Lithium stocks are under-valued because investors misunderstand one key point: analyst
Lithium stocks have taken a beating because investors don’t understand the lithium supply chain an analyst told a Melbourne mining conference on Tuesday.
But Canaccord Genuity mining analyst Reg Spencer reckons there is “a lack of understanding in the depth and the complexity of the supply chain and that’s confused a lot of investors”.
That misunderstanding is “leading to volatility in share prices from many companies that are operating in this sector,” Mr Spencer told the International Mining and Resources Conference.
The supply chain from “mine or brine to market” could take up to a year — and that was before potential bottlenecks in processing, he said.
Meanwhile demand from electric vehicle battery makers was “certainly a mega-trend” with “profound implications for the demand for key raw materials that go into manufacturing the batteries”.
Canaccord believes global electric vehicle (or “EV”) sales will total 12 million units annually by 2025 — a global penetration rate of 14 per cent.
By comparison, about 2 million EVs will be sold this year — double last year’s sales.
“There’s certainly a very significant growth trend taking place,” Mr Spencer said.
A 45-kilowatt-hour battery in a Nissan Leaf electric car requires about 35kg of lithium carbonate or lithium hydroxide.
Based on Cannacord’s forecast for EV sales in 2025, that equates to almost 400,000 tonnes of lithium needed for EV batteries alone.
“Now compared to the lithium market last year, which was approximately 200,000 tonnes — and noting that global non-battery use of lithium was about 110,000 tonnes a year — you can see where this market is starting to go,” Mr Spencer said.
A shift to higher energy density batteries would also increase lithium demand.
Traditional lithium iron phosphate batteries are about 7 per cent lithium, but the “almost overnight shift” in preference towards nickel-manganese-cobalt (NMC) and nickel-cobalt-aluminium (NCA) batteries increase the requirement of lithium by up to 50 per cent.
The key point investors are missing, according to Mr Spencer, is that there is a lengthy “supply chain lag” and that not all lithium dug out of the ground goes into batteries.
“A lot of investors I speak to fear the significant or planned increase in lithium concentrate exports from Western Australia over the coming few years and what that means for the market — will we see oversupply, will we see collapse in prices?” he said.
Lithium comes from two sources — hard rock (spodumene) and brine.
Spodumene producers send their raw material off to China to be converted into lithium carbonate or lithium hydroxide, while brine producers typically produce the carbonate or hydroxide compound themselves.
The carbonate or hydroxide is then sent to a cathode manufacturer, which onsends its cathode product to a battery cell or pack manufacturer before the final battery product is sold to car makers and manufacturers of electronics.
Supply chain lag
“What’s important here is the supply chain lag,” Mr Spencer said.
“From mine or brine all the way through to market you’re looking at somewhere between nine to 12 months.
“It’s very important for investors to understand this because the implications are on risks to bring on new supply.
“Other implications are supply chain lag and the build-up of inventory in that supply chain, the impact on supply and demand dynamics, and finally — probably the most important thing when you’re thinking about the companies and the stocks themselves — is what happens to price.”
Canaccord predicts that 70 per cent of all new lithium supply coming into the market by 2025 will be from hard rock mines and that mine supply will reach almost 1 million tonnes by that point.
The reason for this is that hard rock deposits are easier to mine, capital costs are lower and they typically have a shorter ramp-up time.
But Mr Spencer said hard rock mines do not produce a product that goes into batteries.
“They produce a mineral concentrate, and this is a fact that I think gets lost on a lot of investors in the market,” he said.
“So mine production doesn’t equal lithium carbonate equivalent (LCE) supply.”
Of the 200,000 tonnes of LCE that was dug up last year, 80,000 tonnes was direct shipping ore from projects like Mineral Resources’ (ASX:MIN) Wodgina mine and there was also 10 to 15 per cent conversion losses.
“So by the end of this whole process you end up with about 100,000 tonnes,” Mr Spencer said.
“This is very, very important in trying to appreciate that despite significant increases in spodumene production, not necessarily all of that will get converted into lithium chemicals and potentially lead to oversupply in the market.”
There will, however, be a significant increase in converter capacity.
Canaccord expects global converter capacity to triple by 2020 and increase even further to potentially six times what it was last year by 2025.
But global “effective” mineral converter capacity in the supply chain averages only about 60 to 70 per cent.
“When you have a think about this huge increase in mine production … and overlay that with our effective modelling of converter capacity, you can see a pretty material shortfall in converter capacity,” Mr Spencer said.
Lithium chemicals bottleneck
“So we think that this lack of effective capacity could act as a bottleneck in the supply of lithium chemicals to the supply chain.”
Analysts continue to underestimate demand, not only from the uptake of electric vehicles and increasing penetration rates, but also the actual physical demand for lithium.
“A lot of analyst work that I see models lithium demand in terms of how many EVs are sold in any particular year.
“But when you factor in this 9-to-12 month supply chain lag, the lithium that’s going into the EVs that are getting sold today was actually produced and mined last year.”
Canaccord has revised its own supply and demand forecasts five times since May 2016.
“Every time we revise it, our demand forecasts go up and our supply estimates get moderated and get pushed out, such that when we first published these results we expected the market to be in oversupply as early as 2017,” Mr Spencer said.
“The last time we revised those numbers in April this year, we now expect the market not to hit oversupply until 2020.
“But given all these risks to new supply availability, capital, technical challenges, how confident can we be that this is actually going to happen? That we are actually going to see this oversupply.”