On Thursday, May 24, 2018, Chilean potash and lithium giant Sociedad Quimica y Minera (SQM) announced its first quarter 2018 earnings results. These results proved to be somewhat disappointing to analysts and traders as the company missed on both top- and bottom-line estimates. However, in actuality there was a lot to like in these numbers, especially in the company's lithium business. Investors should certainly not panic too much when looking at the company's failure to meet the Street's expectations as will be discussed below.
As my long-time readers are no doubt well aware, it is my usual practice to share the highlights from a company's earnings report before delving into an analysis of those results. This is because these highlights provide background for the remainder of the article and serve as a framework for the resultant analysis. Therefore, here are the highlights from Sociedad Quimica y Minera's first quarter 2018 earnings results:
- SQM reported total revenues of $518.7 million in the first quarter of 2018. This compares favorably to the $518.6 million that the company brought in during the first quarter of 2017.
- The company had a gross profit of $192.7 million in the most recent quarter. This represents a significant increase over the $177.9 million that it reported in the prior year quarter.
- Market prices of all of the commodities that SQM sells increased during the most recent quarter. Most notable among these is lithium, which increased in price to $16,000 per metric ton.
- The company reported an EBITDA of $222.4 million in the first quarter of 2017. This represents an increase over the $216.3 million that it reported in the first quarter of 2017.
- SQM reported a net income of $113.8 million in the first quarter of 2018, which works out to $0.43 per common share. In the first quarter of 2017, the company reported a net income of $103.2 million so it clearly performed better in the most recent quarter.
It may come as something of a surprise to hear that the market prices of all of the commodities that SQM sells were higher in the most recent quarter than in the preceding ones but the company's revenues barely budged compared to the year-ago quarter. The reason for this was quite unfortunate. In short, with the exception of nitrates, the company produced lower volumes in the quarter than it did in the previous ones.
Source: Sociedad Quimica y Minera de Chile
Fortunately, in most cases, the higher commodities prices were able to make up for the lower volumes and SQM saw its revenues and profits increase in all but two of its lines of business:
Source: Sociedad Quimica y Minera de Chile
As we can see here, only the industrial chemicals and potassium businesses acted as drags on SQM's overall performance. Thus, we overall did see the company's financial metrics increase significantly (except revenues) year-over-year. Admittedly, its performance would have been better had production not been down.
While SQM is typically considered to be a potash company and the stock frequently trades as one, it is the company's enormous lithium reserves that originally attracted me to the company. SQM has long been positioned to become one of the major suppliers of lithium to the world and due to the growing popularity of items that require lithium batteries, SQM stood to profit mightily. We see this story playing out somewhat in this quarter as the growth in lithium demand led the company to predict 20% demand growth this year. The worldwide demand growth has now resulted in a very tight supply-demand balance, causing the market price of the commodity to rise. The average price of lithium was in excess of $16,000 per metric ton during the quarter, as already mentioned. There is a good chance that this high pricing environment will continue throughout at least the first half of 2018 as it does not appear that the demand pressure will abate anytime soon.
SQM is moving to take advantage of this strong environment for lithium by developing a few new projects that are meant to increase its lithium production capacity. First among these is a three stage project in the Salar de Atacama in Chile. The first stage will increase the company's production capacity from 48,000 metric tons to 70,000 metric tons annually, which should be completed by the end of this year. The second stage will increase this capacity to 120,000 metric tons annually, which should be completed in the next eighteen months. Finally, the third stage will increase its capacity to 180,000 metric tons annually. This final stage should be completed by early 2021. In addition to this, SQM is working on some lithium production projects in Australia and Argentina. This massive production increase is not without risk, however. If the lithium market fails to grow by at least 20% annually in 2018 and 2019 then all of this extra production could collapse the market. This does somewhat seem unlikely barring another global recession, but it is certainly a risk.
Meanwhile, SQM's potassium business has certainly seen better days. As already mentioned, this is one of the businesses that saw profits decline in the most recent quarter, with revenues dropping 51.8% year-over-year.
The primary reason for this decline was the substantially lower sales volumes year-over-year, which actually continues a trend that started in the second half of last year. This volume decline was partially offset by an increase in prices but this increase was only large enough to have a token effect on revenues. This trend is likely to continue over the remainder of this year, likely resulting in the company having a total sales volume of less than one million metric tons of potassium compounds in 2018. The company is planning to change its focus towards its lithium productions to offset the inevitable profitability decline that this would cause.
In conclusion, these results were overall quite good despite the disappointment of analysts. We are seeing a clear shift towards lithium production and away from its previous focus on potash in direct response to the demands of the market. This ultimately makes SQM a way to bet on the rising popularity of things like electric cars without having to take on the inherent risks of a Tesla (TSLA). This shift should greatly benefit investors over the long-term.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.