2023-03-14 07:38:09 ET
Summary
- Largo's Q4 2022 revenues declined by 5.6% year on year to $47.5 million while the pre-tax loss soared to $17.2 million due to heavy rainfall.
- However, V2O5 prices are rising, and I think they can remain high thanks to improving steel output in China and soaring demand from the VRFB industry.
- In my view, Largo could be back in the black soon, and I’m upgrading my rating on the stock to speculative buy.
- However, it could be best for risk-averse investors to avoid this stock.
Introduction
I've written several articles on SA about Brazil-focused vanadium miner Largo ( LGO ). The latest of them was in December 2022 and in it I said that the company's Q4 financial results were unlikely to improve and that it could be best for investors to avoid the stock.
Well, Largo released its Q4 2022 financial report on March 10 and it was a difficult period for the company as revenues came in at just $47.5 million and cash costs surpassed $5.00 per pound. As a result, 2022 production was 6% below the guidance while cash costs were 2% above the guidance. However, 2023 is shaping up as a strong year for the company and I'm upgrading my rating on the stock to speculative buy. Let's review.
Overview of the Q4 2022 results
In case you haven't read any of my previous articles about Largo, here's a quick description of the business. The main asset of the company is the Maracas Menchen vanadium mine in eastern Brazil which has a nameplate capacity of 13,200 tonnes and a life of mine (LOM) of two decades. This is the largest vanadium mine in the world and it accounts for about 7% of global vanadium pentoxide (V2O5) supply. About 70% of global vanadium supply comes as a co-product from Chinese steel mills Maracas Menchen and primary supply accounts for around 18%.
Largo's main products include high purity vanadium pentoxide flakes, high-purity vanadium pentoxide powder, and high-purity vanadium trioxide powder. The company also has a clean energy unit named Largo Clean Energy which is focused on vanadium redox flow battery (VRFB) solutions as well as a physical vanadium arm named Largo Physical Vanadium Corp ( OTCPK:VANAF ) ( VAND:CA ) which is listed on the TSX Venture Exchange.
In addition, Largo is building an ilmenite concentration plant with a capacity to produce 150,000 tonnes of ilmenite concentrate per year from the Campbell Pit non-magnetic concentrate. The facility is expected to be completed in 2023 and the majority of the concentrate will be fed through a titanium dioxide pigment chemical processing plant that is expected to produce 30,000 tonnes of titanium dioxide pigment per year beginning in 2024. Overall, the total CAPEX for the mine is projected to stand at $590 million over the LOM.
Moving on to the financial performance for Q4 2022, revenues declined by 5.6% year on year to $47.5 million despite revenues per pound sold decreasing by just 1.4% to $7.77. The main reason for this was heavy rainfall in December which led to V2O5 production remaining flat and sales declining.
As you can see from the table above, cash operating costs excluding royalties rose to $5.15 per pound in Q4 2022 and this was due to shutdowns resulting from the heavy rainfall as well as higher costs for critical consumables, including heavy fuel oil (HFO) and ammonium sulfate. With Largo Clean Energy and Largo Physical Vanadium boosting technology start-up costs and other general and administrative expenses to $16.2 million from $10.5 million a year earlier, the pre-tax loss soared to $17.2 million. In addition, I find it concerning that the operating cash flow was negative and debt levels are rising.
You see, Largo plans to make capital expenses of between $48 million and $53 million in 2023 (see slide 11 here ) which means that the cash balance might start to run out if the company's financials don't improve in the near future.
So, what can we expect for 2023? Well, Largo revealed in its Q4 2022 earnings call that down spills affect from the heavy rainfall in December continued to impact production in January and February so Q1 2023 output from Maracas Menchen is likely to be underwhelming. However, I expect production for the full year to improve by around 10% unless there is heavy rainfall in Q4. This should enable the company to push cash operating costs excluding royalties below $4.50 per pound of V2O5. In addition, the ilmenite concentration plant should provide a boost to revenues in 2023.
Speaking of revenues, the average benchmark price per pound of V2O5 in Europe rose to $10.78 as of March 3 and it has improved significantly over the past few months. Here is the chart for vanadium pentoxide 98% V2O5 min, in warehouse Rotterdam from Fastmartkets :
Fastmarkets
The steel industry accounts for just over 90% of global vanadium demand and data from the World Steel Association showed that crude steel production in its 63 member countries declined by 3.3% year on year in January to 145.3 million tonnes. However, I find it encouraging that output in China is rising and I think that Largo's revenues per pound sold in 2023 could remain above $10.
In addition, 2023 is expected to be a breakout year for the global VRFB market, which currently accounts for about 1% of total vanadium demand. Global VRFB deployments are expected to soar to 2 GWhs this year, which should make this sector an important factor for vanadium demand.
Overall, I think that 2023 is likely to be a strong year for Largo from a financial standpoint and that the company is likely to return to the black if V2O5 prices remain at the current levels. In view of this, I'm upgrading my rating on the stock to speculative buy. However, the debt levels are likely to increase due to the significant CAPEX plans and I don't expect Largo to pay any dividends this year.
Looking at the risks for the bull case, I think that the major one is a prolonged global recession as this is likely to affect real estate demand and prices. At the moment, the real estate market in China accounts for close to 40% of the country's steel consumption. Largo needs high vanadium prices over the coming years to fund its ambitious growth plans and there could be significant stock dilution here if they stay low.
Investor takeaway
Largo had yet another weak fourth quarter from a production and financial standpoint due to high rainfall in Brazil. Yet, 2023 appears to be starting strong for the company thanks to high V2O5 prices and I think that the company could be back in the black soon. In 2021, an updated life of mine plan for Maracas Menchen showed an after-tax net present value ((NPV)) of $2 billion at around $8 per pound for the majority of the mine life but it's crucial for vanadium prices to remain high due to the significant CAPEX needed over the next couple of years. In my view, it could be best for risk-averse investors to avoid this stock.
For further details see:
Largo: Weak Q4 2022 Results But 2023 Is Starting Strong (Rating Upgrade)