PILBF - SQM: My Best Lithium Pick As Chile's President Plans To Nationalize Lithium

2023-04-24 08:30:34 ET

Summary

• Chile’s leftist president announced a plan last week to honor existing contracts but “encourage” a government-private partnership with SQM and Albemarle immediately.
• Too many investors read only the headline and sold at any price they could get in the tumultuous frenzy that followed.
• I bought more SQM (Sociedad Química y Minera de Chile S.A.) and initiated a new position in Albemarle. Why?
• For both geopolitical and long-term investing reasons, I believe these two companies have now been sold down to a sweet spot for purchase.

For reference, you can see my article of December 30 about my 3 favorite lithium companies by clicking here .

First, the Geopolitical - This is where the story begins…

This potential (and partial?) nationalization is a plan floated by Chile's current president, Gabriel Boric, a leftist former student protest leader who took office early last year after the 2021 election.

In that election, Jose Antonio Kast, the most popular candidate on the right garnered more votes in the first round of voting but lost to Mr. Boric in the runoff after Boric created a larger base of the various socialist parties and Chile's small communist party.

Close contests are a feature of Chilean politics. Chile is a vibrant democracy but there are strong feelings about how best to move the country forward, just as is the case in the US and many other nations.

Mr. Boric does not face the electorate until 23 November 2025, a little over 2 years from now. This plan was his biggest campaign promise to voters who were, at the time, just coming out of COVID and facing a difficult economy as well as high inflation and high unemployment.

Who knows if funds will flow into Chile's coffers from new firms willing to accept a minority share of their company in exchange for the funds to produce? Or will Chile's dwindling share of world lithium production provide an incentive to rethink nationalization? After all, Sociedad Química y Minera de Chile S.A. (SQM) contributed more than $5 billion in government taxes in 2022, the largest of any corporation in the country. Do the Chilean people really want to kill the golden geese (including Albemarle) and risk a possibly far less efficient state-run organization?

Then there are the myriad legal issues. SQM has a contract to continue doing business as it does now until 2030. There will be two more national elections in that time -- who knows if the voters will tire of the current regime in either of those? Chile's history certainly shows abrupt swings in voter opinion.

Albemarles contract does not expire until 2043. That would encompass *four* more possible governance changes. Could the golden geese legally tie this issue up until the 2025 elections, two years hence, or even beyond?

And...

What if the price of lithium were to continue its decline?

Can the high level of production savvy SQM and ALB have amassed be duplicated?

How much self-serving baksheesh and corruption do we see in almost every nation where "the government" runs what the private company is already expert at doing?

Private companies must answer to regulators, auditors and shareholders. One wrong step and we can add sharp-eyed competitors as another force to keep them honest.

As the recent 9-0 US Supreme Court ruling on government agencies policing themselves, adjudicating decisions within their domain and meting out punishment, all without outside supervision, every nation that wants a strong economy and a level playing field of opportunity must regularly confront these issues.

In my opinion, nationalization may be a difficult uphill slog for Mr. Boric. Chile's recent economic problems that led to Mr. Boric's election cast Chile, in the eyes of many major corporations, as a less attractive and perhaps less stable place to do business. And, according to the US State Department, the permitting process for mining in Chile is already arduous at best and bordering on onerous.

Make no mistake. I have been to Chile and have a good friend who was a defense attaché there. Wonderful people, beautiful country, temperate climate, blessed by massive natural resources, and a magnet for foreigners looking for opportunity. In fact, one of Chile's early leaders was Bernardo O'Higgins, a Chilean independence leader who helped free Chile from Spain.

But even a great country can be undone by a precipitous change.

Another important consideration I have not seen mentioned in any of the breathless reporting on this issue is that Mr. Boric does not have the authority to make this happen by his unilateral decision or some sort of "executive order." He did not make that distinction in his televised address, saying that the state "would" take a majority stake in partnerships with private companies.

According to Reuters ,

State-owned Codelco, the world's largest copper producer, will be tasked to find the best way forward for a state-owned lithium company and [Mr. Boric] would seek approval from Congress for the plan in the second half of the year. [Emphasis mine.]

Chile's current president, Gabriel Boric:

What trigger happy investors who sold into Friday's decline might not have bothered to read is that this nationalization plan is nowhere near a certainty. What is a certainty is that Chile's share of world lithium production is declining as more countries are attracting lithium companies without having the overhang of a possible nationalization.

Moving on to Investing…

Chile has the world's biggest known lithium reserves but has not been able to capitalize upon those reserves because of a burdensome regulatory environment. This red tape and confusion over how large a role government should play has channeled foreign capital into neighboring Argentina as well as to Brazil, Australia, Canada and elsewhere.

To see how this non-as-yet event made investors skittish, many lithium firms not in Chile rose yesterday! In our Investors Edge® sample portfolio, Australia's Pilbara ( OTCPK:PILBF ) rose more than 5% and Canada's Sigma Lithium ( SGML ), with a large property in Brazil, rose more than 3%.

Here is what convinces me that most people who sold SQM did not really understand the company's true business. The following chart is from Statista this year:

You will notice that as of 2021, the latest full-year comparison from Statista shows that just one-third of SQM's revenue came from lithium . The other 67% was from its long-time businesses of producing specialty plant nutrition, iodine and its derivatives, potassium, industrial chemicals and more. Indeed, SA lists SQM as being in the "Fertilizers and Agricultural Chemicals" industry.

SQM is a diversified miner and producer. It is not wholly dependent upon lithium.

And…

While Chile holds the most reserves of lithium in the world, if they cannot get it out of the ground at a competitive price and at the right time (now!), their difficult-to-deal-with government has seen them passed by Australia as the world's largest producer. If the country selects the wrong path going forward, it may allow for a populist leader to look tough - while making Chile's lithium an even a smaller part of the world's production, resulting in less revenue.

Competitors always get a vote.

I like SQM for its diversity of product and revenue stream, I like it for its solid position as the #2 lithium producer (after #1 Albemarle) and I like it because sometimes fate gives you a thunderbolt of bad news - my initial holding of SQM leaves me with a loss - but also a sunny sky of opportunity - I am adding to my position.

Take a close look at this next chart, from my December Lithium "CCLANG" article:

You will notice that Australia is the world's largest producer, and growing share by leaps and bounds. But try as you might, you will not see Canada on this list of lithium producers. In less than 2 years, however, here is what we see today:

Canada, the world's second largest nation -- with unexplored regions that may contain many other natural resources -- is now a hotbed of burgeoning production. If Chile presses SQM and ALB too hard, it would not surprise me at all to see both begin acquiring some of the new Canadian, US, European et al companies, some of which sell for just pennies per share. (And, without the deep pockets of an SQM or ALB, deserve to sell for just pennies per share!)

To the current valuation:

SQM, with no lithium production beyond Chile, fell the hardest on Friday, double what Albemarlle, with other production worldwide, fell. Here is what SQM currently sells for:

On the first day of trading in 2023, SQM closed at $76.77. On Thursday, April 20, SQM closed at $77.91. Friday it closed at $63.44. Since I reached my conclusion above about Chile's delicate geopolitical positioning, and since the only reason SQM plunged 17% in one day was fear of a massive geopolitical hard strike, I have chosen to add to my position.

One caveat for the above graphic: do not believe this company pays a 20.33% annual dividend! SA has picked up only the "forward-looking-based-on-most-recent" yield. In fact, in the good times SQM shares the wealth via a strong dividend. In the not so good times, they might pay nada.

Here is SA's take on the company. I should point out, as well, that the Quant Rating will likely fall as a result of Friday's market action. I am a fundamental value/growth at a reasonable price investor. But a quant usually needs to account for this one-day plunge regardless of the reason:

I would like to continue with a discussion of Albemarle, but I also want to ensure my opinion of SQM's likely future gets out to all those who are regular followers. I will stop here for today with a promise:

When I discuss Albemarle, I will also cover the biggest threat I see to every lithium company, indeed, to the whole industry. That Black Swan may or may not be landing anytime soon, but it deserves mention. Until next time,

Good investing,

Analyst's Disclosure: Unless you are a client of my portfolio management firm, Stanford Wealth Management, I do not know your personal financial situation. Therefore, I offer my opinions above for your due diligence and not as advice to buy or sell specific securities.

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