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What is the equity market getting wrong about lithium?

  By: Matt Fernley

Posted on - 23 Jun 2022

Answer: Just About Everything!

Today is another day when most lithium equities are heading south and I, and many other industry analysts, scratch my head and wonder why?

Is the market worried about the lithium price? Well, maybe, but current valuations for lithium stocks are factoring in lithium prices which I regard as unlikely in the extreme. At current prices a spodumene concentrate producer that I follow is factoring in a five-year plateau price at US$1800/t SpodCon and a long-term price of US$800/t (both on a CIF China basis). Given current spot prices of US$4500-6300/t, depending on what price series you follow, and today’s Pilbara BMX auction at US$7000/t (6%, CFR China), I regard those prices as highly unlikely.

Perhaps the market is worried about EV demand? Well, again, maybe. For sure there are some concerns, with passenger vehicle sales growth slowing and turning negative in a number of key economies. But I do not expect EV sales to shrink. To be sure, my base case for EV sales in 2022 is below consensus, but that’s based on availability of raw materials, not demand. Going forward over the next 3-5 years I am worried about the consumer in an era of high inflation and high interest rates. But I think that the market is underestimating the political and social will behind the Energy Transition. It would be politically unacceptable for many politicians for the shift to electric vehicles to fail. That means that, even though EVs are more expensive outright than ICEs (although still cheaper over time on a cost of ownership basis, particularly with higher oil prices), there will continue to be political support for them. Whether that is in the form of subsidies, advantaged leasing terms or battery as a service remains to be seen. But I don’t expect to see EV sales growth turn negative, or indeed slow to less than 20% y/y levels in the near-term. If that’s the case, then there’s still a huge demand story for lithium…

And, by the way, lets just look at these arguments in another way. If there’s an oversupply of lithium in the market and it does force lithium prices down, that would have a huge impact on the profitability of EV producers, because the cost of production would fall. That would mean that battery prices would fall and EV prices could then resume their fall as well, meaning that consumers could get more bang for their buck from EVs. Hence demand would increase for EVs and it would soak up a lot of the additional lithium in the market. I therefore don’t see a situation where we would ever have the sort of huge oversupply of lithium that many analysts have forecast, because this material would be used up.

Maybe lithium prices do end up going down. Maybe they even halve from current levels. What does that mean for equities? A drop of 50% from current spot price levels would still be ABOVE current consensus for 2023 onwards. That means that lithium equities are currently still massively undervalued at current spot prices (in my view)…

And when I look at the price that the industry is prepared to pay for lithium compared to sell side consensus, I see a huge gap.

The adjacent chart shows sell-side consensus for lithium hydroxide vs futures prices.

I don’t think I’ve ever seen a bigger gap for a material between what the industry is factoring in and what the equity market is.

There’s something that equity analysts are really not getting, and it’s very much emphasised by recent reports from bulge bracket banks. I’m sure readers know which reports I’m referring to!

I don’t want to bag any analysts, but the fact that these reports are written by generalists with little experience in the sector comes out very clearly. The fund I work with is a client of one of the banks involved and I went back to their team with clear and industry-specific questions around elements of their report. Which they replied to only with generalities, or indeed never replied to. Either this is an unwillingness to reply, or it’s an inability to reply. And I fear that in some of the questions it is an inability. Because I haven’t been able to substantiate very many of their suggestions utilising other sources in China (which are industry specialists).

And that brings to the fore an issue I raised in a previous LinkedIn post. Would investors prefer to listen to industry specialists with many years of experience of looking at this industry or would they prefer to listen to generalists? So far, they are listening to generalists. But that’s a mistake in my view because, of all the industries I’ve researched in over 20 years of experience, this is by far the most complex. I regularly read bulge bracket sell side research on both the raw materials and the battery space and spot quite significant mistakes in it. Just because an organisation has a huge sales team and can shout the loudest in the marketplace, doesn’t make them the best analysts, and I think investors need to understand that.

But I guess it’ll take some time for that to sink in.

So, for the next little while, until the penny drops with most investors, I’ll be enjoying myself doing some bottom fishing and picking up many of these oversold stocks at prices I never dreamt that I would be able to again in this cycle.

Matt Fernley is Head of Research for Westbeck Capital Management’s Volta Energy Transition Fund and Editor of Battery Materials Review.


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