Albemarle Valuation Leaves No Room for Downside Risks to Lithium Market Demand (ALB)

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Investment thesis

While the lithium boom story remains intact, mainly due to the automotive industry’s continued transition to electric vehicles, lithium may not necessarily present a major investment opportunity, due to market overcrowding. Albermarle (NYSE:ALB) has been a major player in the lithium industry and mining in general in recent years. Its finances are solid and growth prospects continue to be attractive, however, the share price has strayed away from fundamentals, with years needed to grow at its current valuation, while there appears to be no market risk to lithium. In other words, the best-case scenario for lithium demand growth is taken for granted, with investors expecting nothing but upside surprises and no potential pitfalls along the way.

Albemarle reports solid financial results in the third quarter of 2022

For the most recent quarter, there was a lot to be excited about in terms of Albemarle’s growing profit and revenue. Its lithium segment reported a 318 percent increase in revenue over the third quarter of 2021. Net income increased to $897 million, compared to a loss of $392.8 million for the third quarter of 2021. net sales were $2.1 billion, meaning profit margins were a whopping 42%.

While revenue and profit growth were outstanding, interest expense was nearly $30 million for the quarter, which is six times higher than the same quarter a year ago. The interest to revenue ratio is currently low, standing at just 1.4%. I expect Albemarle’s debt service costs, which are already low, to improve in the coming quarters as its profit margins and other financial performance metrics continue to put it in strong financial shape.

Valuing Albemarle is increasingly problematic, even for a solidly growing company

Albemarle stock price and financial metrics

Albemarle Stocks and Financial Metrics (Searching for Alpha)

With a market cap of over $38 billion as of this writing, Albemarle’s projected revenue for the year is about 5x less than its market cap. Its forward P/E is above 15, as we can see above, which is significantly higher than a 3 to 5 ratio for most solid commodity extraction companies. It’s true that most mining companies aren’t perceived to be big growth stories like lithium miners, however, at this point, it seems Albemarle’s better growth prospects for the next few years are already embedded in the stock.

Albemarlee lithium production growth forecast through 2025

Albemarle lithium production growth forecast (Albemarle)

While its lithium production and sales volumes are projected to double by 2025 from 2021 levels, most commodity mining companies trade at a level where annual revenues are roughly equal to the capitalization of market. We shouldn’t automatically assume that lithium prices will continue to trade at current levels or even rise. There are many market factors that have the potential to drive lithium prices down from current levels.

Risks to the growth of global lithium demand abound

Given the continuing march of the story of the global EV boom, any suggestion that expectations for growth in global demand for lithium may leave investors betting on it disappointed can be considered borderline heresy. However, sometimes the devil may be in the details of each story, and the story of the EV boom may be no different in that regard.

As I pointed out in a recent article, while an EU ban on the sale of ICE-powered vehicles by 2035 may sound like a bull story for EVs, so for lithium makers, the net benefit may be overstated. Due to some dynamics, such as price/range ratio, which is not an issue with ICE-powered cars, the net effect of an ICE ban could be a dramatic reduction in the overall car ownership rate in the EU. Many consumers may decide that, absent their ability to purchase an EV with sufficient range and other features that would provide them with the same utility that an ICE-powered car currently provides them, they may simply decide to give up driving. In other words, we shouldn’t expect everyone who can’t afford a luxury electric vehicle to settle for a city car. Such issues may start to come into play as automakers look to sell EVs to the global middle class, although there seems to be very limited awareness to date of what is actually a looming social problem, namely the inequality of income-based range. Even among those who are aware of this problem, the optimists among them assume that continued technological improvement will take care of it, which may not be the case.

After electric vehicles, the second most important emerging driver of lithium demand growth globally is thought to be as a means of electricity storage, in the context of the growing need to stabilize grids that are increasingly dependent on intermittent energy sources such as the generation of wind and solar energy.

global demand for energy storage

Energy storage news

Lithium batteries were expected to play an important role in multiplying the growth of energy storage demand worldwide. After the 2021 EU energy crisis caused by a shortfall in wind power generation, it is increasingly clear that battery storage plants that can only provide grid stabilization for a few days will not be enough to solve the emerging problem . My guess is that a big bet will be made on green hydrogen conversion, which is why I recently invested in green hydrogen startup Fusion Fuel (HTOO). As a result, grid-stabilizing lithium batteries will fall out of favor, as once green hydrogen-powered standby electricity generation starts to be ramped up, those battery systems will be seen as redundant.

Investment implications

While Albemarle is performing very well as a mining company, the market is currently priced at levels where there is no room for other market outcomes, but more optimistic lithium demand forecasts are outpacing or even surpassing those more optimistic expectations. It needs the best-case scenario outcome to grow into its current valuation. As I’ve pointed out, however, there are many emerging factors that could throw a spanner in the story of the lithium boom. Demand may continue to grow, but any slowdown in demand growth can easily cause global supply growth to exceed that level of demand, leaving lithium miners exposed, even as they continue to complete existing mining capacity expansion , which will prove to be much less profitable than currently anticipated.

I sold my position in Albermarle stock some time ago on the basis of these considerations. Its shares have risen significantly since then, which shows that trading strictly based on fundamentals, weighing potential long-term risks, against fundamentally justified upside potential can lead investors to miss out on the significant upside potential that could be see far beyond what the fundamentals might dictate. That said, the risk-reward ratio and magnitude of the upside, in a best-case scenario, versus the potential downside in a worst-case scenario of lithium demand leaves investors in a position where they are taking significant risks for limited potential gains.

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