There is an old market adage that says, in a war, don’t put your money on who you believe is going to win the war; instead, invest in the arms supplier, who’s sure to make a profit no matter who comes out on top, asserts Paul Goodwin, editor Cabot Emerging Markets Investor.
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That’s the general theme with Sociedad Quimica y Minera de Chile (SQM), a good-sized Chilean raw materials and chemicals producer, with $2 billion in revenue during the past 12 months.
The company has its hands in many pies, including potassium products for fertilizers and plant nutrition, iodine products used in everything from LCD screens to sanitizers, and industrial chemicals that are used in glass, metal, water treatment and more . Trends in these businesses are solid, but not spectacular.
The real attraction is Sociedad’s leading global position in lithium production, both in terms of output and (according to the company) cost. Lithium has traditionally been used in a variety of products like ceramics, aluminum and rechargeable batteries.
That last part is the big draw — while demand from other sources should remain relatively steady, the boom in electric vehicle production (and the batteries they’ll use) should hike demand for lithium in a big way going forward.
According to many forecasts, lithium demand should increase steadily for many years. Demand was around 200,000 tons in 2015, but most expect that figure to at least double by 2025 as electric car production ramps. Sociedad’s management sees demand up 14% this year and 10% to 12% annually for many years after that, reaching 500,000 tons by 2025.
Not surprisingly, then, the firm is aiming to ramp its output to take advantage of the opportunity. Sociedad currently has capacity of 48,000 tons per year, mostly from its operations in Chile.
This should increase to 63,000 tons by the second half of next year due to expansions that will soon be underway. Beyond that, the company is making some aggressive moves so that it will be ready as demand increases.
First, it’s part of a joint venture at a mine in Argentina that’s in the process of being built out; initial production is expected in 2019, with eventual capacity of around 50,000 tons.
And second, it recently agreed to buy a 50% stake in an Australian lithium project for $30 million (and with a promise to fund $80 million in development costs). Some production is expected within a couple of years, with output expected to reach 40,000 tons by 2021.
Of course, other players in the industry are also busy expanding production, which always raises the specter of overcapacity—there’s nothing proprietary about lithium, so if supply ramps quickly (or if electric car demand fades), prices could fall. In fact, given the history of most commodity-based sectors, overcapacity is probably a sure bet at some point.
But that time is likely many years from now given the lead times it takes to get a project up and running, as well as the likely increase in electric car production during the next few years.
Indeed, Sociedad raised prices nearly 80% last year due to tight supply, and there’s been no retreat this year—in the first quarter, the firm’s lithium sales volumes grew 12% while revenues surged 98%.
That helped Sociedad’s EBITDA (a measure of cash flow) rise 39%. Those trends continued in the just-reported second quarter, where lithium sales were up 33%, thanks mainly to higher prices.
One other thing to note is that SQM has a lot of big owners — Potash Corp. (POT), Pampa (PAM) and Bank of New York (BK) all own huge chunks of Sociedad. We don’t really see that as a hindrance, but it’s always possible that one of them decides to let go of some of their shares if the stock makes a great run.
Right now, though, there’s no question buyers are in control. SQM went over the falls in a big way during the commodity stock bear market in 2015 and early 2016, falling from $32 to $12. But it’s been in a solid, relatively steady uptrend ever since, poking above $30 late last year and rising to $37 in April.
That was followed by a three-month, double bottom base, and since late-June, SQM has been a star performer, rising persistently into the low $40s and, after some shaking and baking, has surged to new highs following its quarterly report this morning. Given the recent run up, we advise starting with a half position.
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