Lithium expansion supported by stable cash-flows
Albemarle Corporation (NYSE:ALB) is mostly known among investors as the world's largest lithium miner. The company however is a diversified specialty chemicals producer with leading positions in bromine specialties and refining catalysts as well, providing strong and sustainable cash flow to fuel the company's ambitious lithium expansion goals. In fact, the latter two business segments still make up more than 50% of the company's EBITDA with strong combined margins at the 30% level, as illustrated below.
The long-term investment story in Albemarle lies however in its lithium business, due to the forecast expansion of battery capacity demand in electric vehicle and grid storage applications. The total worldwide lithium market size is expected to more than triple from current levels, reaching an annual 1000 kilotons (kt) lithium carbonate equivalent (LCE) by 2025, with electric vehicle battery applications accounting for more than 70% of the market, as illustrated below.
In the recent years, lithium miners have responded to the exponential demand growth forecast by heavily expanding supply capacities, leading to falling spot prices for the two main basic materials, lithium carbonate and lithium hydroxide, currently standing more than 30% below the 2017 peaks.
Analysts at Morgan Stanley expect the lithium market to be further dominated by oversupply, reaching a maximal surplus of 150 kt LCE annually throughout 2025.
Albermarle has prudently responded to the market situation during its Q2 2019 earnings announcement, delaying construction of ~125 kt LCE of planned new lithium hydroxide capacity, reducing capital expenditures by approximately $1.5 billion over the next 5 years.
Even with the revised scenario, the lithium growth potential for the company remains overly impressive in the upcoming years. Based on the current conversion capacity plan, Albemarle forecasts a LCE output of more than 175 kt per year by 2021, growing by more than 100% from the 2019 levels. By that, Albemarle is essentially doubling its lithium segment EBITDA, resulting in a 50% EBITDA growth on a company level by 2021.
Rock bottom valuation and insider buys signal an attractive entry point
During its Q2 2019 earnings call, the company increased its full year adjusted EPS estimate to $6.25 - $6.65 amid lithium and bromine YOY pricing and volume improvement. Albemarle currently trades at a P/E of 9.8, considering share price of $63.23 and a mid-point 2019 EPS guidance of $6.45.
Going forward to 2021, consensus analyst estimate EPS is $7.55, translating to a share price of $113 at a P/E multiple of 15 and a CAGR equivalent of over 30% from current levels.
source: FAST Graphs
Insider buys by company executives can often be taken as a sign of confidence in the company's growth and earning potential. Albemarle's President for Lithium, Eric Norris purchased shares in the value of $200k on August 20, at a an average share price of $64.66, which underlines the exceptional growth potential lying ahead of the company's lithium segment.
The company is also a Dividend Aristocrat, having raised its dividend for the past 25 years. Since 2015, the average rate of annual increase has slowed down to 5%, mainly due to Albemarle's heavy investment activity into its lithium segment. We expect however, that the dividend growth rate (DGR) will return to its historic average 10%+ after 2021, once the above illustrated lithium nameplate capacity is reached and the company becomes free cash flow positive as management pointed out during its Q2 2019 earnings call.
source: FAST Graphs
The Adjusted Earnings Payout Ratio sits below 25%, which means the company could easily double its dividend and would still pay out less than half of its earnings. We are confident that this will happen rapidly in the years after 2021. While waiting, the company offers a starting yield over 2.3%, which is at the higher end of its 5-year historic yield range.
source: Seeking Alpha
As outlined earlier in our portfolio introduction article, we currently hold 15 shares of Albemarle in our Danube Dividend Portfolio, representing an investment value of $1.095, providing a forward annual dividend income of $22. Although the current 2.3% yield of Albemarle is significantly below our average portfolio yield target of 4%, we consider it a unique value at today's levels, as well as a great DGI opportunity for the long-term future due to the company's lithium exposure. We are aiming to increase our position to the $2000 range in the near future, bringing it up to 2% of our mid-term $100k portfolio size target. The only reason why we would sell the stock if management decides to cut the dividend, which we consider highly unlikely in light of Albemarle's Dividend Aristocrat status, steadily growing business and very low payout ratio.
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.