Lithium has gained exceptional popularity in the last couple of decades. It’s a soft and light metal with unique properties that make it perfect for rechargeable batteries. This has made it a staple in the everyday devices of our lives, like mobile phones. Further, it will continue to play an important role.
Yet we’re just in the early innings with this metal. In addition to playing a crucial role in mobile devices, the element has two relatively new demand drivers in the way of energy storage for electric grids and renewable energy and electric vehicles. The second area is especially interesting considering that an electric vehicle requires roughly 5,000 to 10,000 times as much lithium as a mobile phone and demand for these vehicles is anticipated to increase exponentially in the next 20 years or so.
Lithium is the “hot metal” of today and tomorrow.
Why Albemarle?
When an investor thinks about lithium batteries and electric vehicles, a business like Tesla (TSLA, Financial), which has a market capitalization north of $60 billion, might come to mind. However, there are a number of potential roadblocks along the way.
For instance, you must weigh the balance sheet burden the company has shouldered to get to where it is. Tesla has racked up $5 billion in losses in the last eight years, which has resulted in dilution in two ways: an 80% increase in the share count and a debt load reaching $10 billion, carrying approximately $600 million in annual interest payments.
Moreover, the valuation is tricky. You have to make guesses about when the company will turn a yearly profit and get to “normal” underlying profitability. And finally, while the prospects for lithium appear bright, it does not necessarily follow that battery makers and users will benefit.
Those factors lead to a company like Albemarle Corp. (ALB, Financial).
Albemarle, which is on the mining side, is headquartered in the U.S., but has operations in over 100 countries. Last year, lithium and advanced materials made up 48% of sales and 55% of operating income. So it’s not quite a “pure play” on the metal, but it remains that the company stands to benefit tremendously should the price of lithium increase in the future.
The thing about lithium is it is a crucial component in making electric vehicle batteries, but it’s not necessarily a huge cost driver. Just to give you an example, Tesla’s Model S battery pack weighs about 1,200 pounds, but the lithium component only weighs 15 pounds or so. There are other materials that are stronger cost drivers.
Phrased differently, battery makers require lithium and cost increases would not be a large burden. The metal enjoys (at least from the supplier side) inelastic demand.
Not only does Albemarle mine an in-demand product, but the company also enjoys other advantages, even over other competitors in the space. The company produces lithium from salt brine assets in Chile and joint ventures in Australian mines.
The Chilean assets are particularly interesting, as a “quad-fecta” of advantages come together: 1) a high concentration of lithium, 2) half of the world’s lithium reserves in the area, 3) optimal mining conditions (high evaporation rates) and 4) a long-term contract to mine with the Chilean government.
Future prospects
Albemarle has had somewhat of a volatile past. While the company has turned a profit every year over the last decade, earnings per share have been as low as $1.69 and $1.94 in 2014 and 2009, but as high as $5.68 and $4.90 in 2016 and 2013.
Luckily, the company is set up for this volatility in two ways. First, the balance sheet is in reasonable shape. As of the most recent quarterly report, Albemarle had $641 million in cash and equivalents and $7.5 billion in total assets against $1.4 billion in long-term debt and $3.8 billion in total liabilities.
Second, the company’s quarterly dividend of 33.5 cents is presently only making up about a fourth of profits. This could be tested as future profits continue to be volatile, but it stands that a good balance sheet and low dividend payout ratio allow for the company to take on less certain times.
Over the long haul, things start to look interesting for the security. While the expectations for lithium and electric vehicle batteries are sky high, this is not currently the case with Albemarle’s valuation. The share price has dropped over 30% in the last 14 months. At a recent quotation near $96, shares are now trading around 15 times trailing 12-month earnings and 17 or 18 times expected earnings for this year.
This isn’t exactly “bargain” territory, but interesting nonetheless given the industry’s growth prospects.
Moving forward, analysts believe the company can earn around $6.10 next year, approximately $6.80 in 2020 and over $8 per share by 2021. If this were to come to fruition, and should shares continue trade at around 16 times earnings – more or less the security’s historical average for the last couple of decades – this would imply a future price of $128. That could mean annual share price appreciation of around 10%, coupled with a 1.4% starting yield that is set to grow over time.
Of course, it’s important to remember that just because analyst estimates are made, this does not mean that they must formulate. This is especially true with a company like Albemarle in a volatile industry.
There are a variety of factors that make the security worth a closer look over the long term, however. In our view, lithium is set to be in demand for some time as the move toward increased mobile device adoption, renewable energy storage and electric vehicles offer a long-term tailwind for the metal. Moreover, the supply side looks more interesting on that front as the component is vital and demand is inelastic.
On the growth side, Albemarle derives a significant portion of its business from lithium and is situated in some of the best areas of the world to capitalize. On the business and security side, the company has taken a conservative approach to its balance sheet and dividend policy and the valuation, after a significant share price decline in the last year, only reflects moderate growth expectations from this point.
Disclosure: I am not long any of the stocks mentioned in this article.
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