Albemarle: Unique Total Return Opportunity For The Patient Investor

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About: Albemarle Corporation (ALB)
by: Freyr Capital
Summary

We summarize Albemarle’s operations by segment and highlight relevant dynamics.

We assess supply and demand and future of the lithium market.

After providing a short summary of Albemarle’s financials and evaluating its valuation with respect to peers and assessing relevant risks we conclude with a Buy rating.

Investment Thesis:

Albemarle (ALB) is a diversified specialty chemicals leader in consolidated industries with exposure to secular growth trends. Its modest valuation, similar to traditional chemicals players, and its shareholder friendliness makes it a uniquely attractive long term total return play.

Short Review of Albemarle’s Business and Strategy – Stable business’ to fund lithium growth

Albemarle operates in three major segments:

Source: Albemarle May 2019 Investor Presentation

Lithium

The Company views its lithium division as its future and strategically prioritizes its growth potentially funding it with the other segments. Albemarle enjoys leading market share of 26% in 2018 (Source: Bloomberg) in an industry with the top 3 players control more than half the supply. Albemarle differentiates from peers, apart from its size, in its geographical diversity of supply from Chile, Australia (joint venture with #3 player, Chinese Tianqi) and Nevada in the USA and quality of product.

The Company is making two strategic changes to its operations to differentiate itself further. First, it is increasing the quality of its product by making it better suited to EV’s. Albemarle is diverging from its rivals with lithium products that can help boost electricity storage and increase battery’s charge and is transforming lithium to a specialty chemical than a commodity. Secondly, it is attempting to smooth lithium price volatility by moving to a long term contract structure. While its main lithium competitor SQM prefers shorter contracts and charging spot prices, Albemarle is moving to a long term model with +10 year contracts where prices can be reset yearly with a base price guarantee which will solidify the Company’s +40% margins regardless of market forces while offering price visibility for clients (Source: Reuters).

Bromine Specialties

The Company is #2 in Bromine Specialties and is vertically integrated serving many industries with various products such as flame retardants, completion fluids for oilfields, industrial water treatment, plastics and synthetic rubbers, Ag and pharma synthesis. Bromine Specialties division produces stable and sustainable cash flow with Albemarle’s competitive cost base and stable end markets. Management identifies Bromine Specialties as the most GDP dependent segment.

Catalysts

The company is the leading provider of catalysts to the refining and chemicals industry with its strength in hydro-processing and fluidized catalytic cracking catalysts. Catalysts are another source of dependable free cash flow.

Lithium Trends – Demand to grow, supply less predictable but will likely not disturb incumbents

Mordor Intelligence expects lithium market to grow with 10.1% CAGR from 2019 to 2024 driven by demand for EV’s, growing usage and demand from portable consumer electronics, increasing demand from the glass-making industry, and many others (Source: Mordor Intelligence).

Albemarle management expects the market to grow with 21% CAGR from 2018 to 2025, and is attributing this growth to EV adoption and energy storage. The company estimates that energy storage related lithium demand was ~56% of total in 2018 and projects that it will rise to ~86% growing with CAGR of 28%. Management expects transportation related lithium demand (EV’s + other mobility incl. e-buses, e-trucks, etc.) to grow from ~35% of total in 2018 to ~71% in 2025 growing with a CAGR of 33% (Source: Albemarle May 2019 Investor Presentation).

These are just two analyses of many out there that are projecting future EV adoption and increasing lithium use in energy storage driving significant growth in lithium demand. Although difficult to quantify exactly how much, it appears very likely that lithium will see significant growth.

Future of supply is even harder to predict but safe to assume that it will stay supplier friendly. As noted above, the industry is quite consolidated with the top 3 players holding more than half the market. It is unlikely that incumbent suppliers will allow lithium prices get to a point where it is detrimental to producers.

Financials - Healthy margins, solid balance sheet, and shareholder friendliness

Albemarle has excellent margins thanks to consolidated industry dynamics as noted above with ~20% EBIT and ~21% net margins leading to a very healthy return profile with ~11% ROIC and 19% ROE. These returns are very stable with the company not registering a single year of loss in the last 15 years. The balance sheet is also very strong with ~1x net debt / 2019 EBITDA, leaving plenty of room for shareholder returns and growth with a long term net debt / EBITDA target of 2-2.5x. The return profile makes Albemarle ripe for income investors as well with the company becoming a dividend aristocrat recently, distributing a safe ~2% dividend at a low 0.2 payout ratio as well as employing a strong buyback program (Source: Gurufocus).

Comparable Valuation - Albemarle is inexpensive

We attempt to assess Albemarle’s valuation by comparing it, quite unfairly, to “old world” peers. Two caveats regarding our assessment, firstly, we say unfairly because we adamantly believe that Albemarle’s lithium business is far from a commodity business; Albemarle differentiates itself in its quality of product. One should expect Albemarle to have a valuation premium compared to our peers just due to nature of its value added business. Secondly, even if we do view Albemarle’s business as a commodity business, it deserves a premium valuation due to its large exposure to secular growth trends and its industry leader status in all its business areas.

With the above in mind we sampled traditional, “old world” companies from chemicals and metals & mining fields. From chemicals we used Eastman (NYSE:EMN), Olin (NYSE:OLN), and Celanese (NYSE:CE);and from miners we used BHP Group (NYSE:BBL), Rio Tinto (NYSE:RIO) and Glencore (OTCPK:GLNCY), as well as using relevant ETF’s of XLB, XME, and PICK.

Source: Gurufocus

Based on the comparison above, one can see that Albemarle is at quite reasonable multiples compared to peers. Due to the two caveats laid out at the beginning of this section, we view this similar price to peer group as highly discounted.

Risks – Mostly addressed but certain areas require monitoring

The main risk regarding the growth profile is, of course, adoption of EV’s and lithium in storage. In our view, Albemarle is relatively safe from these risks due to two reasons: 1) its diversified revenues provide some buffer, and 2) a growth profile isn’t built into the valuation and hence should protect from large drawdowns. Increase in lithium demand, however, is critical for upside and should be monitored carefully by investors.

Lithium prices are very volatile and can cause earnings and margin pressures at times. Albemarle is mitigating this volatility through long term contracts mentioned above. As long as price dips are temporary, financials will be fine. One should bear in mind that long term price decreases are unlikely due to consolidated industry structure.

Bromine Specialties, particularly in flame retardants, are of environmental concern and can be under pressure from time to time. Although Albemarle has no direct mitigation to this risk, diversified revenues and long term projected decrease of bromine specialties as a % of total revenues should be somewhat protective, and the magnitude of risk should decrease going forward.

Industrial use of its products make the Company GDP correlated. Any downturn in global industry would hurt Albemarle no doubt, but mostly hurt the Bromine Specialties and Catalyst segments. Lithium is dependent on secular growth trends like energy storage and EV adoption, which will prop up demand despite lower general industrial output. We already discussed above how Albemarle is valued similar to traditional chemicals companies and miners and that it actually deserves a premium because its demand is and will be more and more exposed to secular growth trends.

Chinese operations of Albemarle may be on concern due to intensifying trade pressures between the US and China. But these operations are insulated from such tensions due to them being a joint venture with Tianqi, a Chinese company.

Conclusion – Buy for the long term

Albemarle is a premium company exposed to secular growth trends with a very modest valuation. The company is expected to exhibit solid growth and have generous shareholder distribution in the process. We view Albemarle as a total return play and recommend it to both growth and income equity investors with long term horizons.

Disclosure: I am/we are long ALB. 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.