2023-06-19 12:02:44 ET
Summary
- Lithium demand is booming due to the rapid increase in electric car production, causing lithium prices to rise and making lithium stocks a very profitable investment.
- Sigma Lithium and Lithium Royalty Corp (LRC) are two companies in the lithium industry that could benefit from this increased demand, with Sigma Lithium being a rapidly growing lithium producer and LRC being the largest pure-play lithium royalty company.
- Both companies face risks such as future lithium prices, mining costs, and government intervention, but they also have the potential for significant returns if lithium prices continue to rise.
Thesis
While there are many ways to profit from the rapid increase in the number of electric vehicles produced, I’d argue that lithium stocks are the best way to play this market, as car companies are buying stakes in lithium miners rather than lithium miners buying stakes in car companies. This article covers companies from two parts of the lithium industry: Sigma Lithium ( SGML ), a rapidly growing lithium producer, and Lithium Royalty Corp (LITRF) ((LRC)), the largest pure play lithium royalty company. The valuation of these companies depends on the lithium price, which has been highly volatile in recent years. Both companies are at least fairly valued at a conservative $20,000 per ton lithium carbonate equivalent ((LCE)) price, and are undervalued at higher prices. Sigma Lithium is the higher risk, higher reward play, as it only operates one mine in Brazil, while Lithium Royalty Corp holds a diversified set of lithium royalty assets and is not exposed to operator risk.
Overview
Lithium demand is booming due to a rapid increase in the number of electric cars being produced. Prices have reflected this increased demand, rising from under $10,000 per ton lithium carbonate equivalent ((LCE)) in 2020 to over $80,000 per ton LCE in 2022 before falling again and settling at around $40,000 recently. Due to the high volatility in prices it is hard to forecast future prices (which was attempted in the figure below), but if it goes back up to $80,000, lithium producers are likely to do very well.
In addition, I’d argue that lithium stocks are the best way to play the electric car theme, as car companies are buying stakes in lithium miners rather than lithium miners buying stakes in car companies. Furthermore, Elon Musk, CEO of the most well-known electric car company, said last year that Tesla ( TSLA ) was open to buying a mining company, and earlier this year there were rumors that they might buy Sigma Lithium.
This article covers companies from two parts of the lithium industry: Sigma Lithium, a rapidly growing lithium producer, and LRC, the largest pure play lithium royalty company.
Altius Minerals 2023 Investor Day Presentation
Sigma Lithium started producing lithium spodumene from its large Grota do Cirilo mine in April 2023 and is planning to scale up its production to produce around 104 kilo tons per annum (ktpa) of lithium carbonate equivalent LCE by 2025. This would make it one of the world's largest producers of lithium (see figure below), and would result in a higher lithium production to market cap ratio than most of its competitors. Its mine life is projected to be 13 years, but it has a large land package which should allow the mine life to be extended.
Sigma Lithium June 2023 Corporate Presentation
LRC is a recently listed lithium focused royalty company, whose most valuable royalty is likely its 0.9% net smelter royalty (NSR) on Sigma Lithium’s Grota do Cirilo mine. The value of this royalty has increased dramatically since LRC acquired the royalty in 2018 (see figure below). The resource on Grota do Cirilo has increased more than sixfold and expected annual production has increased more than threefold. In addition, LRC owns many other royalties on hard rock, brine and clay lithium assets that are in production, under construction or in development. It has two lithium hard rock spodumene royalties in Australia in production and two lithium brine royalties in Argentina under construction.
LRC June 2023 Corporate Presentation
Company Financials
Sigma Lithium is a relatively new producer, and therefore its financial situation is best summarized by looking at the economics of its Grota do Cirilo project. In the 2022 NI 43-101 report for Grota do Cirilo, in its medium case scenario, Sigma Lithium assumes around 5,293 kilo tons (kt) of lithium concentrate are produced over a 13 year mine life (see table below). Over this period Sigma Lithium would incur $2.1 billion in operating costs and $0.4 billion in capital costs or $432 per ton of lithium concentrate. Royalty costs are around 2.8% of revenues and taxes are around 15.3% of profits. Since the NI 43-101 report, Sigma Lithium increased its annual production estimates to 766 kt of lithium concentrate or 104 kt of LCE, resulting in operating and capital costs of around $3,182 per ton of LCE.
Using a conservative per ton LCE price of $20,000, this level of production would generate revenues of $2,080 million, royalty costs of $58 million and mining costs of $331 million. Subtracting costs from revenues gives annual pretax free cash flows of $1,691 million, and subtracting tax gives annual after tax free cash flows of $1,432 million.
NI 43-101 2022 Technical Report: Grota do Cirilo lithium project (note: cropped to fit onto page)
LRC is a relatively new royalty company, and therefore its financials are best summarized through an analysis of its main royalty holdings. It has six royalties in production or under construction, five of which are on lithium (see chart below). Interestingly, the royalties received by LRC from Sigma Lithium are also displayed in the figure above and total $96.6 million or around 0.8% of revenues. The reason this is less than 1% of revenues is that this is a NSR royalty and not a gross overriding revenue ((GOR)). Using the annual revenue value of $2,080 million calculated above, LRC may receive around $17 million in royalties from Sigma Lithium annually. As 0.1% of the NSR goes to Altius Minerals (ATUSF), LRC would receive around $15 million of this amount annually in net proceeds.
LRC June 2023 Corporate Presentation
Examining its other producing royalties, LRC has a 2.5% GOR on Core Lithium’s Finniss mine in Australia and an A$1.5/ton royalty on Allkem Mt. Cattlin mine in Australia. The Finniss mine is expected to produce around 173 ktpa of lithium concentrate, which should work out to around 23 ktpa of LCE. Using a LCE per ton price of $20,000, this royalty is expected to provide around $12 million in annual revenues to LRC. Revenues from the Mt. Cattlin royalty are tiny in comparison as a $1 per ton royalty applied to 194 ktpa of lithium concentrate produced gives LRC approximately $0.2 million in royalty receipts.
The two LRC Argentinian brine assets are massive with each having around 8 million tons of LCE resources. However, the initial annual production plans are fairly modest. Zinjin Mining stated that they're planning on producing 20 ktpa of LCE from Tres Quebradas in phase 1, with the potential to scale up to 40-60 ktpa in future phases. By contrast Ganfeng (GNENY) only stated that they were planning on producing 20 ktpa of LCE from Mariana in phase 1. Using a LCE price per ton of $20,000 and the 1% GOR, Tres Quebradas will provide royalty revenues of at least $4.0 million, with Altius Minerals taking a 10% share of this. The 0.5% Mariana NSR would likely generate at least $1.6 million in revenues with Altius taking a 10% share. These values would obviously be higher if, for example, 50 ktpa were produced and generate $10.0 million in revenues from Tres Quebradas and $4.0 million from Mariana.
Company Valuations
A mining company can be conservatively valued at around 10 times annual after tax cash flows. Therefore, if the assumptions from the NI 43-101 report are accurate, the $1.4 billion annual free cash flow value calculated above would give Sigma Lithium a value of around $14 billion. This is over 3X the current market capitalization of $4.2 billion, which shows that Sigma Lithium is currently undervalued. Granted this valuation assumes things go according to plan, and that there are plenty of additional resources to extend the mine life. It also assumes minimal stock dilution. Conversely, if the LCE price increases to $80,000 or more, then potential returns could be much higher. The chart below shows annual after tax free cash generated at various lithium prices.
Author's calculations based on information calculated above from Sigma's NI 43-101 report
LRC can be valuated based on a sum of parts analysis of its assets. LRC has created a figure in its presentation valuing each of it assets as percent of total asset value (see pie chart below). However, this chart does not look quite right, as it strangely excludes the Mariana asset, while listing the Tres Quebradas asset as being significantly more valuable than either Grota do Cirilo or Finniss. Therefore, it looks like this graph is out of date, and a better indication of the value of LRC’s assets is likely twice the value of its producing and development lithium royalties.
LRC June 2023 Corporate Presentation
Annual royalties receipts for LRC were calculated above and are $15 million, $12 million, $0.2 million, $3.6 million and $1.4 million for Grota do Cirilo, Finniss, Mt. Cattlin, Tres Quebradas and Mariana respectively, totaling around $32 million. Multiplying this value by 2 and assigning a value of these assets of 10 times annual revenue gives a value of LRC assets of $640 million. This is slightly higher than LRC’s current market capitalization of $564 million, indicating it is fairly valued at a $20,000 per ton LCE price. This also means that it would be undervalued at higher lithium prices as the table below shows.
Author's calculations based on information outlined above
Investment Risks
Based on the valuation analysis above, Sigma Lithium looks like a better buy than LRC. However, royalty companies have a number of advantages over mining companies, most notably that they are exposed to fewer risks.
The most important risk is the future price of lithium. My analysis is fairly conservative in using a per ton LCE price of $20,000, but just a couple years ago the per ton LCE price was below $10,000. If these lower prices were to materialize, both these companies should still be profitable, as Sigma Lithium’s costs are below $5,000, and LRC is not exposed to mining costs. This would not be the case though for higher cost lithium producers, who would be losing money at these prices. Therefore, these low prices would likely not persist in the medium to long term. If prices remain volatile, LRC could stand to benefit, as it would need to pay less for new royalties when the lithium price is lower.
Another risk is that mining costs could increase faster than lithium prices. Sigma Lithium should be able to deal with this well, as its mining costs are already low. However, Sigma Lithium only has one asset, and is therefore vulnerable to any issues that could occur at Grota do Cirilo, ranging from the government wanting to increase its take to a disaster at the mine. Fortunately though, Sigma Lithium does not rely on tailings dams for their mining and is therefore not vulnerable to tailings dam failures as is the case for Vale (VALE). LRC does not face any operator risk as it does not operate mines.
Both LRC and Sigma Lithium would be vulnerable to the risk of government confiscation of the Grota do Cirilo mine. While the Brazilian government has not made attempts at nationalizing their lithium assets, and was fairly pro mining during their last stint in office, other countries in the region, such as Chile and Mexico have gone down this path. Sigma Lithium is doing what it can to mitigate this risk by making sure the company is as ESG friendly as possible, but ultimately there is risk associated with any mining project, including those in purportedly safer countries such the U.S. LRC has diversified its assets and would therefore be less impacted by any impairments that could occur at Grota do Cirilo.
Final Thoughts
Given the risks and rewards outlined above, there are merits to buying either of these companies or even both of them. However, I am not invested in either of them, and am instead invested in a smaller cap lithium and copper royalty company somewhat misleadingly called TNR Gold (TRRXF).
TNR Gold holds the other half of the Mariana lithium royalty (minus 10% held by another company), and in fact LRC bought their half of the royalty from TNR Gold. Therefore, in the base case outlined above, TNR Gold could receive $1.2 million annually for the royalty. This would increase to $3.6 million if Mariana produced 50,000 LCE ktpa at $20,000 per LCE ton, or increase to $2.9 million if Mariana produced 20,000 LCE ktpa at $40,000 per LCE ton.
In addition, TNR Gold also holds a 0.36% NSR royalty on the Los Azules copper deposit, which is anticipated to be able to produce 150,000 to 200,000 tons of copper annually. Using a $10,000 per ton price, this royalty could pay around $5 million annually if it goes into production. Thereby, future royalty revenues could exceed this company's current market cap of around $7.2 million. While TNR Gold has a very small market capitalization and is therefore hard to trade, I think it has the highest upside of all lithium focused royalty stocks.
For further details see:
Sigma Lithium And Lithium Royalty: 2 Distinct Lithium Plays For Electric Vehicle Bulls