SQM - SQM: The Future Of Lithium Amidst The Energy Transition

2023-10-09 15:59:09 ET

Summary

• SQM's stock is attractively priced at just 5 times this year's EPS.
• Near-term uncertainties in the lithium market have led to price volatility.
• The company is well-positioned to benefit from the ongoing global energy transition towards cleaner technologies.
• SQM has attractive financials and is expected to benefit from the growing demand for electric vehicles.

Investment Thesis

Sociedad Química y Minera de Chile S.A. ( SQM ) is priced at 5x this year's EPS. Anyone looking at this stock will immediately recognize that it's cheaply valued. So, this consideration is not the main factor that's weighing on the stock.

The problem with this stock is that there's so much uncertainty priced in. Undoubtedly, some aspects are worthy elements that should be priced in.

Demand for lithium is going to massively increase in the next few years. Accordingly, the long-term thesis is clearly intact. However, a combination of risk-off investor sentiment, together with a slowdown in the energy transition is overwhelmingly impacting the stock.

Here I shine a light on why investors are eschewing this stock. Ultimately, even though there are some aspects that should be factored in, I believe that at 5x this year's EPS, a lot of its bad news has already been priced in.

Investors Don't Buy Into the Energy Transition. What Energy Transition?

What's the energy transition? Everyone talks about the energy transition as if it was clear. Is the energy transition when we stopped using wood and dung and started to use coal as the primary energy source? Or is the energy transition when we started to use Diesel oil for mobility? Or perhaps, the energy transition was when we started to increase our usage of natural gas for electricity generation, heating, and cooking?

Perhaps, the energy transition is in the future, when we use a greater proportion of our primary energy supply from solar panels and wind turbines? Do you see the point I'm making here? That we are always transiting from one source of energy to another.

Everyone talks about the energy transition as if it happens overnight. But the fact of the matter is that while we have energy transitions, they take time. And what do investors absolutely hate nearly as much as bad news? Uncertainty!

Not knowing how long we'll have to wait to get paid. And I get it. With the share price going up, nobody is going to bother with difficult questions.

But when the share price starts to move south, everything that was an uncertainty before becomes bad news. Now.

Investors' time horizons shorten, and unless something is expected to go up within the next 12 months with a high degree of certainty, investors lose patience.

I'm not saying that SQM is unquestionably a good investment. I for one, invested with Albemarle ( ALB ) (disclosure: I'm long ALB). Admittedly, both companies have been terrible performers in 2023.

There's no clearer sign of investors' capitulation than the right side of the chart consistently moving down day after day, without respite.

So, What Are The Top Concerns For Investors?

The top concern is the most obvious, and can even be discerned in the company's name. Sociedad Química y Minera de Chile. When investors are risk-seeking, investing in Chile is a compelling opportunity. It's a fast-growing company, that's strategically located in Chile, which grants it access to abundant lithium resources and cost-effective mining operations.

But when interest rates are high, plus investors' temperaments mercurial, all that investors can think about are the political and regulatory risks that arise due to the company's operations in Chile, not to mention the likely overreaching government policies that may capture some of the company's profits.

Why Should Investors Think Positively About SQM?

80% of SQM's gross profits are tied to lithium's prospects. If lithium regains its footing, SQM will do well. And in time, lithium's prospects will improve.

Lithium prices have fallen by around 70% in the past year. This has for the most part been brought about by the sustainable climb in prices in the previous 2 years.

Again, the overall energy transition story is still very much intact. Demand for lithium is expected to increase in the future, primarily driven by the growing adoption of EVs and the expansion of renewable energy storage systems.

As automakers worldwide increasingly shift towards EV production to meet environmental goals and regulatory requirements, lithium-ion batteries, will play a pivotal role in powering these vehicles.

Additionally, the renewable energy sector's need for energy storage solutions to stabilize intermittent power sources like wind and solar will further boost lithium demand, making it a crucial element in the energy transition.

Moreover, lithium demand for energy storage solutions aimed at grid stabilization is on the rise as utilities and the grid seek reliable methods to store excess energy and balance supply and demand, especially given the increasing amount of integration of intermittent renewable energy sources like wind and solar into the grid.

I contend that lithium batteries have gained prominence in this role due to their efficiency, rapid response times, and ability to store and discharge electricity when needed, contributing to grid stability.

The Bottom Line

I have a cautiously optimistic outlook on SQM. While it's trading at an attractive 5 times this year's EPS, there are notable near-term uncertainties and doubts that need consideration.

The demand for lithium, while poised for substantial growth in the long run due to the shift towards electric vehicles and renewable energy storage, has faced recent setbacks, leading to a substantial drop in lithium prices and creating short-term volatility.

Additionally, SQM's exposure to political and regulatory risks in Chile, coupled with market uncertainties, may dampen investor sentiment in the short term.

However, the fundamental strength of SQM's lithium production and its strategic position in the industry suggest a potentially brighter future once these near-term challenges are navigated.

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