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Finding Value In Lithium Developers: A Relative Valuation Approach

Summary

The pre-production lithium developers are an interesting cohort worth of consideration.

A dataset including enterprise values and lithium resource estimates is assembled and analyzed.

The use and limitation of relative valuation parameter such as EV/Li ratio are discussed.

Major observations are further explored to shine a light on investment in lithium developers.

Critical drivers of value appreciation of lithium developer stocks are identified.

This idea was discussed in more depth with members of my private investing community, The Natural Resources Hub.

“A great company is not a great investment if you pay too much for the stock.” - Benjamin Graham

As the ascent of Global X Lithium ETF (LIT) continues (Fig. 1), investor become increasingly enthusiastic about lithium-related companies. However, as we pointed out in a previous article entitled "Where The Money Is In The Electric Vehicle Supply Chain" (see here),

The suppliers of critical raw materials for battery cells hold strategic chokepoints in the EV supply chain.

This is why the lithium raw material suppliers have received a lot of attention lately. It seems another lithium mining start-up comes into existence every the other week. However, from a balanced risk-reward point of view, it is probably advisable to focus on the companies which have graduated from the early exploration stage, are approaching the first production, or the middle of the pack so to speak among the mining concerns (see here).

Fig. 1. The price chart of Global X Lithium ETF (LIT). Source: here.

In this article, I attempt to conduct a reconnaissance of these middle-of-the-pack lithium extractors, using the enterprise value per lithium resource as a yardstick.

Lithium extractors in advanced stage of development

There are approximately a dozen lithium developers, which have come near to the first production (Table 1). They fall into two groups, i.e., the brine (and clay) lithium extractors and hard rock lithium miners.

The brine lithium extractors include Millenial Lithium (OTCQB:MLNLF), Lithium Americas (OTCQX:LACDF), Lithium X (OTCQX:LIXXF), International Lithium (OTCPK:ILHMF), Lithium Power International (OTC:LTHHF), Neo Lithium (OTCQX:NTTHF), Pure Energy (OTCQB:PEMIF), and Advantage Lithium (OTCQX:AVLIF), with clay lithium developer Bacanora (OTC:BCRMF) lumped in and Orocobre (OTCPK:OROCF) and SQM (SQM) included for comparison purpose.

The hard rock lithium miners include Kidman Resources (KDR.ASX), Critical Elements (OTCQX:CRECF), Altura Mining (OTCPK:ALTAF), Pilbara Minerals (OTCPK:PILBF), and Nemaska Lithium (OTCQX:NMKEF), with producers Neometal (OTCPK:RRSSF) and Galaxy Resources (OTCPK:GALXF) included for comparison purposes.

Table 1. The middle-of-the-pack lithium extractors. Source: Enterprise value and market cap are sourced from gurufocus.com as of midday January 8, 2018.

The dataset

These companies are selected because they are precisely or nearly lithium pure plays, with their assets being dominantly lithium projects. Excluded from this study are those that have other major non-lithium lines of business, e.g., Albemarle (ALB), FMC (FMC), Mineral Resources Ltd. (OTCPK:MALRF), and Eramet (OTC:ERMAF). Chinese and private lithium developers are also excluded, including Chengdu Tianqi, Ganfeng, and Energi.

The reported lithium resource net to company interest is considered to represent the size of lithium assets. The lithium resource for each company is taken from the company websites, the technical, PEA or DFS reports or annual reports, with the links to the information sources listed alphabetically below:

  • Advantage Lithium (see here and here); Altura Mining (see here); Bacanora Minerals (see here); Critical Elements (see here); Galaxy Resources (see here); International Lithium Corp. (see here); Kidman Resources (see here); Lithium X (see here and here); Lithium Americas (see here); Lithium Power International (see here and here); Millenial Lithium (see here); Nemaska Lithium (see here); Neo Lithium (see here); Neometals (see here); Orocobre (see here); Pilbara Minerals (see here); Pure Minerals (see here); SQM (see here).

For the brine (and clay) lithium projects, the measured and indicated, aka, M&I, resource is collected along with the inferred resource and exploration targets. The Clayton Valley project of Pure Minerals and Cauchari Project of Advantage Lithium are two exceptions, for which the inferred resource is the only reported parameter and is used in place of the M&I resource. For the hard rock projects, the lithia (Li2O) resource is calculated from reported ore reserve and lithia grade before it is converted into lithium carbonate equivalent (LCE).

To account for the upside potential of a project, I calculated its adjusted net lithium resource by adding 50% of the inferred resource and estimated exploration potential to the net lithium resource, data permitting. Where a range of exploration potential is given, the median value is used. Although the conversion of inferred resource and exploration targets into official figures of lithium resource is not well understood, such an adjustment is believed not to be a problem for the purpose of this article, as long as the same methodology is applied uniformly to all studied companies, where data is available.

The enterprise values of the lithium developers/producers are gathered from Gurufocus.com as at mid-day January 8, 2018. The corralled data are presented in Table 2.

Table 2. The basic information, lithium resource and enterprise value of the selected lithium developers/producers. *, Lithium X was acquired by the Chinese firm NextView for US$206 million (see here); SQM farmed in and took 50% of Mt Holland Project for US$110 million (see here). Source: the author's compilation.

Lithium resource vs. EV

The enterprise values of these companies are supposed to correlate with the reported lithium resource. To examine whether this is the case, I plot in Fig. 2 the enterprise values in covariance with the net lithium resource.

Fig. 2. The covariation of lithium resource and the enterprise value of the selected lithium developers. Source: the author.

Here are a few observations:

  • As expected, there exists a strong correlation between the net lithium resource estimates and the enterprise values, adjusted for exploration potential or not.
  • There is a big difference between the brine (and clay) and hard rock developers/producers. For the former, one ton of lithium resource LCE is valued at approximately $80 or $65 on an adjusted basis; for the latter, one ton of lithium resource LCE is valued at approximately $365 adjusted or not.
  • The evolution of projects from development to production has a significant impact on the valuation of the operator. The producers, i.e., SQM, Orocobre, Neometal, and Galaxy Resources, are accorded substantially higher valuation in terms of the EV/Li ratio than those still in the development stage.
  • The U.S. and Canadian lithium projects receive significantly more generous valuation than those hailing from outside of these two countries. Notable examples are Pure Energy and Nemaska Lithium.

Relative valuation

We now have two linear regression lines, namely EV = 64.935 * Li for brine and EV = 364.55 * Li for hard rock. On the basis of these linear regression lines, predicted EV can be derived at any given adjusted net lithium resource.

By comparing the actual EVs with the predicted ones, I find that some companies are marked down, while others marked up (Table 3). For example, among the brine lithium developers, Bacanora Minerals and Millenial Lithium appear to be trading below predicted EVs, Pure Energy, and Advantage Lithium marked up, while International Lithium Corp., Neo Lithium, Lithium Americas, Lithium X, and Lithium Power International seem to be from fairly valued to slightly overvalued. Among the hard rock developers, Kidman Resources and Critical Elements are marked down, Altura Mining and Pilbara Minerals fairly valued, while Nemaska Lithium seems to be overvalued.

Table 3. Levels of valuation of lithium developers relative to the predicted enterprise value. Source: the author's calculation.

Discussion and investor takeaways

A cautionary note on the use of EV/Li ratio

I have been of the opinion that investors should avoid relying on a single variable in stock picking. I have been actively advocating at The Natural Resources Hub (TNRH) that a value investor should establish a holistic understanding of the business behind a stock, estimate the intrinsic value based on that knowledge, and search for an adequate margin of safety. Such an apparently tiresome approach actually gives the investor the best risk management and consequently the highest rate of return. The practice of this methodology by Laurentian Research is exemplified by the in-depth surveys done on, e.g., Orocobre (see here and here), Lithium Power International (see here), Ardea (see here), and Clean TeQ (see here), among others.

Even though either the EV/Li ratio (Table 2) or the relative valuation based on linear regression (Table 3) should not be used as the endgame in stock valuation, it can be useful for building an initial understanding of an industry. One just has to explore beyond that point of departure, to leave behind the assumption of everything else being equal. The reality is almost invariably more nuanced, richer in complexity, and studded with all sorts of surprises, which a simple tool such as the EV/Li ratio cannot capture.

For example, at first blush, the EV/Li ratio at 355 appears to suggest the gross overvaluation of Advantage Lithium (Table 2). However, a slightly more extensive research would lead to the knowledge that the company is yet to appraise the northwestern flank of its tenements, that even in the southeastern flank only 0.47 Mt LCE of inferred resource in the shallow level have been booked, and that some 0.25 to 5.6 Mt LCE of upside potential exist in the exploration target. This is not surprising at all because sandwiched between the northwestern and southeastern flanks of the Advantage tenements is the Cauchari Project of Lithium Americas, which is reckoned to contain an M&I resource of 11.7 Mt LCE (Fig. 3).

Fig. 3. A map of the Cauchari Project of Advantage Lithium (left) and a schematic cross-section of the Caichari Basin. Source: here.

It is reasonable to expect that, as exploration goes on, Advantage will probably book an increasing amount of lithium resource, just as Lithium Power International has done in the Maricunga Project in Chile (Fig. 4).

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