Allkem: Costs creeping up, keeping our rating on hold

Author name:: By Max Vickerson
Job title:: Analyst
Date posted:: 24 October 2022, 8:00 AM
Sectors Covered:: Industrials, New Energy

Allkem's (ASX:AKE) 1Q production missed expectations but a bigger issue is the cost increases expected for Olaroz’s stage 2 expansion.
We factor in higher capital and operating expenditure but offset by the reserves increase at Mt Cattlin earlier this month. This lowers our price target to (login to view).
We retain our HOLD rating as we keep watch on how the current strong industry demand responds to increasing macro-economic headwinds.

1Q miss mostly driven by softer Mt Cattlin performance

AKE’s 1Q revenue of $298m missed expectations (-17% on VA consensus, -6% on Morgans forecast). The major shift was smaller production at Mt Cattlin. The company has pointed to ongoing pre-stripping activities as it moves to new areas of the mine.

Once new ore is exposed and extraction starts the company expects a strong 2H.

Olaroz’s production was also softer than hoped but not by a significant amount (- 3% on VA consensus, -2% on Morgans forecast). Delays are impacting the expansion and AKE expects an additional $45m (12%) will be required to complete it.

Operating expenditure roughly in-line but lifting Sal de Vida capex forecast

Operating expenditure in 1Q was slightly lower but roughly in-line with our expectations (-1% at Mt Cattlin, -2% at Olaroz) so we believe we’ve adequately allowed for operating cost inflation.

We had not allowed for additional brine project capital expenditure above the forecasts provided by management in April. Given the 12% increase to Olaroz Stage 2, to 17k/tpa, we lift our forecast for Sal de Vida by ~5% to a similar capital intensity.

Forecast and valuation update

We have increased the expected lifetime of Mt Cattlin to 2027 from the announced increase in reserves of 3.2Mt on 5 October. We also factor in higher capital expenditure on Olaroz and Sal de Vida which offsets most of the Mt Cattlin valuation impact.

We’ve also allowed for higher 2Q Olaroz pricing in-line with guidance but have normalized Sal de Vida pricing in line with Olaroz stage 2 which reduces forecast revenue.

The combined impact is a decrease in our valuation by 2%. Our target price (rounded down to nearest 10cps) therefore reduces to (login to view).

Investment view

AKE is a well-diversified lithium producer in terms of products (spodumene, lithium carbonate and soon to be lithium hydroxide) and geographies (Argentina, Australia, Canada). We think it will perform more strongly than peers over the cycle.

However, it’s not clear to us whether or not there will be shorter term interruptions to the likely long term uptrend in lithium demand that means there could be a better entry point.

Given the stock’s previous sensitivity to the outlook for lithium prices and, in our view, the potential for prices to move away from their recent new found highs, we maintain our HOLD rating.

Price catalysts

Further reserves updates at Mt Cattlin appraisal later this quarter.
Price guidance in 2Q23 report (expected on 20 January).
Potential further increase in planned production at Mt Cattlin.
Ramp up of Olaroz S2 and Naraha.

Risks

Lithium prices.
Increasing EV demand to continue to drive battery material demand.
AKE’s ability to deliver its growth projects on time and on budget.
Operational performance at Olaroz and Mt Cattlin.
Exploration and construction risk for growth projects.
Interest rates, inflation, foreign exchange and tax regimes.

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