Forget The Panic, Embrace The Potential: Why Albemarle Is Still A Winner (NYSE:ALB)

Introduction

On April 8, I wrote an article titled “Dirt Cheap: Why Albemarle Is My Favorite EV Stock In A Horrible Market.”

As it turns out, the Albemarle Corporation (NYSE:ALB) has gotten even cheaper, falling 25% since then. The ongoing downtrend is so bad that it has pushed the stock below its 2018 highs.

While ALB has still returned 10.5% annually since January 2004, it has returned just 57% over the past ten years – a horrible return, given the volatility investors had to go through.

In general, while I am very happy with the way things are going (in general), I was dead wrong about lithium and rare earth metals this year. I cannot sugarcoat that.

Although I stick to my call that miners are a better bet than individual car companies in the EV space, I was very wrong about the timing of the recovery.

As it turned out, lithium is still in a tough spot.

In this article, I’ll elaborate on this and explain what I make of the risk/reward going forward.

So, let’s get to it!

Lithium Cannot Catch A Break

On June 24, Bloomberg wrote an article on the massive decline in lithium prices.

Lithium carbonate prices in China, the biggest EV producer on planet Earth, have dropped to the lowest price since August 2021, erasing the entire post-COVID surge.

According to the article, the current decline comes after an 80% price drop in 2023 due to a supply glut and slowing demand growth.

Moreover, although prices have stabilized a bit, producers are still clearing inventories, which hurts demand.

Rising lithium production and expectations of a summer lull are weighing on prices, according to Susan Zou, an analyst at researcher Rystad Energy. Despite the brief rebound earlier this year — underpinned by lower supply around China’s Lunar New Year holiday period and traders’ speculative buying — upward drivers have “mostly disappeared,” she said. – Bloomberg

Meanwhile, earlier this month, The Wall Street Journal came out making the case that because lithium is so important in clean-energy technologies, there has been too much focus on supply, causing an imbalance in the market.

In fact, this is very common when new technologies/trends emerge. Once everyone jumps on board, the risk/reward is “ruined.”

In China’s Qinghai Province, where producers extract lithium from salt lakes, output is experiencing a seasonal boost, adding to pressure on prices. Evaporation rates at the brine ponds are more favorable during the warmer months, said Daisy Jennings-Gray, head of prices at Benchmark Mineral Intelligence.

In western Australia, Liontown’s own big new mine is due to start producing a raw form of lithium, called spodumene, by the end of this month. – The Wall Street Journal

These developments have resulted in lower expected supply growth, which is a good sign for the market.

It also brings me to Albemarle.

It’s Bad – But There’s Hope

On June 25, the news dropped that Lithium prices do not justify investments in new plants for America’s largest lithium producer, Albemarle.

The current price of the key battery ingredient is “concerning” and investors shouldn’t put money into lithium facilities at these market levels, Eric Norris, president of energy storage, said Tuesday at an industry conference in Las Vegas. – Bloomberg

Although bottoms take time, these developments usually occur near bottoms instead of peaks.

So far, volumes were a tailwind for Albemarle.

In 1Q24, for example, the company reported $1.4 billion in sales and $291 million in adjusted EBITDA. The EBITDA result is down 83% compared to 1Q23.

With pricing being the biggest headwind, it saw tailwinds from productivity gains and higher volumes, as we can see in the overview below.

Regarding cost savings, the company achieved more than $90 million in productivity and restructuring cost savings in the first quarter alone and has a target of over $280 million in productivity improvements for the full year.

It also made the case that the long-term outlook for lithium demand remains strong, driven by the global transition to electric vehicles.

The North Carolina-based company expects a 2.5x increase in lithium demand from 2024 to 2030. Back in 1Q24, it made the case that this provides the need for new mining projects.

This is backed by research from the International Energy Agency, which wrote in a 282-page report in May that supply is unlikely to keep up with soaring demand if investments follow current climate guidelines.

According to the report (emphasis added):

Analysis of announced projects indicates that lithium raw material supply grows to 450 kt Li around 2030 in the base case, again more than doubling the current production, and reaching five times the production of 2020. In the high production case, an additional 70 kt Li of raw material supply could be made available on the market. If announced projects come online as planned, this volume approaches the requirements in the STEPS as well as in the APS in 2030, but is insufficient to stay on the 1.5 °C pathway. Beyond 2030, all scenarios require a further investment in new supplies to keep pace with the demand growth.

[…] There are many projects in the pipeline at their early stages of development, but price volatility may delay the projects coming up, particularly those outside of incumbent country producers, with implications for long-term supply and diversification.

The report also makes the case that lithium has the highest price volatility among energy-transition minerals, which makes sense, given current developments.

What helps is that Albemarle is sitting on high-quality reserves, providing strong margins and growth opportunities.

Although it needs to be seen how the company’s growth plans have changed due to this challenging environment, the company has several growth projects, including the Kemerton I and II facilities in Australia and the Meishan facility in China.

In the first quarter earnings call, the company reported that Kemerton I had achieved the milestone of 50% operating rates for battery-grade products. Meishan reached a 50% operating rate for battery-grade material.

Technically speaking, the company could ramp up production to almost 300 kilotons of lithium carbonate equivalent (“LCE”) by 2027.

It also benefits from above-average lithium grades, which provide downside protection and pricing power – especially if demand comes back.

The company also has major production facilities in low-risk jurisdictions, which is increasingly important in light of global geopolitical challenges.

As China currently dominates the EV supply chain, Albemarle has secular tailwinds to de-risk supply risk for Western producers.

It also helps that the company has always kept financial health a priority. The company has an investment-grade credit rating of BBB, $3.7 billion in liquidity, and a long-term bet debt target of 2.5x EBITDA.

On top of that, it has a 1.6% dividend yield, which comes with a payout ratio of just 13.1%. While its five-year CAGR is just 2.6%, it has Dividend Aristocrat status with 29 consecutive annual dividend hikes.

The moment lithium prices bottom, I expect dividend growth to accelerate. I see no risk of dividend cuts in the years ahead – even if the lithium price decline continues.

Where’s The Value?

The FAST Graphs chart below includes FactSet EPS expectations.

To give you an idea of what changed compared to my prior article, the table below shows what expectations looked like on April 5 and what they look like now.

Click to enlarge

This volatility is normal, as the company’s sales are highly dependent on lithium prices. As we can see below, in an environment of $40 per kg of LCE, the company generates $7.1 billion in revenue. At $15 per kg of LCE, that number drops to $3.3 billion (midpoint)

That said, Albemarle currently trades at a blended P/E ratio of just 8.5x. It was only barely cheaper during the Great Financial Crisis.

A return to a 17.2x multiple by incorporation of current subdued expectations could pave the road for a recovery to $131, roughly 34% above the current price.

As such, I still stick to a Strong Buy rating, as even a slight improvement in the supply/demand situation could fuel an earnings recovery.

In other words, the risk/reward down here is fantastic – the volatility isn’t.

Although I cannot make the case that ALB is a must-own stock, I have to say that if I were long, I would stay long, as current big-picture developments hint at a bottoming process.

Going into 2Q24 earnings, I’m looking for more intel regarding its future growth plans and Chinese inventory de-stocking.

Needless to say, if you’re usually an investor in less volatile dividend (growth) stocks, please be careful here. ALB may not be right for you.

Hence, given my elevated exposure to volatile energy commodities, I decided to refrain from adding more volatility to my portfolio.

Takeaway

I’ve been a big fan of Albemarle, but the market has been brutal, and the stock has dropped 25% since my April call.

While the long-term outlook for lithium remains strong, the short-term volatility has been challenging.

Lithium prices have plunged, erasing post-COVID gains, and Albemarle’s earnings have taken a huge hit.

However, the company’s solid reserves, strategic growth projects, and financial health provide a strong foundation for a recovery.

At its current low valuation, I still see ALB as a strong buy with excellent long-term potential, despite the rough ride ahead.

However, while its Strong Buy rating reflects its potential, it is not a “must-own” stock due to the risks that come with it.

Pros & Cons

Pros:

• Strong Long-Term Outlook: Albemarle is well-positioned to benefit from the global transition to electric vehicles, with a 2.5x increase in lithium demand expected from 2024 to 2030. Growth is slower than initially expected, but still expected to cause supply shortages.
• Solid Financial Health: With an investment-grade credit rating, $3.7 billion in liquidity, and a low payout ratio, Albemarle is financially strong.
• Growth Projects: Key projects in Australia and China put the stock in a good spot to boost output – in case it sticks to these plans.
• High-Quality Reserves: The company’s high-grade lithium reserves provide strong margins and downside protection.
• Attractive Valuation: Trading at a P/E ratio of just 8.5x, Albemarle is significantly undervalued, offering a compelling risk/reward profile.

Cons:

• Volatile Lithium Prices: The recent plunge in lithium prices has hit Albemarle’s earnings hard, and market volatility remains a major concern.
• Short-Term Uncertainty: Ongoing inventory issues and production increases are pressuring prices, creating near-term headwinds.
• Market Sentiment: The stock has significantly underperformed, falling 25% since April. It will take a lot to bring back confidence.
• Dividend Growth Risks: While the current dividend is safe, further declines in lithium prices could slow future dividend growth.