Electric Vehicles Will Fuel Growth in Lithium and Chemicals Companies
by David Wang, CFA | 10-28-16
After updating our forecast for lithium prices because of the increasing popularity of electric vehicles globally, we are increasing our fair value estimates for the specialty-chemicals companies we cover, Albemarle ALB, Sociedad Quimica SQM, and FMC FMC.
Whereas our previous price forecast for lithium of $6,000 per metric ton was based on the marginal operating cost of existing production, our new forecast of $10,000 is based on the incentive price needed to bring sufficient production on line to close a looming supply shortfall. This shortfall should widen in the coming years as strong demand growth outstrips the supply growth pipeline.
We expect sales of electric and hybrid vehicles to push lithium demand growth 16% annually over the next decade, faster than almost any major commodity over the past century, from about 175,000 metric tons in 2015 to about 775,000 by 2025. Each electric vehicle uses roughly 28,000 grams of lithium in its battery, about 4,000 times as much as the 7 grams used in a smartphone. Each hybrid uses roughly 1,900 grams, approximately 270 times as much as a smartphone.
Though they made up just under 1% of global vehicle sales in 2015, we expect electric vehicles to reach 10% adoption by 2025, far higher than the 4%-6% expected by consensus. In absolute terms, we forecast that sales of electric vehicles will increase from roughly 0.3 million in 2015 to 11 million by 2025. Hybrid sales (strong hybrids and plug-in hybrid-electric vehicles) increase even more, from 3 million units in 2015 to roughly 16.4 million units by 2025. We expect these higher sales, larger batteries per vehicle, and increasing plug-in hybrid electric vehicles’ share of hybrid vehicles (versus strong hybrids) will help drive a 565,000 metric ton increase (29% compound annual growth rate) in lithium sales to battery applications from about 50,000 metric tons in 2015 to roughly 615,000 metric tons by 2025.
Lithium sales for industrial applications should grow just 35,000 metric tons (at a far slower GDP-like rate of 2.5% CAGR) from 125,000 metric tons in 2015 to about 160,000 metric tons in 2025. We expect the impact of industrial applications to total lithium demand will be overshadowed by extraordinary growth in demand from battery applications, which should increase from 30% share of demand in 2015 to 80% share by 2025.
Supply Won't Be Able to Keep Up
Since the supply pipeline is composed of the most economic projects (typically brine in the lithium triangle or high-grade spodumene in Australia), we expect higher-cost sources, including low-grade hard rock in China, will need to be tapped to fill in this 105,000 metric ton deficit in 2025. And to clear the required return hurdles, lithium prices under this scenario would need to be about $10,000 per metric ton.
We assess these companies through five lenses: exposure, growth, cost, operational risk, and financial risk.
Albemarle scores the best, topping the group in exposure, growth, cost, and operational risk.
We believe Albemarle is the most undervalued, trading approximately at roughly a 30% discount to our fair value estimate. It has the highest exposure to lithium in our coverage and is increasing its lithium exposure through the largest expansion projects in the industry.
Albemarle should double its cash flows by 2020 as a result of higher lithium prices and volumes. The company's moat is underpinned by cost advantages in lithium and bromine as well as switching costs in refining catalysts.
SQM trades at about 10% discount to our fair value estimate. It scores favorably on cost and decently on growth but unfavorably on operating risk as a result of its conflict with the Chilean government, necessitating a larger margin of safety before we would consider buying.
FMC also trades at about a 10% discount to our fair value estimate, but it has low lithium exposure and growth prospects. FMC's outlook will be defined largely by its agricultural chemicals business.
David Wang, CFA does not own shares in any of the stocks mentioned above.
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