SGML - Sigma Lithium: Great Start But More Work To Do

2023-12-18 12:08:34 ET

Summary

• Sigma Lithium Corporation is the only global producer of lithium that meets Triple Zero Green Lithium standards.
• The company's environmentally friendly methods of producing lithium are likely to attract customers in the electric vehicle industry.
• Sigma Lithium Corporation aims to scale its production to achieve higher revenues and profits, with optimistic projections from analysts.
• Last quarter's results and announcement of profitability was very encouraging and likely to attract some potential acquirers if the company can keep this up. Still the company has to prove that it can keep delivering and beating estimates.

Sigma Lithium Corporation ( SGML ) is an ambitious company that mines lithium using environmentally friendly methods and the company boasts being the only global producer of lithium that meets Triple Zero Green Lithium standards which include zero carbon emissions, zero tailings (usage of dry stacked and recyclable tailings) and zero hazardous chemical usage in production of lithium.

The company mainly serves its customers in electric vehicle industry which produce battery packs. People who are against electric vehicles often argued that electric vehicles are not as environmentally friendly as proponents believe it is because production of lithium is a dirty business in itself. As a matter of fact, it is very difficult to produce high quality lithium without using traditional methods so this company's environmentally friendly methods of producing lithium is likely to make a lot of friends in the EV industry.

The company owns 4 mining properties that produce high quality lithium in Brazil: Grota do Cirilo, São Jose, Santa Clara and Genipapo. One thing that seems to be working in company's favor is that its operations are located in a strategically valuable location in many ways. First, the company's mining locations are known to yield high quality lithium. Second, being so close to a river allows it to take advantage of this water source both for electricity generation and other purposes at the mine which makes it more sustainable. Third, the area happens to have good infrastructure and close to Vitoria Port which Brazil often uses for international trading.

Having environmentally friendly mining practices is great and all but at the end of the day investors are mostly concerned about converting this into money somehow. A company could be doing the best work in the world but investors won't buy its stock unless they see a potential for the company to make profits. No matter what material you are mining for, when it comes to mining operations, a few things are very important for a company's profitability.

First, the product you are mining for has to have a lot of demand. If you are mining for something where there is little demand or there is oversupply, you might end up selling your mined materials at a loss if at all. Luckily for Sigma Lithium Corporation, there is plenty of demand for lithium and this demand is only likely to increase in the future as the electric vehicle industry takes off. Global demand for lithium is expected to rise from 310k metric tons in 2020 to 3,829k metric tons in 2035, a rise of more than 12 fold. As a matter of fact, the demand for lithium already tripled in the last 4 years and there is no sign of slowing down.

Second, apart from demand another thing that tells us whether a mining operation will be successful or not is the quality of the mine itself. Some mines are rich of materials, others are not as rich. Some have purer yields and higher concentration while others have more tainted yields or lower concentration. Some mines are easy to mine using traditional methods and others require more advanced methods which can make them more expensive. Ease of extraction is a big deal and can tell whether a mining project will be financially successful or not. So far, Sigma's numbers look encouraging to say the least. The company is in the bottom tier in terms of cash costs per ton, iron oxide content and mica content as compared to competition.

There are other factors in place too. One such factor is scaling. A mining company can be as successful as it can scale quickly. If it can't scale quickly enough before running out of cash, it could go out of business. Scaling will also help keep its operating costs down. Additionally, infrastructure is very important too because if a company can't deliver its mined goods to its customers quickly and efficiently, it may lose money or even lose those customers altogether. Many times mines are located in remote places where there is very little infrastructure and this makes it difficult for mining companies to become successful. As I mentioned above, Sigma seems to be lucky in terms of these factors. Finally, local laws and regulations will play a big role in whether a mining operation can be successful or run to the ground.

Last quarter was the first full quarter where the company had full operations in place including producing lithium and delivering it to its customers. The company was actually profitable during this quarter with adjusted EBITDA of $54 million and net income of $36.2 million which is encouraging because there were many doubts about the company's profitability prospects earlier on.

Moving forward the company is working hard to scale its production to much higher levels so that it can achieve higher revenues and profits. If the company's recent successes (such as how quickly they achieved scalability and profitability as well as details like Greentech Plant reaching 90% throughput) are an indicator, there are reasons to be hopeful about its forward timeline. Others may also say that this timeline is a bit aggressive.

I have to say that analysts are very optimistic about this company. They expect it to generate 25 cents per share in net income this year followed by 92 cents in next year, $3.70 in 2025 and $4.87 in 2026. This would give the company a forward P/E of 29 for 2024, 7 for 2025 and 5 for 2026. These are very aggressive goals and the company would have to increase its net income by more than 10 fold in just a few years. This would also depend on lithium prices driven by global demand for lithium products. Additionally this will depend on how efficiently the company can scale its production while keeping its costs down. One thing for sure, if the company can even come close to achieving these aggressive goals set by analysts, its share price should take off because its forward valuation looks pretty cheap based on these estimates.

Historically when a mining operation becomes highly successful it gets bought up by larger mining companies. There are probably some investors who buy this stock in hopes that it can get acquired by a larger company at a premium price. This is very possible but the company would probably have to show some more success before the bidding starts. If the company can reach its 2025 production target, it will make the company one of the 6 largest lithium producers in the world and this could allow them to be acquired by one of the major players like Albemarle ( ALB ) which would like to boost its production. A merger of the two would become a pretty major player in the global lithium market and Albemarle's global connections would open up new opportunities for this company as well. It's still too early to talk an acquisition for at least another year or two though.

Even though global lithium demand has been rising at a pretty rapid rate in recent years driven by higher adoption of electric vehicles, lithium prices have been on a pretty wild roller coaster. After rising pretty wildly in 2021 and early part of 2022, they have been on an almost free fall this year partially because all commodity prices have been under a pressure because of central banks around the world tightening money supplies. In the future a rise in lithium prices will probably make it more likely for this company to get acquired by a larger player in lithium game.

All in all, this is an interesting play. The company has made a great progress so far and matched or beat most of its short-term goals and reached profitability before anyone expected them to do so even with falling lithium prices. The company has a lot of potential but it must also navigate this environment very carefully and prove it can deliver the goods in a sustainable way and prove to its naysayers that last quarter wasn't just a fluke. In the last quarter's earnings call the company's leadership team was very optimistic and very excited about the company's future opportunities which is always a plus when you are investing in a company but you should also be cautious about overly excited management as they can promise too much at times.

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