Lithium price goes up and up, so why the sell-off in lithium stocks?

Another record price for Pilbara Minerals’ product prompts MD Ken Brinsden to question analysts’ price assumptions. And Sandfire chief Karl Simich also has a message for the market: forget costs, focus on margins.
28th April 2022
Barry FitzGerald

As is always the case in equity market shakedowns, there are babies thrown out with the bathwater.

This time around it is the lithium babies that have been unceremoniously dumped by the professional money managers.

There is really no excuse for it, remembering though that for every panicked seller there was a smiling buyer on the other side of the trade.

Pilbara Minerals (PLS) demonstrates the point. It was trading happily at $3.43 a share at the start of April but has since been slammed 22% lower to $2.69, and that’s after a 9c lift in Thursday’s market.

The reason for the equity market shakedown is multi-faceted. But there are no facets in there to justify the dumping of the lithium stocks.

Pilbara CEO Ken Brinsden takes up the story, speaking as he was after the release of the company’s March quarterly report on Thursday.

Brinsden reported that the acceleration in pricing for spodumene concentrates (6% lithia), which get sent off to China for chemical conversion into lithium carbonate/hydroxide for use in lithium-ion batteries, had continued from the December quarter ($US1,750/t) into the March quarter ($US2,650/t), and was now flowing through to the June quarter ($US4,300t indicative).

Compare that on-going trend of higher pricing for Pilbara and the rest of the WA spodumene producers to the concentrate price in March 2021 of $US550/t and the case for the lithium sector to be treated differently in the current market shakedown is made.

If there is any doubt about that, Pilbara also reported that the latest spot sale on its fledgling Battery Material Exchange (BMX) was put away at the equivalent of $US6,250/t (it was actually 5.5% material).

The BMX sale was a record price. “It represents another high water mark as it relates to pricing in the market and further clear evidence as to how short (of supply) the market is,” Brinsden told the investor call on the quarterly report.

“The conditions are very, very strong.”

In short, Pilbara is enjoying an explosion in margins to the point of becoming a money printing machine.

A question arose from during the call as to why equity analysts remain on the low side when it comes to the prices they are plugging into their price forecasts for spodumene concentrates, particularly for the long-term.

Brinsden’s answer pointed to a major rethink by analysts being required.

“Short and medium-term pricing is a function of the critical shortage of supply in the market,’’ Brinsden said.

“But it is not unreasonable to expect that at some point of time in the future there is going to be normalisation in the supply-demand dynamic, in which pricing will more than likely reflect the cost base – it an issue that has yet to be resolved by analysts and the financial community.

“The key point I will leave you with there is that historical norms are well and truly going to be broken down. So the idea that long-run spodumene concentrate pricing might be $US600-$US650 a tonne is long gone.

“And that’s because the lithium materials industry needs to grow about 10-fold between now and 2030. To do so, projects are going to be built that are nothing like historical norms with respect to cost.

“So the right hand size of the cost curve gets built out and by implication, the long run price must be higher.”

He noted that it is a rare occurrence in the natural resources space.

“But it is clearly going to happen here in lithium.’’

Iron ore provides an analogy. Back in the early 2000s, iron ore was a $US30/t market that did not change much. But then along came China with its seemingly insatiable demand for the steelmaking raw material.

The result is that iron ore is now trading in a $US100-$150/t band because new projects and expansions are – and continue to be - needed to incentivise the production required to meet demand.

“In iron ore, we’re talking about an industry that probably tripled. Here we are talking about an industry that has to grow by 10-fold. So clearly the long run price has to be materially higher than the historical norms, otherwise the industry won’t grow,” Brinsden said.

“What does that result in? I don’t have a crystal ball but I can assure you that it is much higher than what people thought it might have been, even three of four years ago.”

Pilbara is as nicely positioned to benefit as it could ever have hoped to be from its Pilgangoora  operation which was enlarged in late December 2020 with the well-timed acquisition of the neighbouring Altura operation from Altura’s receivers.

It was a time when things were tough in the business. Pilbara is now in the process of turning the Altura operation back on which, with some creep at its existing operation, will carry production to an annual run rate of 580,000t from the end of the September quarter.

That compares with guidance for FY2022 of 340,000-380,000t, with COVID impacts potentially meaning the actual result could come in at the lower end. Pilbara won’t be stopping there, with advanced studies contemplating a push to an annual rate of 1 million tonnes, expected to cost upwards of $300m.

Sandfire (SFR):

It was mentioned here last week that copper stocks also looked like they were being thrown out with the bath water, particularly Sandfire (SFR).

Last Thursday, Sandfire had traded down to $5.60 a share, taking its fall for the year to date to 17%. It got worse in following days, landing as low as $5.20.

There was no good reason for that other than the general shakedown in equity values and some weakness in copper and zinc prices.

By the reckon of its CEO Karl Simich, Sandfire was, and continues, to trade at less than half its value.

Speaking at yesterday’s release of Sandfire’s March quarterly, Simich said that the group’s business -  expanded by the recent acquisition of the MATSA copper-zinc operation in Spain – was probably good for annual EBITDA of between $US600-$US800m.

Take $US700m as the mid-point, and apply the EBITDA multiple of Sandfire’s peers of 4-8 times, and a valuation for Sandfire of $8-$16 a share can be arrived at, with $12 a share the mid-point.

That’s where Simich’s less than half-value thought comes from.

The market must have been listening as Sandfire shares shot 62c or 11.9% to $5.82 in Thursday’s market – still less than half value on Simich’s reckoning.

Simich also did some welcome straight talking on the panic in the equity markets on costs increases across the industry.

The flip side to the inflation is that prices remain at elevated levels (Sandfire’s operating margin in the March quarter was 62% or $US3.50/lb of copper produced).

So despite the cost inflation, Sandfire is “generating strong revenues and healthy, greater, operating margins,” Simich said.

“And ultimately in any business, it is about the margins.”

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