albemarle’s sectors have good margins with lithium being the best lately.

5 albemarle overview

Source: Albemarle investor relations

Let’s take a deeper look at the individual segments and then make an earnings model based on the findings.

Lithium Albemarle investment thesis

Lithium is what pushed the stock above $100 and then brought it back when lithium prices fell due to higher expected supply, cancellation of Chinese EV subsidies and other issues.

6 lithium price

Source: Trading Economics

However, that is completely normal, when the price of a commodity goes up, more investment projects are feasible, therefore there is more supply and the price has to decline. The key is that, at some point in time, it will be nature that will determine the price. In such a scenario it is always good to be the lowest cost producer.

It is good to note here that lithium is not really a commodity as lithium products are not really the same in a way copper is. Albemarle recently decided not to notify the London Metals Exchange on its contracts as it is not possible to compare what is produced and sold. Lithium customers know what they need and they want to get it through long-term contracts.

Lithium cost curve

We can take a look at the cost curve for lithium, but it should be taken with a grain of salt as it depends on what the customer needs and whether the specific mine can provide the necessary chemical formula.

2 cost curve.PNG

Source: Lithium Americas

Alongside SQM, ALB has the lower production costs out there. This means that whatever happens with lithium prices, the company should have profitable operations. If we look at the projects they are ramping up. Xinyu is a project in China that should be on the middle of the cost curve. La Negra is in Chile, thus low cost. The Kemerton plant in Australia will be somewhere in the middle. However, this all depends on what the customer wants. Even if Australia is on the high end of the cost curve, ALB’s mine Talison is one of the best spodumene mines in the world, which means one on the lowest cost hydroxide lithium producers. So, both in Chile and Australia, low cost.

7 alb growth strategy

Source: Albemarle investor relations

If we approach it from a commodity perspective, the question is what will be the price depending on the supply and demand. The current price is around $10,000 and the fact is that production can be easily increased, both in Australia and in South America.

8 lithium price

Source: Lithium Americas

The thing is that lithium is not sold on the spot market. It is sold through long-term contracts at defined prices. Only if ALB gets enough customers, it will develop its projects. For now, everything up to 2021 is sold.

ALB’s plans imply a 150% increase in production. Let’s assume they have half the current margins; lithium EBITDA should be $700 million. If lithium prices go up, well you know the story. At current margins, EBITDA should be $1.25 billion.

So, this should be the easy part of analyzing ALB, now we go to the hard part that includes all kinds of regulations, current situations etc.

Current analysis of Albemarle + the growth story

More rain in Chile slowed down the evaporation process in Q1 and therefore production has been smaller with higher costs.

Current lithium prices have been a bit lower, but still ALB has margins of above 40%. If the EV trend continues, ALB should keep those margins.

11 ev sales

Source: BNEF

If we see the EV trend develop as expected, by 2030, ALB should be extremely well positioned to service the huge demand for lithium. However, as the ramp up in EV takes times, isn’t linear, lithium prices might first go down. This would be detrimental for ALB.

All in all, ALB plans to increase its production from 65,000 metric tons in 2018 to 250,000 metric tons in 2025. The company has invested $700 million in 2018, will invest $900 million in 2019 and this shows how the commitment is there. The company isn’t about what is going on now, but about what will be going on in 2025.

Thus, a 4x production increase in lithium, could lead to EBITDA increases between 3x and 5x, depending on the price of lithium.

Albemarle – Bromine & Catalysts

ALB is the second largest producer of bromine. Bromine is used in flame retardants for electronics. The company has a cost advantage thanks to its Dead Sea operations and we can expect healthy and steady profits there.

Catalysts are needed in oil refining and petrochemical production. There is a steady need for them and therefor the cash flows streams are also expected to be steady.

Both the catalysts and bromine business are nothing spectacular but slow and steady cash flows that help the company grow on the lithium field.

Investing risk

Given that EVs are a new trend, we don’t know whether it will last or not. Perhaps a new technology will be better and therefore there might be less demand for lithium. This is the biggest risk when it comes to ALB.

There are also operational risks in developing the assets. There could be also regulatory risks as countries, like Chile, decide on how much lithium can be exported.

Conclusion – expected investment returns

If lithium demand grows as expected, at double digits over the next years, so will ALB. Thus, at a PE ratio of 10, we can expect the same growth in the stock price. The question is whether the growth will be 10% per year or 18% per year as it ALB’s lithium growth forecast. As lithium makes now 50% of the profits and the other two segments are not expected to grow, we can put a 10% growth rate on earnings.

10% growth on earnings, and that should also be the investment return, plus a 2 to 3% dividend yield.

All in all, we are at 10 to 15%. If there comes a new round of exuberance related to lithium prices given that things look bad now because lithium prices are expected to decline in 2019, we could see the stock price trade at a PE ratio of 20 and then the returns can be achieved faster.

Let me check the other 5 lithium producers and then we will have a better perspective on the sector.

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