Long-term trends, if identified early can be a profitable investment. In such stories, the investor can buy and hold a stock till there is a clear visibility of earnings. One such sector that fits the bill is the Lithium miners. Let’s analyze in detail.
- Electric vehicles will slowly replace the fossil fuel powered vehicles
- As a result, demand for Lithium-ion battery will grow exponentially for the next few years
- There is no replacement for lithium-ion batteries
- Lithium supply is unlikely to keep up with the demand
- Lithium miners will be direct beneficiaries
What are the uses of Lithium?
After debuting 26 years ago in a Sony CCD-TR1 camcorder, lithium-ion batteries have gained widespread use in consumer products, electric vehicles and energy storage.
Last year, lithium-ion batteries equal to a storage capacity of about 45 gigawatt-hours (GWh) were used by the consumer products, according to The Economist. In comparison, the electric vehicles (EVs) only needed about half of the capacity: 25GWh.
However, with the boom in the electric vehicles, demand will increase exponentially. Lithium prices have already doubled in just over a year.
How much demand will the electric vehicles industry generate in the future?
According to Goldman Sachs, EVs will increase their market share from 0.2% of all vehicles sold in 2016 to about 5% in 2030.
However, with advances in technology and price of EVs dropping rapidly, it is likely that the above assumption of Goldman Sachs will be reached much earlier, especially if China and India adhere to their plans.
China wants 12% of all car sales to be from battery-powered or plug-in hybrids by 2020, whereas, India wants all its vehicles to be electrically powered by 2030.
Lithium-ion battery production to skyrocket
Strong EVs sales will stoke demand for the lithium-ion batteries. The top battery manufacturers are gearing up for this challenge by increasing their capacities rapidly. Leading the way is Tesla, with their huge $5 billion gigafactory, which is expected to produce about 4GWh a year from this year. By 2018, Tesla wants to produce 35GWh, a nine-fold jump within two years.
Bloomberg New Energy Finance forecasts lithium-ion battery demand from electric vehicles to increase from 21 gigawatt-hours in 2016 to 1,300 gigawatt-hours in 2030.
Some of the other areas where lithium demand is expected to grow is shown in the table below.
Agreed that the demand for the lithium-ion batteries is going up. But, is there a shortage of Lithium? Will the raw material prices shoot up or is there abundant supply that can push prices down?
Lithium demand and supply
Considering the huge demand for lithium, several projects have been announced that are likely to increase the supply in the near future. However, will this lead to a supply glut similar to crude oil? Let’s listen to some experts in the field.
Joe Lowry, lithium industry consultant and commentator, believes that even with all the new supply additions, “supply shortage will cause significant issues in the battery supply chain by 2023.” (“Lithium Investment at the Crossroads”, July 17, 2017).
Chile’s SQM has been a leader in lithium production for almost two decades. Its Chief Executive Patricio de Solminihac believes that the present demand for lithium is about 200,000 tonnes LCE, which is likely to grow by about 14% per year.
“We believe it is highly probable that worldwide demand will exceed 500,000 tonnes by 2025,” said Solminihac, reports Reuters.
A few analysts, however, believe that lithium supply will overtake demand as soon as next year.
Rebecca Gordon of the UK-based consultancy CRU believes that by 2018, lithium supply will meet demand if all the new projects come online. This will cause a sharp drop in prices from the current levels.
Can the demand stall due to advance in battery technology?
The popularity of electric cars is unlikely to slowdown anytime in the near future. However, is there a technology that can make the lithium-ion batteries redundant or replace them?
Recently, Bill Joy, the Silicon Valley guru and Sun Microsystems Inc. co-founder, announced a new alkaline battery that can compete with lithium-ion and better it in certain areas. Though this is a revolutionary find, it is yet years away from mass adoption. According to Joy, it may take another five years for it to gain wider acceptance.
Lithium-ion battery prices are dropping with new advances in technology. Prices fell 73% between 2010 to 2016. Therefore, any new entrant will find it difficult to displace lithium-ion from its leadership position.
Hence, lithium demand is here to stay, at least for the next decade.
Now, after having established a strong demand growth for lithium, let’s search for a stock to invest in.
What companies do we like and why?
We shall cover two companies in short. If the readers feel that the lithium story is compelling, we shall delve into greater detail in examining these stocks in the future.
Sociedad Quimica y Minera (NYSE: SQM)
Sociedad Quimica y Minera is one of the largest producer of lithium in the world. It is based in Chile, which has the largest lithium resources in the world.
It is a dividend paying company, though the dividend amount keeps varying depending on the company’s profitability. However, with greater demand, SQM is likely to increase its earning and thereby its dividend.
In terms of valuation, the stock is quoting at price/earnings of 35.3, which is way above its 5-year average of 21.7 and the industry average of 21.7.
Nevertheless, with its leadership position and a growing demand, the results are likely to surprise on the upside and the price/earnings multiple will look more reasonable after a few quarters.
What do the charts suggest? Is it time to buy?
SQM was stuck below the $32.8 level for more than three and half years. Finally, the stock broke out of the resistance in March of this year. The stock successfully retested the breakout levels twice and has since then resumed its uptrend. The stock doesn’t have any major resistance until it reaches $59 levels. However, periodically, every stock corrects.
Therefore, at the current levels, we shall only buy 25% of the allocation. Rest 50% should be purchased when the stock falls to the trendline support and the final 25% allocation should be done once the stock resumes its uptrend after a correction. We don’t want to hold the stock if it starts to trade below the $32 levels. That will signal a change in the fundamentals of SQM or the sector as a whole.
The stock can easily surpass its lifetime highs in a couple of years if the demand projections prove correct.
Orocobre Limited (OTCPK: OROCF)
The second stock that we like is an Australian based company Orocobre limited. The company holds 66.5% interest in the Olaroz lithium brine mine in Argentina, which is operated by them and is their flagship project.
They plan to ramp up production in the next 2-3 years, without issuing any new equity, according to the company’s latest presentation. If they are able to achieve their target, the stock is likely to get re-rated.
Currently, the stock is being punished as its production in June quarter was 2,536 tonnes of lithium carbonate compared to 2,784 tonnes in the March quarter. The company attributed the fall to bad weather. Nevertheless, the markets did not buy the argument and punished the stock.
This is a risky stock. We are not buying this for its past track record, but are expecting it to get its act together and reap the benefits of the lithium boom. Therefore, the allocation to this stock should be low.
When should one buy? Let’s look at the charts.
This is a volatile and trendless stock as seen in the charts. It is stuck in a range of $1 to $4.
Nevertheless, it has already fallen from its highs of $4, thereby reducing the risk. We can keep a stop below $1 and buy 25% of the allocation at the current levels. Next 50% can be bought if price falls to $2 levels. The last 25% should be invested once the stock breaks out of $4 and makes a new lifetime high.
We believe that the downside risk in the stock is limited, whereas its upward potential is attractive.