SQM - SQM: Seriously Undervalued Lithium Player With Lucrative Prospects

Summary

• SQM has strong financials and a positive outlook.
• Macroeconomic tailwinds ensure demand for its products.
• The stock is trading at an attractive valuation.

Thesis

For the past year, Sociedad Química y Minera de Chile (SQM) has risen over 29.72% reflecting a good year for lithium and iodine producers and positive economic headwinds for the company. However, there are risk factors present, such as COVID-19 disruptions in China and looming recession fears in the United States. At the same time, there are positive markers that indicate a good future for the company. With these conflicting factors at play, although Que Capital recommends a buy rating, we recommend readers exercise their own judgment and discretion regarding their investment decisions.

Company Financials Overview

SQM primarily deals in Specialty Plant Nutrients, Lithium, Iodine, Potassium, and Industrial Chemicals but sources most of their income and business from lithium, specialty plant nutrients, and iodine with those three alone comprising over 94% of their most recent revenue figures in Q3 2022. SQM's mining operations are almost exclusively found in Chile, with expansion into Australia planned. Their processing operations are found in both Chile and China.

From Q3 2021 to 2022 SQM's financials performed phenomenally in multiple areas. Over this period, revenue increased by 322%, and Net Profit Increased by 926%. In addition, the profit margins also increased significantly in the same time period, specifically, increasing from 15% to 36%. This trend continues on from previous years marking a company with strong financials that indicate solid long-term growth in store.

Tailwinds

Increased Processing and Consumption of Lithium and Lithium-Based Products in China

China experienced a 192% increase in EV sales over the past 3 years, with sales projected to increase by another 75% in the following 5 years. Furthermore, China has also extended EV subsidies into 2023 ensuring that demand for lithium and lithium-based products will not fall in China as a result of increased lithium prices, previously a major fear of investors' analysis of Chinese-reliant lithium companies. SQM has expanded its production and processing to China, which along with Chile is also one of the largest producers of lithium as a country in the world. They are looking to begin producing up to 30,000 metric tons of lithium hydroxide a year in a recently acquired plant in China. SQM's Vice President of Business stated that they hope to begin production in Q2 2023 . Overall, SQM's business in China is only slated to increase with SQM capitalizing on increased demand for its products in the EV sector.

Increased Operations in Australia

Through its wholly owned subsidiary, SQM Australia, SQM has also signed an agreement with Dart Mining to earn a 70% stake in the Dorchap Lithium Project in Australia. This deal allows SQM to explore, treat, and mine lithium and other minerals throughout the project. Ensuring long-term growth prospects in the region and for the company as a whole

Increased Demand for Lithium and Lithium-Based Products in the USA

President Joe Biden has recently signed the Inflation Reduction Act into law, whose light duty EV tax credit of up to $7,500 per vehicle has been extended through 2032. Furthermore, the law also allocates $1 billion to States, Municipalities, Indian tribes, or non-profit school transportation to replace class 6 and 7 heavy-duty vehicles with EVs. Both result in guaranteed increases in demand for EV vehicles in the United States. This is important, as this increase in demand will ensure that lithium prices will continue to hold, if not increase, of great benefit to SQM whose lithium primarily is involved in EV production.

Stability in the Iodine and Speciality Plant Nutrients (Nitrates) Markets

Since 2021, there has been a 66% increase in the price of fertilizer due to shortages. The shortage of vital agricultural input stems from a combination of pandemic-fueled supply chain issues, Russia's war in Ukraine, and high inflation. In addition, disruptions to the prominent German Agrochemical Industry will continue due to the war in Ukraine, forcing Germany to source Natural Gas, Ammonia, and Potash, all crucial in the production of Agrochemicals, from sources other than Ukraine, Russia, and Belarus. Each of these factors is not slated to end anytime soon. Ensuring that the increase in demand for SQMs Speciality Plant Nutrients coming from a constriction in supply will continue, maintaining if not increasing revenue in the years to come.

As for iodine, its demand increased during the COVID-19 pandemic due to its widespread use in the pharmaceutical industry. As a result, iodine prices rose and have continued to stay high due to the ongoing pandemic which will continue for the foreseeable future. This maintenance of prices ensures that the spike in revenue experienced by SQM in the Iodine Segment will continue for the foreseeable future and won't quickly subside.

Risk

COVID-Related Disruptions in China

COVID-19 has exploded in China, with major cities like Beijing being hit the hardest, with Beijing and nearly 50% of its population infected with the illness serving as an example. This is resulting in factories facing disruptions from workers calling in sick or dying. This could pose risks for SQM's business in China. By far the most concerning issue is the fact that the ongoing pandemic in China could disrupt lithium demand from EV and Electronics manufacturers from the world's largest consumers of the resource, whose factories are located in the same major cities hit by the pandemic. In addition, SQM's own processing plants may face the same issues regarding labor disruptions or the planned construction of said processing plants may be impeded by the pandemic. Overall, this may blow over or not depending on the Chinese Government's handling of the pandemic, but with zero-covid restrictions being suddenly lifted and an acute lack of other public-health tools present, the risk of massive infections disabling parts of the Chinese economy is very real

Global Recession Fears

With the industry consensus that some form of a recession awaits us in 2023 the risks to SQM, even as a foreign company, are great, as a recession in the United States would inherently trigger a global recession as well. Such a global recession would inherently mean reduced demand for electronics products and EVs. Given that lithium is 75% of SQMs business, these expected headwinds could do a lot of damage to SQM. However, energy security is still a priority of governments and corporations going into 2023. Meaning that a recession would not wipe out demand for lithium, even if it does take a hit.

Valuation

To value the company, we used a discounted cash flow model. For its discount rate, we used data from Finbox and assumed a conservative 2% terminal growth rate. For its growth rate, we assumed an 8% CAGR, taking figures from the overall growth rate of the lithium market. This yielded a price target of $135, a 70% upside from current price levels.

This is further corroborated by a wide array of Industry Analysts as shown by the example from Yahoo Finance above, showing an average of $113.86 and not a single analyst believing the fair value is below what the stock is currently trading at.

ESG

As with any other mining company, SQM has had its fair share of controversy. According to ISS ESG , the company has not implemented comprehensive strategies to protect biodiversity or water resources. In addition, the company does not manage ESG risks in its supply chains. In the past, they've also faced controversy with high-profile human rights allegations.

As a result, SQM has had workers' rights issues very recently, with a strike led by Chilean Miners complaining about low pay and hazardous work conditions requiring government intervention after SQM was unwilling to negotiate with the union on fair terms

Conclusion

Overall, SQM benefits from multiple strong tailwinds which paint a promising picture for the company. However, some risks are present that sow doubt in the certainty of such a future. Still, even with the risks accounted for, SQM is still a good stock at its current price level.

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