Albemarle's Materially Undervalued

Albemarle ALB reported solid second-quarter results against a backdrop of falling lithium prices. Lithium adjusted EBITDA was flat year on year, and the company’s realized prices increased 2% as Albemarle sells lithium on long-term contracts, which insulates it from short-term price fluctuations. Management also outlined its revised strategy to increase its lithium capacity post-2021. Previously, Albemarle had focused on building new downstream hard rock conversion assets in Australia, which have a high capital intensity.

However, the company now plans to either acquire existing conversion assets or build lower-cost brownfield expansions at its existing sites. Although this will delay Albemarle’s lithium production growth until after 2021, we are in favor of the move as it greatly reduces the capital intensity of the capacity expansions. Having updated our model to reflect these changes, we maintain our $130 fair value estimate for Albemarle as the delayed lithium production is offset by lower capital expenditures. Our narrow moat rating is also intact. With the shares trading in 5-star territory, we continue to view Albemarle as materially undervalued.

The lithium market is currently oversupplied as a wave of new capacity has come on line over the past year. As a result, prices have fallen roughly 20% year to date through the end of July based on Benchmark Minerals lithium price data. We continue to view the oversupply as temporary. As electric vehicle adoption increases globally from 2% of new-vehicle sales in 2018 to 15% by 2028, we forecast lithium demand will grow roughly 5 times to 1.5 million metric tons. Lower-quality, higher-cost supply will need to come on line to meet demand. We maintain our long-term lithium carbonate price forecast of $12,000 per metric ton in 2019 real terms on a Chilean export basis. For Albemarle, higher prices should translate to stable margins as we forecast adjusted EBITDA margins to remain around 40%.

A large part of the company’s strategy change is the revised joint venture agreement with Mineral Resources. Although the deal has not officially closed, the revised terms give Albemarle a controlling 60% interest in the joint venture and 100% of the marketing rights for $820 million in cash versus the previously announced $1.15 billion. Mineral Resources will contribute the Wodgina spodumene operation, which will be able to produce enough spodumene to make 100,000 metric tons of lithium annually. Albemarle will contribute its 50,000-metric-ton Kemerton lithium hydroxide plant to the joint venture. Lithium hydroxide production at Kemerton is expected to begin in 2021.

Because Albemarle will control the joint venture, we forecast no spodumene to be sold into the market this year or next year. This should help reduce excess spodumene supply, which has contributed to falling lithium prices, as spodumene is the largest cost for nonintegrated lithium producers, which largely use spodumene as their primary feedstock.

Previously, Albemarle and Mineral Resources had agreed to build two 50,000-metric-ton lithium hydroxide plants that were separate from the Kemerton plant, which was going to be 100% owned by Albemarle. While we still think a second 50,000-metric-ton plant at Kemerton will eventually be built, we do not think this will happen until the second half of the next decade.

All in all, we forecast that Albemarle will not build 75,000 metric tons of lithium capacity in Australia and delay another 50,000 metric tons. We are in favor of this move, given the capital intensity of new lithium facilities in Australia. In Australia, a new greenfield lithium plant that converts spodumene can cost $15,000-$20,000 per metric ton, more than double the cost to build a similar plant in China. As a result, we think Albemarle will either build brownfield capacity expansions at its existing Xinyu facility in China or acquire existing conversion assets, such as the Xinyu acquisition in 2017.