Albemarle (NYSE: ALB) stock is down 49% over the last 12 months. After its third-quarter earnings report, here is Morningstar’s take on the shares.

Key Morningstar metrics for Albemarle

  • Fair Value Estimate: $300.00
  • Morningstar Rating: 5 stars
  • Morningstar Economic Moat Rating: Narrow
  • Morningstar Uncertainty Rating: High

What we thought of Albemarle’s earnings

Albemarle’s (NYSE:ALB) third-quarter results and management’s updated guidance reflected the decline in lithium spot prices, which will weigh on near-term profits. In response, management said it will review the company’s lithium growth investments, aiming to preserve its financial flexibility. We think the likely outcome is that Albemarle will slow its lithium capacity investment, which is in line with how the company has historically operated during a lithium price downturn.

We updated our model to assume lower volumes and reduced capital expenditures throughout our 10-year forecast period, as well as to account for lower profits in the nonlithium battery segments and lower near-term lithium prices. As a result, we’ve reduced our fair value estimate to $300 per share from $350. Of the $50 reduction, $30 comes from our outlook for lower volumes, $15 is from our reduced forecasts for specialties and Ketjen segment profits, and $5 is due to lower near-term lithium prices. Our narrow moat rating is unchanged.

We view Albemarle shares as materially undervalued, trading in 5-star territory and at roughly 40% of our updated fair value estimate. We think the market is concerned that lithium spot prices will fall further through the end of 2023 and into 2024 due to oversupply concerns. We disagree, and expect prices will rise in 2024 as battery producer inventory destocking runs its course. In recent days, multiple top-seven lithium producers have announced supply delays or production cuts, or have signaled a review of growth plans in response to lower lithium prices.

Further, recent announcements from marginal-cost producers in China indicate supply is beginning to shut down in response to lower prices. We think this will result in the market balancing over the next couple of quarters. As demand grows, we see lithium returning to structural undersupply in 2024, leading to higher prices.

Albemarle Stock Price

Albemarle is one of the world's largest producers of lithium, which generates the majority of total profits. It produces lithium through its own salt brine assets in Chile and the United States and two joint venture interests in Australian mines, Talison (Greenbushes) and Wodgina.

The Chilean operation is among the world's lowest-cost sources of lithium. Talison is one of the best spodumene resources in the world, which allows Albemarle to be one of the lowest-cost lithium hydroxide producers as spodumene can be converted directly into hydroxide.

Wodgina is another high-quality spodumene asset that provides Albemarle with a third low-cost resource, though not as high quality as Talison's. Albemarle also owns resources in the U.S. and Argentina that are still in the early development phase, which should allow it to boost its lithium volumes through the development of new projects.

Fair value estimate for Albemarle

With its 5-star rating, we believe Albemarle’s stock is undervalued compared with our long-term fair value estimate.

Our fair value estimate is $300 per share. We assume roughly a 10% weighted average cost of capital. We use a multiple of 11.5 times midcycle EBITDA to value free cash flows generated beyond our 10-year explicit forecast horizon.

Our price forecast is based on our forecast for the marginal cost of lithium production on an all-in-maintaining cost basis. We expect lithium demand to grow at nearly a 20% annual rate from around 800,000 metric tons in 2022 to over 2.5 million metric tons by 2030. By 2030, roughly 95% of lithium demand will come from batteries that require high-quality lithium with few impurities. To meet demand, higher-cost supply will need to come online from lower-quality resources that will require higher processing costs.

We forecast Albemarle’s lithium capacity will grow to nearly 600,000 metric tons during the next decade and benefit from strong demand growth. The firm’s low costs should let it benefit tremendously from additional volume sold. Higher prices and volumes will help Albemarle’s energy storage EBITDA more than double from 2022 levels by 2030, even with lower lithium prices versus the $70,000 per metric ton average index price in 2022.

Albemarle Historical Price/Fair Value

Economic moat rating

We assign Albemarle a narrow economic moat, based on its cost advantage and switching costs.

Switching costs refers to the high degree of expense and effort needed for a customer to switch to a rival provider. Cost advantage is awarded to a company that can produce goods or services at a lower cost than rivals. Both factors contribute to a sustainable competitive advantage or moat.

Albemarle possesses the lowest-cost sources of lithium and bromine production. It also benefits from switching costs in its catalyst business, where refiners and petrochemical producers tend to stick with existing catalysts tailored to their facilities to maximize product yields.

Globally, lithium carbonate is produced from either the lower-cost evaporation of brine or the higher-cost mining of spodumene minerals. Albemarle has a cost advantage in lithium carbonate production due to its lucrative brine assets in the Salar de Atacama in Chile.

The company benefits from switching costs in refining catalysts, which are tailored to specific refineries to maximize customer profits. Refiners are essentially a commodity spread business, earning profits by converting crude oil into refined end products, including gasoline and diesel. These catalysts make up a small portion of a refiner’s costs and are priced based on the value they contribute to customers through improving yields, quality, and output. Catalysts provide value to refiners far in excess of their cost. Albemarle, W.R. Grace, and BASF make up the majority of the FCC catalyst market. Existing catalyst providers hold the advantage of being able to tweak their catalyst over time and maintain customer relationships, as catalyst suppliers continually improve refiner economics.

Risk and uncertainty

We assign Albemarle a High Morningstar Uncertainty Rating.

The biggest risk for Albemarle is volatile lithium prices. Prices could decline if EV demand grows more slowly than expected. New batteries, such as sodium-ion, could overtake lithium as the preferred energy storage resource.

Albemarle faces execution risks in ramping up its lithium production, including production delays and cost overruns. Albemarle is also subject to political risk, especially in Chile. President Gabriel Boric announced a plan to nationalize lithium whereby the government would own a majority stake in all projects. If this occurs, Albemarle could be forced to sell a 51% stake to the Chilean government at a price as low as asset book value to extend its lease when it expires in 2043.

The largest ESG risks come from potential new regulations. Regulations that limit emissions in the bromine business could hurt profit margins, as Albemarle’s profits come from its cost advantage rather than pricing power, and it may not be able to pass along the cost increases. We see this as having a moderate probability and materiality.

ALB Bulls Say

  • Albemarle has top-tier lithium assets through its brine operations in Chile and spodumene hard-rock operations in Western Australia, which are among the lowest-cost sources of lithium production globally.
  • Lithium prices will remain well above the marginal cost of production through at least the remainder of the decade, leading to excess profits and return on invested capital for Albemarle.
  • Albemarle has low-cost bromine production through its highly concentrated brines in the Dead Sea and Arkansas.

ALB Bears Say

  • Lithium prices will fall as new supply comes online faster than demand, which will weigh on profitability. Albemarle’s plans to increase its lithium production capacity will prove value-destructive in the wake of lower prices.
  • Albemarle’s bromine business will decline from weak demand for flame retardants as consumers shift from computers to less bromine-intensive tablets and smartphones.
  • The Chilean government’s plan to nationalize lithium could result in Albemarle being forced to sell a majority stake to the government at a price around asset book value, destroying shareholder value.

This article was compiled by Brendan Donahue.

 

* What do the different star ratings designations mean?

5 stars indicates an investment idea with a high probability of significant risk-adjusted appreciation from the current market price during a multi-year time frame. Scenario analysis developed by our analysts indicates that the current market price represents an excessively pessimistic outlook, limiting downside risk and maximizing upside potential.

4 stars indicates that appreciation beyond a fair risk-adjusted return is likely.

3 stars indicates that investors are likely to receive a fair risk-adjusted return (approximately cost of equity).

2 stars indicates that investors are likely to receive a less than fair risk-adjusted return and should consider directing their capital elsewhere, in our opinion.

1 star indicates a high probability of undesirable risk-adjusted returns from the current market price over a multi-year time frame. Our scenario analysis indicates the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.