October 5, 2017
Lithium Americas is one of the more followed potential new entrants to the lithium industry. Over the last couple of months, the stock has been on a wild ride, rising over 100%, and now pulling back 20% from the highs. While we were hoping to get this analysis out when the stock pulled back to the C$1.04 level in late August, we still believe the company has tremendous value potential going forward from these levels. Below, we present our thoughts on the company and how we believe the market is pricing everything in.
Lithium Americas is a Canadian company focused on two potential lithium projects: the Cauchari-Olaroz project in Argentina, which they are developing in conjunction with SQM, and the Lithium Nevada project in Nevada, USA. Additionally, their organoclay plant in Nevada produces organoclay products for sale to the oil and gas and other industries. However, the organoclay business is small, and the company has yet to generate meaningful revenue. As such, we will focus our analysis on their most advanced stage lithium project, specifically the Cauchari-Olaroz project.
Cauchari-Olaroz Project: LAC’s flagship project is the cauchari-olaroz project, which they are launching via a 50/50 joint venture with Sociedad Quimica y Minera (SQM). Given SQM’s status as one of the world’s largest lithium producers, their presence in the JV is a big boost of confidence for investors looking to put their faith in LAC.
The Cauchari-Olaroz project is located in South America’s Lithium Triangle, which produces approximately half of the world’s lithium. The project is in the Jujuy province in Argentina and is in the vicinity of Orocobre’s Olaroz operations. Additionally, it is about 300 km east of Salar de Atacama (Chile), where SQM and Albemarle have operations, and 200 km north of Salar del Hombre Muerto (Argentina), where FMC operates. Aside from its proximity to other projects, it also possesses favorable access to infrastructure like paved highways, deep sea ports, access to freshwater, and a natural gas pipeline. This is a crucial point for Lithium Producers as the closer they are to key infrastructure, the better they are able to lower their costs and increase their gross margins.
From the feasibility study, we know that the Cauchari-Olaroz project has an estimated 1.499 million reserves of LCE at an average concentration of 698 mg/L. While not as amazing as Atacama, which boasts an average concentration of around 1,400 mg/L, the project is very high grade. Additionally, it has low impurity ratios (even compared to Atacama) of 8.3 K/Li and 2.43 Mg/Li, which will help reduce some of the costs of extraction. The below chart from Albemarle’s investor presentation does a good job showing Cauchari’s and Olaroz’s relative positioning among other projects in terms of estimated reserves and lithium concentration.
Favorable production economics: The feasibility also estimates that the average operating costs for LAC will be $2,495/t. This is a big deal, as it is on the low end of the cost curve. As you see below from LAC’s investor presentation, while it’s not the cheapest producer, it’s definitely very competitive, which gives them an advantage over other new miners if lithium prices should drop.
Partnership with SQM, offtake agreements: As we mentioned earlier, the company has de-risked their operations somewhat by partnering in the project with SQM via a JV. As construction delays, difficulty ramping up production, and maximizing efficiency are big issues to overcome for new miners, having SQM there to guide the process will help investors sleep better at night. SQM has extensive experience in the lithium industry, and in constructing and scaling operations. Additionally, they are currently already one of the largest lithium producers and are thus in tune with the overall market.
Furthermore, LAC has secured financing for their share of the expected project construction costs. Their offtake partners are Ganfeng Lithium, one of the world’s leading lithium producers, and Thai energy company Bangchak Petroleum. Combined, the companies invested $285m through debt ($205m) and equity ($80m). Note, the estimated construction financing needed was about $212.5m for LAC’s share. So the company is in sound liquidity positioning after the investments by the two partners.
Ganfeng and Bangchak also agreed to offtake agreements with LAC for 100% of their Stage 1 production (25,000 tpa). Ganfeng is contracted for 80%, with Bangchak getting the remaining 20%.
Development timeline: LAC is now fully funded and has secured offtake agreements for their phase 1 production. The company is currently underway on construction, with production slated to begin in early 2019. SQM during their investor day on September 7, reiterated that they were on track for early 2019. For a brine operation, the biggest part of the construction phase is the pond development. That is really where the production delays occur, should they arise. Assuming there are no issues related to weather or anything else, we don’t see any other major risks to the construction phase given that SQM brings extensive experience in developing and constructing projects.
LAC plans to expand their cauchari project in stage 2 to production of 50,000 tpa, or double that of stage 1. This expansion project will cost $250m ($125m for LAC’s share), and is expected to be financed by the company’s cash flows from stage 1 operations.
Nevada clay project: Lithium Americas also owns a project in the Clayton valley region of Nevada. The company is currently working on advancing a flow sheet to develop lithium hydroxide from clay at scale. Thus, this project is still in the early stages, and we chose to ignore it for the time being for the purposes of our investment analysis.
Looking briefly at management, LAC has a solid team in place. They have a good combination of financial professionals, surrounded by science and engineering expertise. We’d like to note that among the senior officers is David Deak, a Tesla alum. With this type of team, investors can rest assured that the company is competent enough to handle the challenges of lithium production, while understanding how to manage and deliver on Wall Street expectations.
Furthermore, shareholders are well represented on the board of directors. Management and Directors hold approximately 12% of the company’s shares. This is a net positive which aligns the board’s interests with that of shareholders.
Notable shareholders: It should give investors relief to see the list of prominent shareholders. Representing a huge boost of confidence from two prominent companies, Ganfeng Lithium and Bangchak Petroleum not only agreed to offtake agreements with LAC, but they also helped fund capex costs by investing in the company via debt and equity. Ganfeng and Bangchak own 17.5% and 16.4% of Lithium America’s, respectively. And as noted above, management and directors own about 12% of the company. This tells us that management and shareholder interests are well aligned.
Tight supply, elevated demand: As with all of the lithium miners, the supply/demand picture is very favorable for those producers that can come online quickly and sell their product. In particular, we are bullish on those producers that can produce within the next 2-3 years because of the supply/demand imbalance that has presented itself currently.
Demand forecasts continue to grow as countries and automakers focus on electric vehicle sales, and energy grid storage begins to gain steam around the world. Supply will struggle to keep up as existing producers will not be able to expand capacity enough, and new miners encounter roadblocks and delays in their path to market. If Lithium Americas can utilize their partnership with SQM to enter the market in a timely manner, they will be able to benefit from the favorable pricing for their product.
Partnership with SQM: Lithium Americas’ JV with SQM is one of the biggest reasons why we like the company. In an industry where it is very tough to bring on new supply and ramp up production, Lithium Americas alleviated those concerns by partnering with a proven leader in the space with extensive experience in establishing large scale operations
Low cost of production: As mentioned above, LAC’s expected lithium carbonate cost of production is among the lowest in the world, which will enable their operations to better outlast any unexpected drops in lithium pricing. In the long run for any commodity industry, the cheapest producers win. And in the short run, the cheapest producers enjoy the best margins, making them better investment candidates.
High Quality Resource: While not on par with the quality of SQM and ALB’s Atacama resource, LAC has a high quality resource with low impurity levels. This allows for easier lithium extraction from the brine, enabling the company’s ability to keep production costs low.
US Listing: This driver is potentially a few years away, but the company could benefit from listing on a US stock exchange. It would bring more credibility to LAC, and allow them to access a wider pool of capital. With that being said, the company is currently funded and fully focused on bringing their production online. Thus, this is something that is unlikely to happen until the company is closer to commencing operations.
- USD to CAD conversion ratio assumed at 1.27
- Management is hoping to produce around 6,000t LCE in year 1. However, in our model, we wanted to be more conservative in case the company runs into delays in the construction and commissioning phases. So we estimated 3,000t in 2019, growing to 15,000t in 2020, and 25,000t (max capacity for stage 1) in 2021.
- Similarly, we dropped the pricing received by the company in 2020 and 2021 to account for uncertainty in the outlook over a multi-year period.
- Operating costs per ton were taken from the DFS- $2,495/t
- Maintenance capex was assumed to be $190/t and was sourced from company filings
- The EBITDA multiple used for valuation of 12x is low by today’s standard, especially given that the company has the potential to double output via their stage 2 plans. However, given that we are valuing the company four years out, we prefer using a lower multiple to account for uncertainty in the outlook. As time goes on, we will update this model and the valuation multiples used as appropriate to account for market conditions and the company’s future outlook for expansion.
- In valuing Lithium Americas today, we set out to determine the company’s NAV at peak production for stage 1, which we estimate could be reached by 2021. Then applied a discount to that NAV in each year. For example, in 2017, there is a lot of runway left to go and ample room for execution risk before they reach their peak production. Thus, we only value the company at 40% of 2021 NAV for 2017. As we move forward and the company continues to execute and ramp up production to full capacity, the gap between the current valuation and 2021 NAV will close, as evidenced in the third table above.
After looking at the above tables, it seems that investors who were prudent enough to get in on the pull back to C$1.04 prior to the recent surge (during which time we were unfortunately still working on this piece), have the potential to triple their money. However, even at current levels, there is still significant opportunity for new investors looking to pick up the stock.
With the excitement, and increasing investor awareness in the lithium space, it’s hard to bet against this company. Thus, even though the we list the current value at C$1.39, we are by no means saying the company is good sell, or short. So while the stock may have run ahead of itself a bit in terms of valuation, investors looking to get in would benefit from being patient and buying on dips.
Furthermore, it is important to remember that we are being conservative by using 40% of 2021 NAV as a valuation assumption. Given that we have established LAC as a solid investment candidate, our goal is to worry more about the downside than the upside. Using conservative valuation assumptions and waiting for pullbacks to build a position in LAC would accomplish that goal. But that doesn’t change the fact that market participants using higher numbers will have higher intrinsic values in mind for LAC, and buy the stock, which could insulate it from a broad selloff.
Risk to thesis
As with other new miners, execution risk is a major issue. A lot can go wrong in two years (construction delays, flooding issues, etc.), impacting the valuation that LAC will trade at. Thankfully, the company has mitigated this risk somewhat by entering into the JV with SQM to develop and operate their Cauchari-Olaroz project.
Another risk to keep in mind is that lower than expected lithium concentrations could lead to increased operating costs. This would impact margins, and depending on the market price of lithium, the project’s ability to profitably compete on a global scale.
Finally, as we have outlined in our posts about other miners, supply and demand related issues should be at the forefront of investors’ minds when considering investments into miners. Demand could dry up in lithium, or new supply could come online faster than expected. Either scenario would have the impact of bringing pricing down, decreasing sales volumes, and hurting margins for miners.
Disclaimer: All thoughts presented are our own. These views are not investment advice, and investors should do their own research before entering any position.
Disclosure: We currently hold a position in LAC.