SQM - SQM Stock: Still At Bargain Levels

2023-05-19 10:30:00 ET

Summary

• SQM has outperformed the S&P 500 significantly since it bottomed out in April amid massive pessimism due to Chile's lithium nationalization policy.
• More positive developments in China's EV market have helped improve sentiments for the second quarter.
• China's battery-grade lithium prices have surged more than 60% since bottoming out in April, further supporting the recent recovery.
• SQM stock remains highly attractive at the current levels, even though near-term headwinds could persist.

Sociedad Quimica y Minera de Chile S.A. (SQM) delivered its highly anticipated first-quarter earnings release this week after the leading Chilean lithium miner suffered from significant risk-off sentiments last month.

Keen investors should recall that the Chilean government announced its plans to nationalize its lithium industry. I also shared an update last month, highlighting why the market's pessimism created a marvelous entry point for long-term dip buyers.

Accordingly, SQM has outperformed the S&P 500 ( SPX ) ( SPY ) in total return terms since late April, stunning the sellers who sold at its April lows. While the selloff is justified to reflect significant political risks, SQM's well-battered valuation likely attracted buyers to return.

Investors who missed buying last month's lows are still afforded another opportunity to add shares, as its valuation is still attractive. However, investors must reflect a substantial discount against its peers' median, as the negotiations with the government are still unresolved.

In its recent earnings commentary, management attempted to assuage investors' fears that the company expects " to start talks with Codelco in the coming weeks." In addition, management stressed that it continues seeking "an agreement that would be positive for the country, the Antofagasta region, the communities and, of course, for the 2 companies (Codelco and SQM)."

Therefore, I expect the uncertainty to continue weighing on SQM's buying sentiments, suggesting investors must be cautious with their capital allocation to avoid overexposure.

Morningstar's updated bear case, including the need for SQM to divest a " majority stake of its lithium and potash assets," leads to a fair value of just $30 (down nearly 60% from May 18's close).

However, underlying lithium market developments have helped lift some of the doom and gloom hampering investors' confidence in SQM. Moreover, given its huge cost advantage, SQM is a prime beneficiary in the secular growth of EVs.

However, that thesis was tested, as SQM delivered lower-than-expected volumes of 32.3K MT in FQ1, down from 15% YoY. However, market operators are likely already looking ahead, which could suggest why SQM outperformed the broad market significantly since its April lows.

Management highlighted that it's confident of a 20% growth in total lithium demand this year, predicated against a healthy global EV sales increase of 30% YoY.

Given that China's EV market is the world's largest, investors must pay careful attention to market developments there. Notably, battery-grade lithium carbonate spot prices in China have rebounded sharply from April levels, outperforming the global index.

Accordingly, China's spot prices have surged more than 60% to RMB 290K per MT from RMB 180K per MT in mid-April. As such, the lower prices have likely attracted buyers to return to restock their inventories, helping to bolster a further recovery in the underlying lithium prices.

Recent EV market trends in China are also constructive. The recent price war in China's EV market has abated, as analysts noted that " some automakers have stopped offering increased discounts to dealers and have scaled back." As such, analysts expect the wait-and-see attitude from consumers to lighten, helping to underpin a more robust Q2 sales recovery after April's EV sales fell MoM.

However, the momentum has shifted more positively in the first two weeks of May, as "Chinese passenger car retail sales were up 55% YoY and 24% from the same period the previous month."

Therefore, if the momentum can be sustained, I believe that SQM's attractive valuation should continue to attract buyers to return.

Despite that, Wall Street estimates suggest that the normalization in SQM's GAAP EPS could continue through the end of FY23. Hence, analysts aren't optimistic that SQM could repeat its spectacular performance last year, suggesting investors should bake in a significant margin of safety into their purchases.

SQM is given a "B" valuation grade by Seeking Alpha Quant, down from its "A-" grade three months ago. However, with a forward dividend yield of nearly 10% at the current levels, it's still well above its 10Y average of 3.2%.

Therefore, I assessed that SQM's valuation is still attractive, with significant pessimism baked in at the current levels.

However, investors must note that SQM has moved into a medium-term downtrend, suggesting its momentum has reversed.

I see a potential resistance zone at the $86 level that could attract sellers to cut exposure. However, the support level at its April lows seems robust, further supported by SQM's 200-week moving average or MA (purple line), which could attract more dip buyers to return.

Therefore, while the buy levels are less attractive than in April, it's still attractive enough for me to maintain my Strong Buy rating.

Rating: Strong Buy (Reiterated).

Important note: Investors are reminded to do their own due diligence and not rely on the information provided as financial advice. The rating is also not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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