ALB - Albemarle's Big Purchase Sets It Up For Long-Term Success

2023-09-06 08:15:20 ET

Summary

• Albemarle has entered into a non-binding agreement to acquire Liontown Resources for $4.3 billion, a move that will have a significant impact on the company.
• Albemarle's focus on lithium operations has led to a surge in revenue and EBITDA, with lithium accounting for 68.4% of its revenue in 2022.
• The acquisition of Liontown Resources, particularly its Kathleen Valley lithium mine, aligns with Albemarle's strategy and positions the company well for the future demand for lithium.

The past few days have been really interesting for shareholders of Albemarle ( ALB ). On September 3rd, the management team announced that they had entered into a non-binding agreement to acquire Australian company Liontown Resources Limited ( LINRF ) in a transaction valued at roughly $4.3 billion on an equity basis. No matter how you stack it, this is a rather large transaction that will have a material impact on the enterprise moving forward. Based on the data provided by management, as well as the firm's track record leading up to this point, investors should view this transaction in a bullish light.

A value-accretive bet on the future

Historically speaking, Albemarle has described itself as a developer, producer, and marketer of specialty chemicals that are sold for various uses. Customers include those in the energy storage space, petroleum refining, consumer electronics, construction, automotive, and other markets. While this is an appropriate description, I would describe the company a bit differently. For the most part, the business focuses on the production and sale of lithium and various lithium compounds. Examples here include lithium carbonate, lithium hydroxide, lithium chloride, and others. The firm does engage in the production and sale of bromine, which is used in things like fire safety solutions. And it also has a segment that it calls Catalysts, which focuses on a variety of products under three different categories. These categories are clean fuel technologies, fluidized catalytic cracking catalysts and additives, and performance catalyst solutions. These can be used in areas like the oil refining industry.

Realistically, I could spend an entire article just detailing the various uses for all of these product lines. But for all intents and purposes, it would be best to think of the company today as one that prioritizes its lithium operations. I say this because, in 2022 alone, 68.4% of its revenue came from its lithium business. That is up from the 39.4% that lithium accounted for back in 2020. While the company has seen its production of lithium grow from 18,000 metric tons per annum in 2020 to 34,000 metric tons per annum last year, most of the increase in revenue that it saw, with sales climbing from $1.14 billion to $5.01 billion for this category alone, was attributable to higher pricing on its offerings. In fact, from 2021 to 2022, the tight lithium market resulted in higher pricing, contributing $3.2 billion of the company's sales growth. By comparison, higher volumes of sales contributed only $549.2 million to the company's increased lithium revenue, with some of this being offset by foreign currency fluctuations to the tune of $133.1 million.

The lithium business has been truly good for Albemarle in recent years. Not only has the company seen revenue increase significantly because of it, but it has also seen a surge in EBITDA because of the higher pricing and greater volume. Back in 2020, only $393.1 million worth of EBITDA was generated from the company's lithium operations. That was only slightly higher than the $323.6 million that came from its bromine business. By 2022, bromine was responsible for producing $456.9 million of EBITDA for the business. But that paled in comparison to the $3.10 billion attributable to the company's lithium business.

This is not to say that things will always be great when it comes to lithium. Anybody with significant expertise in the commodities space should know all too well just how volatile commodities can be. However, Albemarle does have some really great things going for it. Most significant is the reality that lithium is used in battery technology that is instrumental in the production of electric vehicles. According to the IEA , at the end of 2021, there were only 16.5 million electric vehicles on the road across the planet. By 2030, it's expected for this number to climb to 350 million and for up to 60% of all new vehicle sales each year to be in the form of electric vehicles.

In addition to there being great demand for lithium, there's also very limited supply. This year alone, it's believed that the deficit of lithium in the market, which would mean the shortfall relative to demand, works out to roughly 22%. Because of projects coming online over the next few years, that deficit will decline, eventually hitting a surplus of 1% by 2027. But after that point, it looks as though demand for lithium will far outpace supply. By 2036, we could see a deficit totaling 51%. And anybody who has taken any economic courses can tell you that a scenario where demand significantly outpaces supply should result in higher prices and higher margins for the companies that have access to the product that the market is short of.

For various reasons, Australia has long been a really attractive market for certain commodities. Its proximity to Asia, combined with its large amount of certain commodities, has made it a major source of resource extraction. Examples include iron ore and metallurgical coal. However, we can also add lithium to the list. By 2030, it's believed that Australia will be the single largest source of lithium on the planet, accounting for 26.2% of all extraction. China will be a close second at 23.8%. But after that, no country comes close. Third place would be Argentina and only 12.8%. Sadly, the US will likely account for only about 3.2% of all lithium extraction.

It is with these factors in mind that the management team at Albemarle decided to acquire Liontown Resources. At present, the agreement is non-binding, which means that either party can back out of the transaction at the moment. The goal is to move in the direction of a binding agreement, but only after additional due diligence is conducted. The price in question for the company is $4.3 billion, or about $1.94 per share for Liontown Resources. Truth be told, Liontown Resources was an unknown company to me prior to this announcement. But after digging in, it has become clear to me that this is a positive purchase for Albemarle.

The reason behind the transaction centers largely around a tier-1 lithium mine that Liontown Resources is working on in Australia which is called Kathleen Valley. While the company also has another mine called Buldania, it is responsible for a lower grade of lithium and for only 0.4 million tons of product. By comparison, Kathleen Valley has estimated reserves of 5.4 million tons and the grade is considerably higher, which means that it is more profitable.

The management team at Albemarle did not just pick this particular operation at random. Part of the reason has got to be the proximity of both of these mines to assets that Albemarle already owns, some entirely and others through joint ventures. It's unclear how much in the way of synergies might be realized from this transaction, but clustering resources nearby to one another can help to keep costs down. And in the commodity space, cost control is incredibly important.

Production at Kathleen Valley is expected to begin sometime next year. At the moment, the management team at Liontown Resources is ramping up operations. Phase one of the project is expected to be running at full capacity sometime in 2026. In 2024, it's expected for the company to extract around 320,000 tons of lithium. By 2026, output should grow to 550,000 tons per annum. Phase two of the project will eventually take output to some number above 700,000 tons per annum by the year 2030. And again, this is not just any lithium. This is known as SC6, or spodumene concentrate 6, which is a high-purity refined ore of lithium that is highly desirable in the battery manufacturing space.

Truth be told, I am always very cautious when it comes to major acquisitions. But this one just makes sense to me. According to the management team at Albemarle, achieving the 550,000 times per annum that's forecasted by 2026 and selling it at a price of between $15 and $20 per kilogram should result in an EBITDA multiple on the transaction of 9. As a note, this refers to lithium hydroxide prices. And at the moment, they seem to be around $30 per kilogram. If pricing climbs to between $25 and $30 per kilogram, this multiple drops to only 5. And if we get to prices of $40 to $45 per kilogram, the multiple is only 3. If the supply shortfall does turn out to be accurate, this could prove to be very bullish for Albemarle.

Takeaway

Based on all the data that I see at the moment, I believe that investors in Albemarle should be happy if this deal is ultimately realized. For years now, the management team at the business has been focused on growing its lithium operations, and that has proven to be incredibly fruitful. In the near term, we might see some issues on the horizon. But if you focus on the long-term picture, Albemarle does look to be in a really great position.

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