Albemarle (ALB) is a specialty chemicals company with significant lithium operations. The company derives 36% of revenue from the lithium business and is considered the industry leader for lithium and lithium derivatives. The stock has been lagging this year as the market has been hung up on supply fears. However, I think the supply fears are overblown. Albemarle is not likely to be affected due to its long-term contracts with customers.
The supply fears that I mentioned stem from the idea that mining for lithium will ramp up significantly to meet demand to a point where we have an oversupply. The fear is that an oversupply could cause price weakness for the industry’s lithium, which could have a negative effect on revenue.
Albemarle stated that they believe the lithium market will have a supply-demand balance through 2021. Even if an oversupply situation occurred, Albemarle would not likely be affected due to the nature of their long-term contracts with customers. Therefore, the fears weighing on Albemarle’s stock are overblown, in my opinion.
Lithium to Drive Growth
I expect Albemarle to perform well over the long term as the demand for lithium grows. The global demand for lithium is expected to grow at a CAGR of 12% through 2024. The high expected annual growth is a result of the strong demand for lithium ion batteries used in electronic devices and electric vehicles [EVs].
Albemarle achieved a 14% increase in net sales and an 18% increase in EBITDA for Q1 2018 for the Lithium segment. So, this is the growth driver for the company.
Albemarle will benefit from this demand for lithium due to their leading position in the industry. The company has the strongest vertical position in the industry (from raw materials extraction to specialty product manufacturing. As a result of this, Albemarle has large economies of scale and has the lowest cost position for lithium carbonate and lithium hydroxide.
Albemarle has most of their contracts with customers for long-term agreements. While many of these contracts have been for 3 to 5 years, the company is seeing a shift to 10-year contracts from the leading providers of batteries and cathodes. This is why I see Albemarle as a long-term lithium play. You have multiple years of growth for lithium demand, combined with Albemarle’s multiple-year long-term contracts.
Another long-term growth catalyst for Albemarle’s lithium business is the potential shift to solid-state batteries. Solid-state batteries are lighter and have 2.5x higher energy storage than lithium-ion batteries. Solid-state batteries are considered safer due to their non-flammable solid electrodes/electrolytes. Lithium-ion batteries are more flammable due to their liquid electrodes/electrolytes. Solid-state batteries can be charged at a faster rate than lithium-ion batteries.
The shift to solid-state batteries would be positive for Albemarle because it would increase the demand for lithium. Solid-state requires more lithium molecules to increase energy density. However, solid-state batteries are still in the R&D phase and may be a few years away from hitting the market. Companies such as Tesla (TSLA), Toyota (TM), and Dyson are developing solid-state lithium technology.
Tesla boosted production of their Model 3 EVs to over 5,000 per week in Q2, which is positive for lithium demand. Tesla was only producing 2,000 Model 3s per week in the beginning of 2018. If you add in the production of Model S and Model X vehicles, Tesla is now producing a total of over 7,000 EVs per week.
Major auto manufacturers have announced plans to expand their EV production. Volkswagen (OTCPK:VLKAY) has a goal of producing 2 million to 3 million EVs by 2025. Volkswagen is contracting for 150 gigawatts of battery capacity per year, which is equal to about 140,000 metric tons of lithium capacity.
If Volkswagen has plans for large EV production increases, other major auto manufacturers are likely to follow suit. This depends on whether demand for EVs is warranted. Bloomberg’s forecast shows that the demand for EVs is expected to grow from 1.1 million vehicles in 2017 to 11 million in 2025 and to 30 million in 2030. So, other vehicle manufacturers are also likely to ramp up production over time to meet this growing demand.
Additional Business Segments
Albemarle’s other large segments, Catalysts and Bromine, help to diversify the company for a balance of revenue sources. The Bromine segment comprises 32% of Albemarle’s total revenue. Bromine is used as a flame retardant for fire safety. It is also used for the following applications: oilfield drilling, pharmaceutical manufacturing, high-tech cleaning, water treatment, and food safety. The Bromine segment achieved a sales increase of 3% and EBITDA growth of 2% for Q1.
The Catalysts segment comprises 27% of Albemarle’s total revenue. This segment provides performance catalysts and related services to the refining, petrochemical, and electronics industries. The company recently sold the polyolefin catalysts portion of this segment. Going forward, Albemarle expects to achieve full year adjusted EBITDA growth in the mid-single digits for 2018 for the Catalysts segment.
Albemarle strategically uses the Bromine and Catalysts segments to generate cash to grow the Lithium business. This strategy will help support Albemarle’s growth going forward. The strategy helps keep the company from diluting shareholders with new stock offerings. It also helps keep the balance sheet strong as this lessens the amount of new debt that Albermarle needs to take on.
Albemarle reduced total long-term debt from $1.8 billion at the end of 2017 to just under $1.5 billion at the end of Q1 2018. The company has a strong current ratio of 2.48, which shows that the company should have no issues handling short-term debt. Albemarle has 2x more total assets than total liabilities. The company maintains positive operating cash flow. Therefore, Albermarle should be able to handle their long-term debt without any issues.
Albemarle is now trading about 16x expected EPS for 2019 (consensus). The company’s competitor, SQM (SQM) is trading higher at 21.5x expected EPS for 2019 (consensus). Albemarle’s forward PE improved significantly since the stock was trading at its 52-week high back in November with a forward PE of over 27.
I see the current valuation improvement for Albemarle’s stock as a good buying opportunity. The stock appears to be bottoming out at these levels. I think the stock will make gains again as more investors realize the long-term potential growth for the company as the leader in the lithium space.
Risks to the Investment Thesis
Albemarle’s Bromine and Catalysts segments are growing at a much slower pace (low to mid single-digit rates) than the Lithium segment (strong double-digit rate). If growth of the Bromine and Catalysts segments slow down, the company wouldn’t have as much cash available to grow the Lithium segment as part of their strategy. This could hinder the company’s growth and hurt shareholders if the company would have to do an equity raise to grow.
Outlook for Albemarle
Albemarle should be considered a solid long-term investment. The growth for lithium demand as a result of higher EV demand will happen over many years. So, I see this as a stock to own for 10 years or more.
The sell-off in the stock this year has the valuation at attractive levels. I see this as a good buying opportunity for a long-term position. With the long-term strong prospects for lithium demand growth, I expect Albemarle’s stock to achieve double-digit increases annually, driven by the company’s strong double-digit earnings growth.
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