SQM (NYSE: SQM) reported lackluster first half results on August 24 with declining net income, declining gross profit and flat revenue. They also announced no near term resolution with CORFO on the horizon, but rather further delay and additional arbitration proceedings.
Quick summary of SQM's Q2 news release and conference call:
- Potassium revenues 18% lower in 1H due to average prices down by 28%.
- Specialty plant nutrition revenues were flat. Pricing for this business line is under pressure related to the lower prices in the potash market.
- Iodine revenue decreased by 15% as average price for Q2 was $23 per kilo, 5% lower than the Q1 average price. Pricing expected to continue to have negative impact in this business line.
- Industrial chemicals revenues for 1H 48% lower in line with 45% decrease in sales volumes.
Yet SQM, which has traded for the past month in a tight $24-25 range has jumped 11% over the past 4 trading days to a 52-week high just before the Labor Day holiday. Why?
SQM is forcefully exerting its dominant position as the lowest cost, highest margin incumbent lithium producer with aggressive growth plans in Argentina. It has also responded rapidly to the lithium market tightness in Q2 using up its spare capacity in Salar de Atacama, Chile, with increased production and sales volume.
SQM's average price per ton in Q2 for mostly contracted (not spot) sales was $9,400, up more than 30% compared to Q1. Prices throughout 1H 2016 were 50-60% higher than last year.
Lithium revenues totaled $193 million in 1H up 92% compared to $100 million in 1H 2015. Q2 lithium revenues of $114M were up 120% from Q2 2015 revenues of $52 million.
SQM stated that its lithium business accounted for 47% of SQM's gross profit margin in the 1H 2016. This translates to $122M lithium gross profit, representing a spectacular 63% gross margin on SQM's $193M 1H lithium sales.
Lithium brines are a very good, high margin business.
SQM's market value is currently $7.5B. With 47% of its gross profit now coming from lithium, up from low 20% last year, the market seems to be valuing SQM's lithium business at $3.7B.
Lithium Americas - Substantial Leverage to SQM's Aggressive Lithium Growth
The Cauchari JV in Argentina, at 50,000 tons, will be larger than SQM's current capacity at Salar de Atacama.
SQM stock has risen 11% on strong volume since breaking this news in its Q2 earnings announcement. This represents an addition of $750M to SQM's market value over 4 trading days, despite the lopsided performance of its 5 business lines. With this $750M value accretion, the market seems to be starting to price in SQM's lithium growth in Argentina, which should translate into a 50% increase on top of SQM's 48,000 production in Chile.
Lithium Americas (TSX: LAC, OTCQX: OTCQX:LACDF), on the other hand, has traded sideways on low volume, as it has for much of the dog days of August. LAC seems to be experiencing a similar delayed reaction to what occurred at the end of March when the SQM JV was first announced. LAC actually fell from 47 cents to 45 cents for two trading days after the March 28 Joint Venture press release, before more than doubling to 94 cents over two weeks from March 30 to April 19.
I anticipate a similar re-rating is again possible as the growing number of LAC institutional shareholders digest, with a post-Labor Day back-to-school, back-to-investing mindset, the major SQM catalyst that is an even bigger catalyst for LAC.
SQM's Public Guidance for Lithium Americas JV
SQM provided materially updated guidance in its earnings announcement and conference call August 24/25, with further substantive color added last Thursday through an Investor Day Presentation hosted in New York. This event seemed to take a page from the Lithium Day Presentation organized by Albemarle (NYSE: ALB) last year.
SQM left no doubt that they are moving as fast as possible to bring their LAC JV into production, laying out the following timetable:
Production to start in 2019:
- September 2016:Exploration campaign
- November 2016:Training of pond operators
- Early 2017:Plant construction begins
- Mid 2017:Ponds to start operating
SQM increased by 25% to 50,000 tons from 40,000 tons their plan with LAC to bring new supply from Cauchari in Argentina, guiding first production of 25,000 tons starting in a bit more than 2 years from now.
They suggested operating costs will be on the low end of the cost curve and articulated new, lower start-up capex of $425M.
Canadian brokerage Cormark Securities' analyst Alec Meikle forecasts approximately USD240M EBITDA for the Cauchari JV or ~$120M net to LAC by 2022 at full 50K production. A conservative 10X multiple on this would result in $1.2B forward valuation for LAC.
Cormark raised its target to CAD 1.70 last week, while Dundee re-iterated its CAD 1.90 target price and both highlight LAC as their top lithium picks. Their target price equate ~100% above LAC's current market cap of ~USD 200M today, but at a still un-demanding market value of ~USD 400M.
Underpinning Cormark's target price is a quite conservative long-term LCE price of $7,500 per ton. At $10,000, Cormark's NAV for LAC would be CAD 2.93 and at $12,500 its NAV forecast would be CAD 3.99.
SQM's View on Supply/Demand
SQM, recognized as a conservative company, observed in its Q2 release:
"The lithium market continues to demand more supply from major players. In response to this need, our sales volumes grew over 30% during the first half of this year. We continue to see very strong demand in the lithium market, primarily driven by batteries, and we estimate that global demand growth for this year could exceed 10% compared to 2015."
Their Investor Day Presentation further suggests by 2025 the global demand for LCE could be between 300-490K tons. This is a wide range and is more conservative than Deutsche and Goldman Sachs's forecasts for 535K tons by 2025.
SQM's 50,000 ton expansion is an enormous number, considering the entire lithium market in 2016 is ~175,000 tons. But SQM's demand forecasts suggest an incremental 20K tons of new supply will be needed every year for the next 5+ years.
Having watched its lithium market share shrink to 29% from 35%+ a few years ago, SQM is now poised to regain and grow that share. SQM's dominant position as the world's lowest cost supplier should enable the company to continue to be among the industry's price makers in an industry that should continue to rely on privately negotiated contracts with customers desperate to secure long-term, stable lithium supply.
LAC should also benefit from this pricing dynamic through its association with SQM.
Additional Lithium Market Observations
Since my April 11 post about LAC, which attracted over 6,000 views, I have been a bit surprised that LAC hasn't reacted as quickly or consistently as has DJI (AIM: DJIH), a Chinese lottery and e-payments company, I first wrote about July 11 which is up over 60% over the past six weeks.
Over the past few months before last week's news from SQM, LAC had announced additional executive hires, including Myron Manternach for their finance team and a quickly expanding technical team on promising developments at Lithium Nevada, led by former Tesla (NASDAQ:TSLA) executive David Deak. LAC benefited in July from high profile Goldman Sachs sponsorship, which hosted a conference call with David Deak and LAC CEO Tom Hodgson. Goldman earlier this year published research suggesting the LAC/SQM JV will be the only new lithium supply before 2020, other than existing production underway at Orocobre (TSX: ORL; ASX; ORE: OTCPK:OROCF) in Argentina and Mt. Cattlin and Mt. Marion spodumene deposits in Australia.
I have observed over the summer what I consider to be a lot of lithium misinformation, in particular from Australian brokers Canaccord and Macquarie, who seem pre-maturely to be forecasting an oversupplied lithium carbonate market, based on a rose-colored view that announced supply additions, in particular from high cost spodumene developers and producers, will get fully financed and be built and producing at name-plate capacity on time. The history of failure with lithium start-ups leads me to believe that lithium supply is far more uncertain than is lithium demand. I'm in the camp that the lithium market should remain tight for many years with elevated pricing.
I have much greater trust in the views widely cited by Mr. Lithium Joe Lowry. His Global Lithium LLC consultancy was the source of price forecasts used by Galaxy Lithium (ASX: GXY, OTCPK:GALXF) in their recently announced DFS for its Sal da Vida brine in Argentina. That DFS, based on a 25,000 ton per year production plan similar in a number of ways to the SQM LAC JV, presented a US$1 - 1.4B NAV using "base case" LCE prices ranging from US$11,000-14,000 per ton.
Joe Lowry's tweets over the past 10 days:
- "Leaving Japan for Korea. Convinced#lithium supply won't exceed demand in this decade.#Ganfeng$GXY$PLS$LAC$NMT"
- "Asia trip update: biggest worry of major#lithium buyers is cloudy new supply situation not price."
- "Back in the US, still pondering the huge#lithium demand numbers I heard last week.#Ganfeng$GXY$LAC$PLS"
- "Earlier this year my#lithium demand forecast for 2020 was 285K MT. I am reviewing all I have heard recently and will be upping my number."
It has been about one year since the lithium junior equity bull market began, largely led by ASX-listed high cost spodumene developers. The TSX-listed juniors awoke in April led by LAC and Nemaska (TSX: NMX, OTCQX: NMKEF) and further energized with Argentina brine entrants Lithium X (TSX: LIX, LIXFF) and Neolithium [TSX: NLC].
As we enter the final four months of the year, I expect renewed interest in lithium juniors, but likely with a more discerning focus on brine plays in Argentina, an increasingly foreign-investment-friendly jurisdiction that is poised to challenge Chile's dominance in the lithium space.
LAC represents the purest-play lithium exposure to the nearest term, fastest growing, lowest cost, highest margin new lithium production for 40+ years, de-risked by its operator SQM, the strongest strategic lithium partner in the world.
I believe the market should start soon to believe Cormark and Dundee's price targets for LAC are realistic, and begin trading LAC as the near-term producer it will be: construction is set to begin in a few months and the JV is set to begin 25,000 T production in 2019.
The market may also start to wonder if SQM or some other strategic buyer may seek to acquire LAC's very attractive near term lithium cash flow.
Disclosure: I am/we are long LACDF.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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