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Earth Week: 3 top picks for EVs, clean energy

Glenn Freeman  |  23 Apr 2020Text size  Decrease  Increase  |  
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Lithium miners Albemarle, SQM and Livent have dipped into buy territory as the market underestimates demand for electric vehicles beyond 2021, but there will be bumps in the road ahead, warns Morningstar.

The trio of stocks are each trading more than 50 per cent below Morningstar's fair value estimate, SQM currently at a 63 per cent discount as investors err in pricing in lower-for-longer lithium prices, says equity analyst Seth Goldstein.

He concedes the double-whammy of a supply glut coupled with the demand hit from covid-19 will suppress lithium prices over the near-term, but tips a sharp turnaround from the end of 2021.

"By the end of 2021, the lithium market will return to balance as demand growth resumes from increased electric vehicle adoption and other batteries and eats up new supply."

SQM, ALB, LIV sell-off between 2018 and 2020

Lithium plays

A transformational decade

Goldstein expects demand to grow six-fold in the 2020s versus 2019 levels, but acknowledges the likelihood of further lithium price volatility in the near term.

"We forecast long-term prices will settle at a marginal all-in sustaining cost of US$12,000 per metric tonne, as high-quality lithium needed in EV batteries grows to account for 80 per cent of total demand."

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He says Morningstar's contrarian view on lithium prices places his fair values for the three top picks in the sector "at the top of the Street".

Lithium finds a floor

Electric vehicles and power grid storage will comprise the lion's share of high quality lithium consumed between 2019 and 2030. And almost all the growth will come from batteries, Goldstein says.

But he warns the supply response will be lumpy, creating boom and bust periods during which lithium prices will swing wildly above and below the long-term marginal cost of production that typically informs commodity prices.

Goldstein points to the experience of copper and iron ore to demonstrate why he believes 2020 will mark the price bottom for lithium.

"The prices of copper and iron ore, two commodities that saw major demand growth over the last 20 years, have increased (in real terms) amid China’s economic rise," he says.
"We expect the same for lithium, although driven by different factors."

The coronavirus slowdown will weigh on lithium demand in 2020. But Goldstein doesn’t expect a lasting effect on lithium prices, and tips demand to stabilise in 2021 and accelerate again from 2022.

He cites a four-stage commodity cycle to explain why he believes now is a buying opportunity for lithium stocks:

  1. Demand exceeds supply - commodity prices are high, as are producer stock prices
  2. New supply enters production - prices fall but are still elevated, while producer share prices level off
  3. Supply exceeds demand - A supply far outstrips demand growth, prices fall and some high-cost producers may struggle or shut-down. This phase marks the best buying opportunity
  4. Demand growth soaks up new supply - Prices begin to rise again and producer stock prices near fair values.

Six-fold growth through 2030

  • Lithium demand will grow over 6 times from around 300,000 metric tons in 2019 to roughly 1.9 million metric tons in 2030.
  • Demand will fall over 5per cent in 2020, versus our previous forecast for 15per cent growth, due to the coronavirus-related economic slowdown, but growth will resume in 2021.
  • The largest growth driver will be greater electric vehicle and hybrid adoption due to the number of autos sold globally each year.
  • Future annual demand from other batteries, including grid storage, nonauto transportation, and consumer electronics, will exceed total 2019 lithium demand.
  • Batteries will grow from just under 60per cent of total demand in 2019 to over 90 per cent of total demand by 2030. A greater proportion of batteries will require higher energy density, driving the need for high-quality lithium to over 80per cent of total lithium demand, up from a little over 30 per cent in 2019.

Top lithium picks

lithium stocks

Source: Morningstar

Goldstein cites SQM and Albemarle as his picks of the sector because of their cost advantages and lower risks. Both companies hold narrow moat ratings, underpinned by their secondary businesses that provide further competitive advantages.

Albemarle produces low-cost lithium carbonate globally from Salar de Atacama in Chile, and hydroxide from Greenbushes in Western Australia. It also operates a bromine and catalyst business.

SQM also produces lithium at the Salar de Atacama, giving it the lowest carbonate production cost globally. The company's low-cost specialty fertiliser and iodine production also carry cost advantages that underpin Goldstein's narrow moat rating.

Livent's reliance on a single asset and production strategy is an elevated risk in the eyes of Goldstein, which in turn underpins his High Uncertainty Rating.

"We caution investors that many new entrants to the industry carry additional company-specific risks that could ultimately outweigh lithium’s favorable demand growth."

This article is based on a recent Morningstar Materials Observer, "Look to lithium's bright long-term future"

is senior editor for Morningstar Australia

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