Revisiting Our Long Albemarle Thesis

May 21, 2019


Price (as of close today): $104.07

Back in July, we published our thoughts on Albemarle Corporation (ALB), outlining why we believe the stock is a good buy for anyone interested in the lithium space.  The stock subsequently ran up to $145 per share before selling off (along with the rest of the sector) all the way down to the mid $80s per share. We continue to believe in the stock, and believe that it is undervalued for value and growth investors alike. Here, we revisit our thesis.

The Opportunity

While certain analysts have sparked oversupply worries in the sector, for those that have done a deep dive into the mechanics of the industry know that it has just created a second chance buying opportunity.  While the stock has bounced over 20% from recent lows, in our opinion it’s still worth over 40% higher based purely on lithium growth as we’ll outline below. We don’t know about you, but we’ve rarely seen a situation where the largest and one of the lowest cost miners in a rapidly growing industry with very healthy margins are trading at non-growth multiples (~12.5x 2018E EBITDA).

What’s Intriguing About the Company

Albemarle is very intriguing to us for a few reasons- it’s lithium assets, balance sheet flexibility, and the industry’s barriers to entry.

Lithium Assets:  We’d argue that the company operates two of the best lithium assets in the world in Atacama (brine) and Greenbushes (hard rock).  With these two projects they have the potential to provide both lithium hydroxide and carbonate at among the lowest cost in the industry.  So until the hydroxide push really takes over, ALB can continue to competitively supply carbonate led by their Atacama operations. And if or when that hydroxide demand really starts to dominate the industry, they can let their hard rock Greenbushes operations satisfy demand on that front at a similarly low cost.  Even their chief rival SQM can’t say the same until they bring on the Mt. Holland Lithium Project with Kidman Resources. Thus, we believe ALB has a unique advantage that is not being appreciated by the market.

Balance sheet flexibility: The company levered up to 5x in 2015 when they purchased the lithium business, but has quickly de-levered to around 1x net debt/EBITDA. Furthermore, they are taking advantage of the beneficial lithium industry conditions, allowing them to generate ample cash. A majority of this cash is being reinvested into future lithium growth, however, they have the flexibility to take on debt should they feel the need to go out and acquire interesting projects.  

We outlined Sigma Lithium Resources, who recently listed on the TSX, and has yet to secure offtake agreements.  They are on the fast-track to production with a high quality project that could be interesting to Luke and the boys.  Or maybe they take a look at Galaxy Lithium’s Sal de Vida project in Argentina, for which the company is exploring “strategic options”.  Regardless, the bottom line is that Albemarle is in a great position position to solidify their market share for the future, and should look to do so when they find an interesting project.

Barriers to entry: The company enjoys a few competitive advantages and barriers to entry.  Given that they operate two of the best lithium projects, and make up ~30% of the lithium market today, they’ve clearly reached scale.  Beyond that though, they have a long mine lives left in their projects, which ensures their ability to produce at a low cost. Furthermore, the lithium production game as a whole is an expensive one for new companies to enter.  It can take up to a decade to successfully establish operations, spending hundreds of millions (if not >$1B) of dollars along the way. Thus, incumbents like ALB who are already taking advantage of current market conditions, and reinvesting the cash generated from operations for the future have a big advantage over all of the newer projects sprouting up, many of which are having a tough time raising capital in the current environment.

Even those companies that do have access to the necessary capital have found it challenging to bring their projects to market.  New lithium supply has historically been very tough to bring online, as even Albemarle themselves have been struggling with their La Negra expansions.  This shows that lithium production is no cake walk, as it takes a high level of expertise to bring new projects online, and consistently produce high-quality battery grade purity lithium products for customers at a low cost.

All We Care About is Lithium

Moving on to the financial performance of the company, the core story remains the same since our original piece- investors really only care about the outlook for lithium.  So, once again, we conducted our valuation looking purely at growth in the lithium business. The below graphic shows our production estimates for ALB, their effects on market share, and the resulting revenue growth:

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Source: Thomson, company filings, internal estimates

Note:

  • Consensus market supply was derived from sell-side analyst estimates to give an idea of what investors are expecting.
  • Given that ALB has long-term agreements in place with customers for their supply, even if a major oversupply occurs in 2021/2022 as analysts are expecting, ALB shouldn’t see large negative effects on pricing immediately.

As you can see from the graphic above, we are expecting the company’s growth over the next 5 years to come more from increased volumes rather than pricing.  If new industry supply fails to materialize, pricing could remain elevated, which would add further upside to our estimates.

Valuation

Below, we show how the above expected revenue growth translates into our forecast for the company’s consolidated results.

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Source: Company filings, internal estimates

As you can see, our expected lithium growth alone can carry the company to mid single digit revenue growth, and an EBITDA margin expansion of over 500 basis points over the forecast period.

Below we bring all of it together in our valuation analysis.

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Source: Company filings, internal estimates

A few notes:

  • Given that the company is spending heavily on capex for lithium, a dcf wouldn’t paint the full picture.  Additionally, given that one business disproportionately affects the current valuation, we decided to go the sum of the parts route in our analysis to break it down by segment.
  • Again, Bromine, Catalysts, and Other were all held to 0% growth.  Thus, investors buying into the company today would be getting growth in those businesses for free.
  • Given that the lithium business is generating double digit growth and mid 40s percent EBITDA margins, and the lithium industry is in a tight supply/demand environment, many have made the argument for much higher multiples.  However, we lean more toward the value investing camp, and tried to stay conservative.
  • As can be seen in the graphic, the stock can provide investors with potential double digit annual returns. Thus, investors can buy into a solid business without overpaying (or paying at all) for growth.

That’s It?

With everything we’ve been saying about the lithium industry, and how stocks are very undervalued, we completely understand why readers may be wondering why we’ve only presented an upside case of low double digit annual returns over the next 5 years. Fellow bullish analysts at UBS upgraded ALB a couple of months ago while using similar multiples to us in the other businesses, but attaching a 25x multiple to 2018 EBITDA for the lithium business, bringing their valuation target to $150/share for the next 12 months. That’s almost as high as our whole 5 year outlook. So, what’s the deal?

Well again, we err more on the value end of the spectrum, and refuse to get carried away with our valuation multiples when buying into stocks.  We look for sound businesses with competitive advantages and strong balance sheets to buy at a reasonable price. Looking at lithium specifically, we’re looking for companies with top tier assets, balance sheet flexibility, and the ability to meaningfully take part in the secular industry trend.  

As we outlined above, we believe Albemarle possesses all of these qualities.  So, the next step for us is to figure out what we think the business is worth in the event that growth plays out as expected, but without irrational market conditions.  In that scenario, we believe we will receive a return of over 50% over the next five years. If, as UBS predicted, we get all of it in the next 12 months, that’s great! In that scenario, we’ll do a full scale reassessment of the business and determine how to proceed.  

On the flip side, if that scenario does not play out, we like to know that we’re not getting swept up in the mania, and chasing up a stock that could potentially cause large draw-downs in our portfolios.  Capital preservation is our number one goal, so knowing that even in our modest case analysis outlined above the stock is very cheap allows us to confidently hold onto the shares.

We’ll be updating our thesis on this stock as well as others in the space as developments unfold.  So stay tuned via Twitter and email to get our analysis as it hits the tape!

Disclaimer: We own ALB.  This is not investment advice.  Readers should do their own research prior to investing.