Albemarle 2Q18 Earnings Call

August 8, 2018

Albemarle held their second quarter 2018 earnings call this morning which was unsurprisingly mostly focused on the lithium business.  Below are the lithium related comments from the call.

Highlights from prepared remarks:

  • Lithium growth continues to be driven by accelerated demand for EVs.  2017 sales of plug in and pure EVs were up 56% yoy.  First half of 2018 up 90% vs prior year.
  • Major cathode and battery manufacturers have reported yoy sales growth of 21-25%.
  • “Our customers and our customers’ customers continue to invest for future growth in a manner that is consistent with the ALB demand model”
  • All of our lithium capital projects are on track
    • During Q2, commissioned front end of the Xinyu 2 liOH expansion
    • Anticipate mech completion and commissioning of backend in Q4
    • Design phase and pre project work for Kemerton plant are well underway
    • Tie-ins at la negra 2 remain on schedule for this quarter
  • Financial highlights
    • Reported net income of $302m, $2.73/share diluted
    • Adj eps of $1.36, up 28%
    • Growth in core segments resulted in increase of about $.34
    • Results boosted by share repurchase program and offset by net cost increase primarily due to higher effective tax rate
    • Almost completed $250m buyback initiated in May
    • Continue to believe stock is undervalued, intend to initiate a second buyback of $250m of stock via another accelerated program
      • Total $500m buyback in 2018, equating to 5m shares
      • Strong balance sheet, OCF, growth potential of businesses give them the confidence to take this action, execute capital projects, maintain long term EBITDA ratios, and still have plenty of firepower leftover for opportunities consistent with their strategy.
    • Net cash from operations of $224m in first half
    • On track to end the year between $660-730m
    • Adj FCF of $30m for first half
    • Capex for first half of $281m, will continue to ramp during 2018 for growth capital deployment in lithium
      • Expect $800-900m for full year
    • Lithium Q2
      • Net sales grew 30%
      • Adj EBITDA inc 23%, margins were 45%
        • Driven by 15% inc in volume, 12% inc in price
      • Conversion facilities are all operating at maximum rates
      • Expect to see increase in tolling volumes in second half
    • Lithium Guidance
      • Expect FY adj EBITDA growth of low to mid 20% range
      • Tie ins at La Negra 2 currently on schedule for third quarter
      • Second half of 2018 expected to look like first half
      • Q3 earnings similar to Q1, and Q4 similar to Q2
    • New 2018 company wide guidance
      • Sales of $3.3-3.5B
      • Adj EBITDA $990m-1.02B
      • Adj EPS $5.3-5.5

Lithium Q&A

Seeing weakness in Chinese spot lithium prices, as you look forward to second half, how are contract pricing discussions going? Also could we expect further incremental pricing growth from laddering structure of contracts?

  • As we’ve always said, because of our long term contract strategy, the spot price has no impact on our pricing, and you shouldn’t see a correlation.  Our pricing is up yoy this year, while china spot prices are down.  We’ve said pricing will be in similar range for full year.  Too early to talk about 2019, but we’re having good discussions from a volume, commitment, extensions, and price standpoints.  More on that as we start talking about 2019.

For lithium EBITDA, you said Q3 will be similar to Q1, but I’m more curious about the flat EBITDA from Q2 to Q4, could you talk about what that implies for volume and pricing trends?

  • You’ll see, third quarter will be down sequentially for the tie-ins with La Negra, and then they’ll be up from third to fourth quarter from a volumetric standpoint.  Part of that, remember, is we do tie-ins in the third quarter which allows us to bring the rates of La Negra up to the full potential.  In the fourth quarter we’ll start to have the benefit of the higher production rates.

In lithium when we’re thinking about your longer term contracts.  You’ve mentioned they range from 3-5 years, up to 10years.  Is there a particular grade of lithium you’re seeing longer term demand from versus others (hydroxide, carbonate, etc.)?

  • So, yes, when we enter the contracts, they are product specific, and it’s split between carbonate and hydroxide roughly, which mirrors our production and capex planning.  Beyond that, they’re specific to a grade of carbonate and hydroxide.  Their very specific, and allows us to plan accordingly.  Hydroxide is coming off a lower base, so on a CAGR basis, hydroxide is higher.  But the demand is roughly split between the two.

Can you tell us the sequential price change in lithium?  How do we think about product mix in that business?

  • Sequentially up 2%.  There is some customer mix in there which is hard to strip out.  But product mix, and another mix are not included, so it’s about as pure of a price number as you’ll get from our results.

When you look at the lithium market today, do you think the supply demand balance is becoming looser, tighter, or staying the same over the next 12 months?

  • Our view is that it’s pretty balanced, about the same, hasn’t changed much.  It’s challenging to produce where the growth is- battery grade.  The majors are expanding to meet that, but the time to bring that on as it corresponds to demand, I see that as pretty balanced.  If you look out over the next 12 months, our forecasted growth, and what our customers are saying- We’ll be about in the same position as we are today, sold out, with some reliance on tolling.  If looking at carbonate vs hydroxide, you might see one being tighter than the other.  But from pricing, demand, we’re not anticipating anything in the next 12 months that would have a material impact.

So as a base case, as you model potential returns of the lithium business, do you assume the benefits to ALB over a longer period of time are going to come from volume growth, and the pricing would be neutral?

  • Absolutely, when we model it to look at investments, returns, what we should do- it is now for the next few years a volume story for us.  Where we are able to achieve price in these long term contracts, we will do so.  But we look to have a minimum price guarantee, and a minimum volume in those contracts.  But it will be a volume story more so than a price.

On lithium pricing in 2018- are you still up high single digits yoy?

  • Yes, that’s correct.  We’re still on track with what we came in to the year expecting.  We expected higher growth in first half, and declining later in the year given tougher comps.

On lithium volumes- still on track for 10,000t increase yoy?

  • Yes

Given the rapid pace of battery chemistry evolution, how quickly do you need to tweak the formulations on products to meet customers specs?

  • It’s an ongoing evolution to meet specs.  There is continual effort by cathode manufacturers to get more energy density out of the cells- 5,10,20% greater density per cell.  There are incremental innovations looking at changes to potentially the anode, slight doping of the anode.  Will often happen on the cellphone side before it happens on the EV side.  But those are ongoing.  From the cathode standpoint- some of those innovations may use the same cathode chemistry, in others you’ll see evolution toward higher energy density cathodes.  6-2-2, is definitely the trend we see today for high nickel cathodes, 8-1-1 is often talked about but still has a lot of engineering to go in terms of safety and cost effectiveness in application.  It is an ongoing effort that requires us to be responsive in terms of ideas we have and formulation tweaks in cathode chemistry.

Given the lifespan of most vehicle programs being 5-7 years, how much fluidity are you expecting within those vehicle programs? Trying to get some insight into your customers’ customers.  As they try to extend range, lower weight requirements, how much fluidity are you seeing in terms of that chemistry evolution you were just talking about?

  • Hard for me to separate the two questions.  But in a lot of cases, the 5 year plan is locked down and there are certain targets for energy expected out of the cell for certain models.  There is some flexibility for the battery producer to manipulate materials/chemistry to hit that target.  So I guess there is some fluidity there in terms of how they get there.  But the target of range per vehicle tend to be locked down over a long period of time.

Perhaps I’m reading too into it since you are still on track for La Negra, but I noticed that on the slides that “wave I expansions on track” is no longer there?  And related to that question, can you comment on two of the regions you are expanding capacity.  First in Australia, the dispute with Global Advanced Metals- if that’s having impact on your ability to increase production, and what potential damage they’re claiming.  Second, in Chile- news articles about being slow to respond to CORFO, if that’s having any impact at all?

  • You’re reading way too much into the messaging, we’re right on track.
  • Australia- the dispute with GAM is against Talison.  We don’t see it having any impact.  Our partners’ public comments would probably be similar.  It will get resolved if needed, or if not, we’re confident in our position.
  • Chile- we are in compliance with every term of every agreement we signed regarding lithium, and I don’t see any issue with our ability to get the brine, to run our facilities in La Negra throughout the term of that agreement.

You’ve accelerated another share repurchase, you commented about an undervalued stock.  During the last couple of months, the junior companies have also experienced greater declines in share value.  Can you update on how you think about consolidation in the industry, and the relative importance between relationships with customers and low cost assets?

  • The low cost assets drive your cost position, and then the relationships with customers drive what your prices are going to be, and how you’re going to move that supply once you have it, so I think you need to have both.  If you have one and not the other, you may have a decent business, but you’re subject to whims.  What we have are low cost resources that are geographically diverse, with long term agreements with the major cathode producers around the world.
  • As I look to other juniors, and the valuations- what we have to look at is what we have in front of us that we can execute on, what’s the cost to that, and what’s the return on that capital we’re going to invest, and what’s the time it takes to do that?  Any acquisition needs to be one that accelerates, de-risks, and provides a better return of our capital than what we see in front of us.  If we see that in front of us, we have the capability in our balance sheet, and our ability to execute to be able to seize those opportunities, but we’re going to be disciplined in doing so.

We see the China spot prices falling for carbonate, but there’s questions about how good the info content is in that data.  Can you comment on that- is there any connection between those data points, and what you’ll see in your contract pricing?

  • I don’t look at that data.  The only time I bring it up is when you ask me about it, because it’s irrelevant for us.  I’m the wrong guy to talk about the spot pricing in China and its relevance because I never look at it.

Could you provide an update on your contract negotiations with Cathode manufacturers.  You expressed a goal of converting about 80% of the contracts by the first quarter of 2019, is that still the case.  Can you elaborate on the contract features you’re seeking and how that’s received by customers?

  • We indicated this was an important year because we had some maturing contracts, and other contracts that weren’t maturing that wanted to be extended.  We’ve had a few more contracts we’ve closed that move out to the middle of that next decade.  So we’re moving beyond 5 years on contract terms.  But we have more to go, we’re making progress thus far, and like what we’re seeing.  The terms of these aren’t different than what we’ve described before- floor price, minimum volumes, right of first refusal on additional volumes based on the customers growth.  A price that results in a return of 2x our cost of capital.  All of those elements are still in play, what’s changing is the length of terms and the volumes.  We’ll give more updates in coming quarters.

How would you contrast demand for hydroxide versus carbonate?  One of your peers seems to be seeing a mix shift toward hydroxide- are you seeing that as well, and how sustainable is it?

  • Given our size, we have the opportunity to serve both markets.  That’s where we differ from some competitors.  We have significant carbonate, and have and are building even more significant hydroxide capacity.  The plan has us building more hydroxide capacity going forward than carbonate, but that’s because we’re starting from a smaller base.  We’re seeing demand for both.  In China, we’re seeing a clear move to nickel chemistry, and will likely see an uptick in hydroxide needs for what’s going on in China as they put their EV infrastructure and vehicles in place.  That being said, the contracts we have going out are pretty balanced between the two as we get into the next decade.  It really does depend on the cathode manufacturers infrastructure, the know-how they have, the process, and therefore the preference they have for one or the other.

I recognize that you don’t have exposure to the China spot market, but can you offer your view of what’s going on in that whole lithium to EV value chain over there, is there anything you see that has implications for EV sales in China and therefore global demand for lithium?

  • The only thing I can hypothesize is that there is some lower grade carbonate in China, that when you look at the Chinese regulations moving toward longer battery range, is having a harder time finding a marketplace in EV because it won’t meet the standard for a longer drive time.  That’s the best I can offer you, but I don’t think it’ll have any impact on our business.

Xinyu 2 in China– what could be the benefit in terms of volume next year.  Will it just offset the tolling volume you have, or incremental to that?

  • It’s going to be incremental- at full rates, will be 20kt per year.  I don’t think we can expect to start up and sell out 20kt and run that way.  So we’ll have a better handle around the next call, but my expectations would be to get something around 15kt next year, that would be good operations, assuming that they get commissioning started on the back end of that during the fourth quarter.

On the extent of coverage of your volumes in longer term contracts- can you give an idea of what % of volumes are booked out for the next 2-3 years? 

  • That’s probably going to be 95%+ from what we can produce.  Next year, we’re going to have to rely on tolling as well.  So we’re selling more than we can produce internally.  Our goal long term is to be around 80%, but we won’t get there until early in the next decade.

On the development of lithium demand this year- do you have enough visibility to say you’ll expect the market to grow by  let’s say 20 or even more %, or in absolute terms this would be about 260-270kt?

  • The growth is somewhere in the neighborhood of 20% yoy in terms of expectations.  What we see for the next year looks stronger than that on a percentage basis.  We’re seeing demand that can grow by 50kt yoy on a market that last year we indicated was 20kt by our estimates.  That’s stronger growth than we would’ve thought at the beginning of the year.

I wanted to ask about the costs you’re experiencing in lithium- how would you characterize the cost curve over the last year and your outlook for the next year.  Any material changes in cash costs for yourself?

  • If you look at cash costs at plants, there are always yoy inflationary impacts.  Our relative position in the cost curve hasn’t changed for carbonate with brine and similarly with rock for hydroxide- we’re on the left side of the curve.  Now you have to also consider what you’ll see in our results is the royalty structure.  At current volumes, we’re at the high end of the royalty curve, so at times you’ll see on a comparison basis we’re higher because of that impact.

When you see the high single digit price increase this year go through, does that bring you more in line with where it should be, or is there further roll overs that could raise it next year?

  • We’ve still got a few roll overs, but I wouldn’t characterize it as not inline?  We’re in line with where we are, but when you see contracts renew, there’s opportunity for adjustments in price.  But as we talked about earlier, next year will be more of a volume story than price.

Tianqi recently announced they’re investing more to increase spodumene production in Australia- would you get any offtake from that, or is it something we’d expect you to grow further in?

  • It was actually Talison that made the announcement.  This is part of what’s enabling the growth plan we have described- expanding lithium capacity via wave I and II.  Any increase in offtake- we get half of and Tianqi gets the other half.

You spoke positively on EVs again- can you update us on your outlook for lithium, has it increased since the beginning of the year, and to what degree?

  • If you look, our demand model remains fairly consistent with what we spoke about earlier.  In 2025, we’re seeing total demand of around 800kt.  Transportation would be 550kt, consumer electronics 110kt, and all other industrial uses would be 140kt.  So we haven’t changed in that, although what I was trying to point out is that the data we’ve seen, demand from customers, the steps taken by customers’ customers committing the capital, is all consistent with those views.  So during the course of the year, we’ve gotten even more confident in our model and the growth we anticipate between now and 2025.

There seems to be concern that lithium prices could fall significantly, do you have a concern about your prices falling significantly?

  • No

Any concerns about the worker strikes in Chile?

  • No concerns at all, in fact we just renegotiated our union contracts for three years.  We have wonderful working relationships with our employees.

Can you talk about lithium margins- how should we think about the cadence of margins quarter by quarter?

  • We look on an annual basis.  What I would say is what we’ve always said, we expect margins to be north of 40%.  We believe we can hold that well into the future.  Last year were roughly 43/44%, this year it’s 44/45%.  On the full year you’ll see that range, as well as for 2019.

Increased activity with tollers- it’s always been a part of the mix for you.  Are these tollers you’re working with now, are they totally focused on battery grade, and you’re comfortable with them hitting the specs?  And is it having any dampening effects on margins? If so, when you shift volumes back in house, will it impact the margin outlook?

  • With regard to tolling- we spend a lot of time working with the right tollers.  But it’s not used in battery grade, its for technical grade product lines.  We’ll continue to use that as swing capacity to support ourselves.  It does have a margin dampening effect, and you’ll see a little bit of that in the coming quarter since we’re having a little tie-in at La Negra.

Since most are not focused on battery grade, is it fair to assume then that the strategy will be to build out in house conversion capacity instead of another converter acquisition?

  • We will look at it when the time comes- it depends on what the timing is, what the capability of that toller is, and what the return on invested capital would be, and what we would have to invest in there.  We will look at it but the returns have to be right for us.  We’ve talked about the importance of having assets within China as well as outside of China.  There’s a nonrecoverable 17% VAT for any export from China.  So we want to be able to service our customers outside of China as well as within China.

The lithium sector continues to heat up going into the second half with SQM set to report earnings on August 22, 2018.  We will have you covered with their results as well, so stay tuned via Twitter and email for our analysis!