We’ve got a good backlog of teaser pitches to get to, as usual, but this one filtered to the top for our attention today — it’s an ad from David Fessler for his Oxford Resource Explorer newsletter (currently $79), and the ad seems mostly to have gotten folks’ attention because of a link from one of Fessler’s free articles last week about the rise of electric vehicles.
Which means, you’ll be unsurprised to hear, that it’s about lithium — there are other critical resources that go into making electric cars, from copper to cobalt to graphite to aluminum, etc., but the biggie that always comes up is lithium because of the outsize impact that electric vehicles can have on the lithium market.
Lithium has been in use for a long time, of course, and holds price of place as the lightest metal on the periodic table (the lightest solid, really), and it’s very reactive and has great energy density, which makes it appealing for batteries — which is why lithium ion batteries have taken over in most portable electronics and in most electric vehicles.
That has led to the idea that lithium should become far more expensive, because demand for electric vehicles is ramping up. Consumer electronics are one thing — the lithium producing world has pretty well met the required demand for millions of laptops and billions of cellphones, essentially all of which have lithium ion batteries, but millions of electric vehicles is another thing entirely because of the massively different size of the batteries required.
A Tesla, Goldman Sachs estimates, uses as much lithium carbonate as about 10,000 iPhones…. so if that’s true and 1.5 billion iphones (or similarly sized smartphones) are sold a year, which is roughly true, then adding 150,000 electric vehicles to the annual sales mix would effectively double the demand for lithium carbonate and/or lithium hydroxide for batteries.
Tesla is talking up 500,000 electric vehicles as its goal, and says they’ll be close to a 250,000/year run rate by the end of this year (that’s their 5,000 vehicles/week production goal by the end of 2017)… and, of course, though Tesla is the biggest producer of electric vehicles in the US, it’s far from being the only EV maker — just going by the US market, which is expected to grow much more slowly than China and Europe, there were about 85,000 battery-only electric vehicles sold in the US in 2016 (not including plug-in hybrids), and just over half of them were Teslas.
So yes, the demand for lithium ion batteries is expected to explode. Tesla’s Gigafactory has been the poster child of this as it scales up to make batteries and drivetrains for the new lower-cost Model S, which is supposed to see its first deliveries in a ceremony hosted by Elon Musk on Friday.
If you’d like a great overview of the lithium market, including some analysis of why Chile’s production has not kept up with demand (and a good reminder that lithium production could be increased dramatically), I highly recommend this FT article from about a year ago. Chile has changed a little bit in the past year, but remains the potential “Saudi Arabia of Lithium” even as political disputes and quotas hamper their largest producer, SQM (to the benefit, currently, of Albemarle (ALB), which recently boosted its production quota.
But anyway, that’s just a backgrounder — what is the lithium investment that David Fessler is hinting at? Let’s give you a taste of the ad:
“You see… one company is perfectly set up to become THE preferred provider of this metal to industries around the globe.
“This company is like a sheikh holding the deed to the only well in a desert…
“It’s sitting on a HUGE stockpile…
“Enough to help meet worldwide demand, preventing Tesla and other huge global players from running out – just as they desperately need a jaw-dropping amount of this metal simply to stay afloat.
“Better yet, the metal this one small company produces is far superior to other producers on the market today…
“Not surprisingly, the world’s biggest and smartest investors are getting involved… Royce… BlackRock… Vanguard…”
“Far superior to other producers” sounds a little questionable, frankly. This is a commodity, after all — some varieties of it are a little easier to process, or a little higher value, or purer, but my impression is that the end product, whether lithium carbonate or lithium hydroxide, is pretty standardized.
What else do we learn about this “secret” stock?
“My research shows that if its share price follows a substantial bounce in revenues, this $3 stock MUST trade at least as high as $27… a 900% gain over time… simply to reflect the massive increase in demand.”
That’s making some HUGE assumptions about future lithium prices — no one can increase production 900% quickly, so that means he must be assuming that the lithium price will skyrocket from here. Which would, of course, benefit all lithium producers… but we’ll see if he provides more detail on that 900% promise as we go along.
“… what you likely have not heard is that there’s a radically different type of lithium that’s coming onto the market…
“That’s far more powerful.
“Brilliant engineers have figured out how to take lithium and essentially transform it into its purest form…
“I call it ‘ultra-lithium.’
“This refined type of nearly 100% pure lithium is what I believe will be the most promising form in the coming years.”
I think he must be talking about Lithium Hydroxide, which is not commonly produced by lithium “miners” (most lithium, though certainly not all, is extracted from brines, not really mined), but which is growing to be preferred for battery production. Lithium Hydroxide is made out of Lithium Carbonate in most cases, as lots of different lithium compounds and levels of purity are demanded by different industries (batteries need the purest stuff, ceramics and glass a little less pure, industrial lubricants much less pure, etc.).
If this company is really able to produce lithium hydroxide more easily than competitors, that would perhaps give them a cost advantage, but not necessarily a scarcity advantage — presumably that scarcity advantage would go to the chemical companies in China who have most of the capacity to produce hydroxide, though I’m not at all an expert on the complexity or economics (or chemistry) of that business. And, of course, if prices are going to go up by 500% or 1,000%, as Fessler seems to think, a relatively minor cost advantage won’t be too meaningful.
I’m getting a bit mired in this one already, though, so let’s move on and get this stock ID’d for you…
“Engineers at this company have perfected a breakthrough new technique for pulling already high-grade lithium out of the salty muck…
“And its patented ‘Olaroz process’ lets it produce an even better form of lithium…
“The super high-purity product that’s light-years ahead of anything else….
“Mining Global raves about ‘the high-purity battery-grade product produced’ at this site.”
OK, so those are some decent clues… what else?
“Production is blasting through the roof… Quarterly output soared from 492 to 3,000 tons last year – for a total of about 10,000 tons….
Yet its initial processing facility has a design capacity of 17,500 tons per year. I expect production to keep growing without a hiccup….
“… there’s plenty more lithium to be had in this one unique spot.
“This project is so big, the company estimates that it could operate for a decade or more, and even then, it will have extracted less than half of the resource!”
OK, so sounds like there’s no shortage of reserves… are they making any money? This is what Fessler says:
“Operating costs recently came in at $3,500 per metric ton. They’re projected to plunge to $2,500 per metric ton in fiscal 2018.
“Meanwhile, it receives north of $9,000 per ton for its lithium product!”
OK, so that means they should be profitable, assuming no other major costs (like debt service or capital investment). But it doesn’t indicate a 900% rise… where does that come from?
“Based on my research, it shows that the price should rise to at least $36 per kilogram.
“That’s four times the current rate, which means this small company would then bring in around $36,000 per ton for the lithium it sells today for $9,000.
“With costs of just $2,500 per ton, that’s a mammoth gain of $33,500 per ton… and a whopping profit margin of 93%!”
Ah, so there you go — yes, he’s assuming a massive ramp-up in lithium prices. He sketches out the detail a bit more here:
“This year, this company will produce about 10,000 tons of lithium at a profit of $5,600 per ton. That’s a revenue of $56 million from this facility.
“If it reaches the output capacity of 17,500 tons next year – with gains of $33,500 per ton – that’s more than $586 million in earnings per year, a gain of 946%…
“And if its shares follow suit, that could be enough to turn your $5,000 into more than $50,000.”
That’s a long sequence, of “ifs”, no? IF they reach output capacity, and IF lithium quadruples in price, and IF the shares follow those rising profits, your shares end up 10X more valuable. Any of those “ifs” could go the other way, of course, but this company Fessler is teasing is Orocobre (ORE in Australia, ORL in Toronto, OROCF OTC in the US).
Orocobre went on my watchlist earlier this year because the shares had a huge drop — they fell roughly 40% in the late Spring when investors started to panic about the cost of their expansion plans — but I haven’t actually bought shares to this point, and haven’t seen a real rush to get in… I’m hoping for a bit more of a washout in the share price, but we’ll see where things go.
What makes Orocobre particularly interesting is that it’s probably the largest operating company that’s close to being a “pure play” on lithium — they produce phosphate and magnesium from their Salar de Olaroz in Argentina as well as lithium, and they have a smaller Borax business, but they do not have the large global chemicals industry presence that the biggest players have… and, unlike all the heavily touted junior explorers who are trying to develop projects, Orocobre is an actual producer, so they’ve got that little “emerging power” niche to themselves at the moment. (Galaxy Resources might argue that point). Albemarle, FMC, SQM are the old “big three” who used to completely dominate the market, despite mostly getting less than 20% of their revenues from lithium… lately Chinese players who do most of the refining have much more influence, like Tianqi and Ganfeng, though Albemarle has grown its lithium business dramatically faster than FMC and SQM and sold off some of its lithium businesses, and is now really the global superpower.
That doesn’t mean Orocobre is a dominant producer, though, not by any means — just that moves in the lithium price will probably have a more immediate impact on their bottom line than would be the case of the larger and diversified players like Albemarle or SQM… though it could be close when it comes to industry leader Albemarle — ALB as of the end of 2016 was getting 40% of its sales from their Lithium and Advanced Materials division, which was also growing more quickly than the rest of the company (about a 30% pace in both earnings and sales growth). And, unlike a lot of the junior hopefuls, Orocobre is ready to catch at least some of the expected supply imbalance and hopefully higher prices over the next three or four years, before more capacity is expected to come online from lots of different players (anyone starting up a project to create a new lithium brine extraction and evaporation facility today would likely have at least five years of work ahead of them, maybe 10, before production).
So that’s the positive — Orocobre is producing, and if prices start spiking they’ll enjoy substantial revenue increases. What are the negatives?
Well, despite the seeming simplicity of the process of producing lithium salts from brine (pump the brine out from underground into large evaporation pools in the Andes Mountains, wait for water to evaporate, dig up the salt and sell it), there’s plenty of complexity to be had — all you have to do is look at the challenges Orocobre has had in building and commissioning their plant, which was supposed to be producing 17,500 tonnes/year by the end of 2015 but is still down around 10,000 tonnes in the second year since the initial production started.
And, as I noted, Orocobre is also being punished for the fact that they want to expand a bit more, to a hoped-for 35,000 tonnes of capacity, to provide revenue growth, establish them as a major producer, and make the economics of the site work better at current prices… and investors are worried about how they’re going to pay for that expansion and for their lithium hydroxide plant joint venture in Japan.
Orocobre is really sensitive to those concerns, or at least to the impact they’ve made on its share price, and you can see that in the comments included in their latest investor presentations — in the most recent one, to a mining conference last week, the emphasis is that they are strongly cash flow positive after debt service, are paying down project debt rapidly, are capable of “sustaining multiple internally funded expansions” and will only move to Phase 2 expansion if they can do it without raising more equity capital (they think they have access to lots of cheap money from Japan from project debt finance still, which is probably true, and their cashflow can service quite a bit of debt).
The other concern with Orocobre has simply been that it is taking forever for them to get even close to the 17,500 tonnes of production they have planned, to say nothing of expanding the project… so the stock did surge higher late last year as lithium prices continued to surge, but the bloom has come off the rose a bit as investors process the actual dirty and difficult work of starting and optimizing this lithium manufacturing process.
They have had production constrained by a number of things, from snow to the need to tweak the processing plant to speed up flow to I don’t know what else. They think that starts to look much better starting roughly now, with the second half of this year seeing substantial increases in production, so that would be good news — and the decision about their Phase 2 expansion and the start of construction at the planned Japanese lithium hydroxide plant are probably at least a couple quarters away, more likely a year or two, so I would imagine that lithium prices and Orocobre’s production numbers will be the primary driver of the stock for the second half of this year. (Orocobre has production “penciled in” for their expansion in 2020, but that’s certainly no promise.
Beyond that, I’m still on the fence about Orocobre — they’re the most appealing emerging producer that I’ve reviewed, mostly because we know the economics work pretty well and they are actually producing and have that “pure play” exposure to lithium prices, but they are not expected (by analysts, at least) to be growing revenue all that much faster than Albemarle, which seems to be just getting more dominant.
On a revenue basis, the Financial Times notes that Orocobre is expected to earn 8 cents this year and 16 cents in 2018 (Australian$), which would give them a forward PE of about 20 and an exciting-looking 100% earnings growth rate. Albemarle, by way of comparison, is expected to earn $4.27 this year and $5.04 next year, for a forward PE of about 23 and a still-very-impressive 18% earnings growth rate. It makes sense for ALB to be more expensive, they are far more stable and predictable and even pay a dividend (yield about 1%), but for the risk-takers and the small-cap lovers there is more growth potential in Orocobre because of its small size and possible substantial production increase over the next several years. If lithium rises as sharply as Fessler expects, certainly both of them will do really well.
Anything else jump out? Well, Orocobre spun out most of its exploratory properties to a junior player, Advantage Lithium (AAL.V), so they do have some exposure to way-in-the-future upside there (they own 35% of Advantage now). Orocobre’s last quarterly operations update indicated that their cash costs are now about $4,279 per tonne sold, higher than they were in the previous quarter (because production dropped, this is the weakest time of year and they had snow) and average sale price was about $10,700/tonne, so there’s still plenty of nice gross margin there, and things are indeed starting to turn a little bit… though it’s still quite early, the next “peak season” starting in the Fall will be a big test (evaporation rates are much stronger in the South American summer).
Oh, and that “Ultra-Lithium” stuff, as far as I can tell, is just nonsense. I think Fessler is just talking up their Lithium Hydroxide plans — it’s likely that we’ll see the cost projections and more detail about that possible plant, which would be in Japan, in the next quarterly update.
That’s just my take, though — it’s your money, so what matters is what you think. Expecting a huge surge in lithium prices? How long do you think it will take for new production to meet that demand? Will Orocobre finally hit their stride and generate production increases? Inquiring minds want to know, feel free to share your thoughts with a comment below.