2023-11-17 11:42:23 ET
Summary
- Sociedad Química y Minera de Chile stock has dropped over 55% from its all-time highs due to declining lithium prices.
- SQM's financial results for Q3 2023 showed lower average sales prices in the lithium and fertilizer businesses.
- The company's outlook for lithium demand and prices remains uncertain due to an oversupply of lithium in the short term and potential negative impact from a global recession.
- We remain patient waiting for a lower entry points as our model shows modest returns during the following three years.
Investment Thesis
Sociedad Química y Minera de Chile ( SQM ) is widely viewed as the world's second-largest lithium producer, behind North Carolina-based Albemarle ( ALB ). Demand for the silvery-white metal has surged in recent years, driven by the rapid adoption of electric vehicles. However, after soaring to all-time highs last year, lithium prices have significantly retreated as supply has catch up.
As a result, SQM stock has dropped more than 55% from its all-time highs. Furthermore, the stock crashed 8% after presenting 3Q results. Despite the significant decline, a lot of doubts remain about the future price path of lithium and the company's profitability as a result. We think it would be best to wait for things to clear out and try to get a better entry point in the future.
Financial Results
SQM released lower-than-expected third-quarter revenue and earnings on November 15. Revenue for the three months ended September 30 was $1.84 billion , down 38% compared to a year ago. The main culprits for the disappointing results were significantly lower average sales prices in the company's lithium and fertilizer businesses.
Lithium Segment
Revenues for lithium and derivatives amounted to $1.27 billion, a decrease of 45.3% compared to $2.33 billion a year ago. Sales volume increased 4% from the year-ago period to over 43,300 metric tons of lithium carbonate equivalent, a quarterly record. However, this small volume gain was more than offset by a much lower average realized price, which dropped 47% year over year.
Specialty Plant Segment
The revenues from the specialty plant nutrition business line were $221.7 million in Q3, down 24% YoY. They were impacted by significantly lower average sales prices when compared to the same period of 2022. However, the management believe that downward price trend observed during this year could have concluded and market prices might have reached the bottom. The demand recovery seen during the third quarter is anticipated to continue for the reminder of the year and extend into 2024.
Iodine Segment
The iodine and derivatives business revenues during the third quarter 2023 were slightly lower compared to the same period last year as result of lower sales volumes partially offset by higher realized sales prices(+6% YoY).
Potassium
Potassium revenues during the third quarter 2023 increased almost 25% YoY to $75.2 million as a result of significantly higher sales volumes partially offset by lower average sales prices. They believe that the price decrease could have a positive impact on global potash market demand resulting in a growth of approximately 10 million metric tons during this year when compared to 2022.
Industrial Chemicals
Industrial chemicals revenues during the third quarter 2023 were $43.3 million, slightly lower than a year ago because of lower sales volumes.
Profitability
SQM recorded a gross profit of $753.6 million, which represented a 39.3% margin vs. 55.2% a year ago. G&A expenses increased $5 million to $40.1 million, and although the financial expense almost doubled from $16.6 million in Q3 2022 to $30.3 million, the financial income grew 314% to $34 million. As a result, the company recorded a net financial income of $3.7 million.
Income before taxes was $697 million, and the effective tax rate was 31%. Taking everything into account, net income was $479.4 million, a 56.4% decrease YoY. The net income margin was 26% vs. 37.2% a year ago.
Adjusted EBITDA for the third quarter of 2023 was $788.2 million (42.8% margin), compared to $1,660.3 million (56.1% margin) for the third quarter of 2022.
Outlook
SQM doesn't provide quarterly or annual guidance. That said, Ramos(the CEO) commented on management's broad outlook for lithium demand and prices:
We continue to see strong fundamentals behind long-term lithium demand growth, supported by strong EV sales volumes and decarbonization targets across the globe. However, the excess of inventory accumulated across battery and lithium chemical supply chains, particularly in Asia, as well as additional lithium supply, have put pressure on lithium market prices and could continue to have a negative impact on lithium prices in the short term.
At the end of Q3 the price per ton of Lithium Carbonate was $23.000 and has since fallen to $20.700, according to Trading Economics (price in CNY converted to USD). This is the lowest level since September 2021. SQM majority of sales contracts are linked to price indices which follow market price trends(although they have a lag), so we should expect lower revenues from the Lithium segment in Q4 and possible into 2024.
The global demand for lithium is expected to be just shy of 1 million mt in 2023 , and it's set to double to over 2 million mt by 2028, a CAGR of 14.8% in 5 years. However, that's all very nice, but we have to consider the other side of the equation: there is an oversupply of lithium right now. The production of lithium is expected to exceed 1 million mt globally this year, and in the case of SQM, they have already said that they are building inventory for when "demand returns to a normal level."
Although new supply takes years to become operational, there are many projects coming online in the short term. For example, in Argentina, production of lithium is expected to be 70k mt in 2023 and multiply by 3 to 210k mt in just two years . SQM alone is expected to increase yearly production from 210k mt in 2023 to 265k mt in 2025, a 26% increase. And Albemarle is estimated to grow volume at a 20%-30% CAGR in the coming years. I think the questions isn't will supply catch demand, but vice versa.
The problems the industry is facing now could be further exacerbated by a global recession. Given that the majority of the demand comes from electric vehicles, we know what would happen under this situation, as consumer prioritize basic needs.
With SQM, there is also the risk of the nationalization of the lithium industry, proposed by President Boric. However, as far as my knowledge goes, he doesn't have the votes to pass the law through Congress, so the probabilities that he could make this happen seem low.
The company's shorter-term outlook is brighter for its specialty plant nutrition business. It said in the earnings release that it believes pricing could have hit a bottom and that the market could rebound in 2024.
Valuation
At the time of this writing SQM stock if falling 8% after they posted results. The price per share is $47 dollars, which translates to a $13.54 billion market cap. The stock is trading at 6x P/E and 4.3x EV/EBITDA(forward). Albemarle, for comparison, is trading at 5.8x P/E and 5.2 EV/EBITDA .
Let's model how SQM's financials would look in the coming years. Production capacity is expected to ramp up to 235k mt in 2025, but they won't produce that amount in that year, so we shifted it to 2026, assuming a price per mt of lithium of $35k. This results in $8.225 billion in lithium revenue in 2026. For the other segments, we annualized the revenue from the 9 months ended September 2023, and assumed it grows at 3% per annum. Overall, we estimate revenue in 2026 to be $10.7 billion. Keep in mind that this greatly depends on the price of commodities, so it could vary a lot.
For production costs of lithium, we assume $5k per mt and 40% of total sales as royalties to the government. For the cost of the other segments, we made the same calculation as before(annualized the last 9 months). Lastly, we assumed depreciation of 3.5% of revenue every year. This yields a gross profit of $4.04 billion in 2026, or a 38% gross margin, which is 500 basis points (bps) lower than today.
We estimate 3% for other costs (corporate, interests, etc.) and a tax rate of 28%. With this, we arrive at a net income of $2.68 billion in 2026, representing a 25% margin. If we assume a 7x P/E exit multiple, we arrive at a market cap of $18.7 billion, or 38.6% higher than today. This translates into an expected CAGR of 11.5% over three years(plus dividends, which we don't take into account).
However, for the returns to be positive, under our model, the price per mt of lithium should be higher than $26.7k. Below that, and assuming a 7x exit multiple, the returns would be negative. For us to believe that we could achieve an attractive CAGR, we should believe that the price of lithium will hold up and increase, and we are not entirely sure about that given the supply and demand situation we are seeing today.
Takeaway
The lithium market is undergoing a severe bear market, with supply growth outpacing demand growth in the near term, which is being reflected in the price of lithium. However, in the long term, it depends significantly, as with any commodity, on where the price ends. For anything above $35k per mt, we think SQM may represent an attractive opportunity, but below that, the potential returns seem very low. We think it would be best to wait for prices to stabilize and get a better entry point.
For further details see:
SQM: We Are Not There Yet