Electric Car Demand Juices Lithium's Prospects
The metal has one of the best growth profiles of the commodities that we cover.
We recently initiated coverage of lithium producers Albemarle (ALB), Sociedad Quimica y Minera de Chile (SQM), and FMC (FMC). Lithium is a great way to gain exposure to the electric car market, providing investors with a play on the high-growth industry. Lithium has one of the best growth profiles across all the commodities that we cover. We expect at least high-single-digit annual demand growth; this requires that electric car sales achieve a market share of just 1% by the end of the decade, up from approximately 0.25% in 2014. Narrow-moat Albemarle is our preferred way to play the lithium market, since it has the most upside to growing volume. Its shares currently trade at a discount to our fair value estimate. We think SQM and FMC are fairly valued at their current share prices.
Although lithium volume growth should be strong, we are less optimistic about pricing. Lithium producers have increased capacity in anticipation of healthy demand growth. As a result of this plentiful capacity, we expect lithium carbonate prices to fall from $5,700 per metric ton in the first half of 2015 to real midcycle prices of $5,500 per metric ton, based on our estimate of the marginal cost production. Still, prices remain elevated compared with recent years as a result of strong demand growth.
Lithium is produced from either lower-cost evaporation of brine or higher-cost mining of spodumene minerals. Albemarle and SQM have cost advantages in lithium production because of their lucrative brine assets in the Salar de Atacama in Chile. Two factors make the Salar de Atacama the lowest-cost source of lithium in the world: dry conditions and high lithium concentration. This high concentration makes Albemarle and SQM the lowest-cost lithium producers, even among brine-based producers.
Albemarle makes up 35% of global lithium supply and possesses a narrow economic moat due in part to its advantaged brine assets in Chile. Given this, combined with its stake in Talison, a higher-cost Australian operation that produces lithium from spodumene mining, Albemarle has the best volume growth prospects among major lithium players. We expect the company to ramp up production and capture roughly half of incremental lithium demand through the end of the decade. Short-term headwinds in its refining catalyst business have driven down the share price this year, as integrated oil companies delay the replacement of clean fuel catalysts used to meet regulatory requirements. However, we expect these issues will abate as replacement is eventually needed. After a weak 2015, we should see profit growth from rising high-margin lithium production.
With 22% of supply, SQM also possesses a cost advantage in lithium, thanks to its Chilean assets. We do not award the company an economic moat, however, because it is possible that the company may lose its mining rights in a conflict with the Chilean government. Primarily as a result of this issue, we assign a Poor stewardship rating and very high uncertainty rating to SQM. The company is a low-cost producer of specialty fertilizer and iodine, but we expect realized prices to decline for those businesses.
Narrow-moat FMC is a higher-cost lithium producer and makes up 13% of supply. The company produces lithium from its salt brine operations in Argentina, which have experienced rampant inflation without commensurate currency depreciation. The recent election of a center-right party to power bodes well for the likelihood of peso devaluation, which would make FMC more cost-competitive against its peers. Lithium makes up a far smaller portion of the company's profits relative to its larger crop chemical division. The intangible assets associated with the crop chemical business form the basis of FMC's narrow economic moat. The shares have traded down significantly this year as a result of weakness in Brazil, FMC's primary end market. We expect the company's agricultural profits to improve, with additional upside, as Brazil is one of the few places with meaningful growth potential in arable land.
David Wang, CFA does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.