A joint venture with Australia's Kidman Resources ranks among the reasons why Morningstar likes this US-listed Chilean lithium miner.

Through its access to high-quality mineral deposits, SQM is one of the world's largest low-cost producers of lithium, iodine, and nitrates used in specialty fertilisers. Its lithium deposits in Salar de Atacama - the largest salt flat in Chile - boast the highest concentration of lithium globally, and benefit from high evaporation rates in the Chilean desert.

A major supplier of lithium carbonate, SQM should take advantage of the higher capacity it has built in recent years. In Australia, it is finalising a joint venture with Kidman Resources, which will mine and produce spodumene, then convert this into lithium hydroxide.

This project should boost profits in the next decade, as its unit costs would then sit on the bottom half of the lithium hydroxide cost curve.

SQM also holds a joint venture stake in a low-cost brine resource in Argentina. This remains under development, but its considerable stake is set to be sold to another large industry player, Ganfeng Lithium, by the end of 2018.

Cost advantage digs a moat

Morningstar regards SQM as holding a narrow economic moat rating, based on the company's cost advantage in the production of lithium, iodine, and specialty fertilisers, stemming from its salt brine and caliche ore assets in northern Chile.

Globally, lithium is produced from either lower-cost evaporation of brine, or higher-cost mining of spodumene minerals. SQM's considerable cost advantage in lithium production stems from its lucrative brine assets in Salar de Atacama.

Two factors make this the lowest-cost source of lithium in the world: dry conditions and high lithium concentration. Salar de Atacama is one of the world's driest places, and boasts Chile's largest salt flat, with an extremely high evaporation rate and low rainfall.

Following an evaporation and concentration process, the lithium brine is processed into lithium derivatives, including lithium carbonate and lithium hydroxide for batteries.

SQM has a contract through 2030 with the Chilean government to extract 414,369 tonnes of lithium – roughly 2.2 million tonnes of lithium carbonate equivalent. The Australian joint venture will add another low-cost lithium hydroxide operation, when the spodumene mine and accompanying lithium hydroxide conversion plant fully ramp up by the mid-2020s.

mining lithium

SQM has signed a joint venture with Kidman Resources in Australia

Altogether, we estimate that roughly 85 per cent of SQM's gross operating profit comes from products that have a distinctive cost advantage – lithium, specialty fertilisers, and iodine. 

The company's cost position in potash, which makes up the bulk of the remaining gross profit, is average, but considerably better than high cost producers in Europe.

While the quality of SQM’s asset portfolio gives the company a considerable competitive advantage because of its low-cost position, we award a narrow instead of wide economic moat rating, since the mining rights to Salar de Atacama only run through 2030.

Although we are confident that SQM will be able to renew the lease before it expires, there have been some tensions between its former chairman – and largest shareholder – Julio Ponce and the Chilean government.

If SQM can renegotiate a longer-term lease on Salar de Atacama of at least 20 years, we would consider upgrading our moat rating to wide.

Electric vehicles among other risks

Another risk is slower-than-expected growth in electric vehicle demand, or production ramp-up occurring too quickly.

EV demand could undershoot expectations if fuel cell or other technologies overtake lithium as the most likely power source for next-generation vehicles. Other competitors within the space, such as Talison, Ganfeng, or Orocobre (ASX: ORE) may also bring too much supply to the market.

In addition, SQM’s lithium capacity expansions carry project execution risk, especially the spodumene-based operation in Australia, as the company has never operated a hard rock project.

Future potash prices are also uncertain as SQM has no pricing power in the potash market. If new supply from other competitors takes off faster than expected, potash prices could further deteriorate. This would expose SQM’s specialty fertilisers to a sustained decline in potash prices.

 

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Seth Goldstein, CFA, is an equity analyst for Morningstar , Inc, covering agriculture, chemicals and copper companies in the basic materials sector. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. The author does not have an interest in the securities disclosed in this report.


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