Lithium: How to ride what’s left of the rising tide

About the author:

Chris Brown
Author name:
By Chris Brown
Job title:
Senior Analyst
Date posted:
20 January 2022, 9:00 AM
Sectors Covered:
Junior (Emerging) Resources

  • Spot lithium prices have hit new records and are putting pressure on contract prices.
  • Tight supply is expected throughout 2022 with futures in contango.
  • Our key pick Allkem (ASX:AKE), which we upgrade to an ADD (login to view), is expecting strong price increases in 2H22.

Spot prices are surging past contract prices

In the first week of January the spot lithium price carbonate price in China, reached a record high of USD41,925/t as noted by Benchmark Minerals, while LME’s lithium hydroxide benchmark is up 177% from its low in May 2021.

A gap is growing between contract prices and spot however. Pilbara Minerals’ third spot auction in 1Q22 traded at USD2,350/t (5.5% LCE) compared to its expected average price of USD1,650 – 1,800/t (6% LCE) during 2Q.

We expect contract prices to rise but likely by not as much as spot prices. Some producers negotiate price updates and given the smaller volumes in the spot market we expect buyers will push to limit increases.

Shortness of supply looking to last even with extra tonnes expected

The industry is expecting the tight market to continue with CME lithium hydroxide futures in contango throughout CY22.

PLS has reduced its FY22 production guidance by 12% to between 400 – 450kt of spodumene concentrate from commissioning delays in WA.

AKE has a strong December quarter and a long growth runway

Our preferred stock for lithium exposure, Allkem (ASX:AKE). As detailed overleaf, we upgrade our forecasts, and upgrade to an Add recommendation with (login to view) price target.

AKE announced a 68% qoq increase in revenue at Olaroz and a 7% CY21 beat of production guidance at Mt Cattlin with large increases in realised prices at both projects.

AKE expects USD20k/t for lithium carbonate sales in 2HFY22 at Olaroz.

Production growth continues with Naraha commissioning, progress on Sal de Vida and FID expected on James Bay in 2QCY22. Construction is expected to commence the following quarter.

In the medium term - pressure will be on battery prices

Cell manufacturers and automotive OEMs are likely to be squeezed between the pressures of the raw materials markets and the need to continue to reduce the cost of EVs to drive mass market adoption.

In April 2021, Benchmark Minerals estimated that 65%-70% of battery costs come from raw materials. We think the tight market has the potential to slow the uptake of EVs in the medium term however there are no indications of slowing demand in the short term.

We expect ongoing volatility in the sector as the market seeks to understand how supply and demand will be balanced. We think that while this cycle has moved out of the early stages it still has some room to run in the short term.

Figure 1: CME Lithium Hydroxide forward curve (USD/kg as of 4PM AEST 19/1/2022)

Growth stocks have had a choppy ride since the onset of the pandemic

Source: CME, Morgans Financial 

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

Solid top-line outcome: BAP’s 1Q22 revenue was flat on the pcp, an extremely resilient result given the extent of lockdowns in the period (~70% of stores impacted) and the strength of the pcp (cycling 27% growth). Composition comprised: Trade +2%; NZ -10%; Retail -12%; and Specialist Wholesale +7%. Overall, BAP stated that non-lockdown areas are outperforming expectations. ▪ 1Q22 trade & retail: Trade/Burson revenue was up +2% on the pcp (LFL sales - 1%; cycling 8% pcp); NZ/BNT revenue was down -10% (LFL sales -15%; cycling +4%); and Retail/Autobarn revenue was down -12% (LFL sales -16%; cycling +36%). Within the Retail segment, online sales were +80% on the pcp. Stores percentages impacted by lockdown were: Trade 70%; NZ 100%; and Retail 50%. ▪ Specialist segment results: Specialist wholesale revenue is up 7% on pcp, with Auto electrical/Truckline divisions ‘performing strongly’; and WANO underperforming. ▪ GM pressure expected to be temporary: BAP stated GM was stable across Wholesale and NZ (45% of FY21 revenue); and down ~50bps Trade and Retail (~55% of FY21 revenue), driven by promotional and online pricing in lockdown areas (we assume no margin pressure witnessed in non-lockdown areas). BAP expect margins to revert once lockdowns ease. ▪ The cost base has increased vs pcp, a function of duplicated DC costs (commencement of new VIC DC), and higher group and team member support (covid related) costs. BAP noted FY22 store rollouts and refurbs are on track.

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