This lithium miner is an undervalued dividend aristocrat
The shares trade at a 65% discount to our fair value estimate.
Mentioned: Albemarle Corp (ALB)
Dividend aristocrats are popular with investors. After all, what dividend investor wouldn’t want to own the stocks of companies with a history of growing their dividends consistently over time?
What is a dividend aristocrat?
Dividend aristocrats are defined as companies that’ve increased their dividends every year for 25 years or longer. There are currently more than 60 dividend aristocrats among the companies included in the S&P 500 index.
Investors often buy dividend aristocrats because they expect companies with a history of dividend growth to be able to continue to grow their dividends in the future. In addition, dividend aristocrats are mature companies with sufficient earnings to continue to increase their dividends and are run by management teams that prioritize dividends in the capital structure.
That being said, dividend aristocrats aren’t immune to dividend cuts. Early in 2024, for instance, onetime dividend aristocrat Walgreens Boots Alliance WBA cut its dividend nearly in half.
How can investors avoid those dividend aristocrats that may be more likely to cut their dividends?
“Companies with wide economic moats have been less likely to cut dividends than companies with narrow moats,” explains Morningstar Indexes strategist Dan Lefkovitz in his new research paper. “No-moat businesses are most likely to cut.”
To come up with our list of the best dividend aristocrats to buy, we screened on the following:
- Dividend stocks included in the ProShares S&P 500 Dividend Aristocrats ETF NOBL (which trades in the US).
- Dividend aristocrats with Morningstar Economic Moat Ratings of narrow or wide.
Albemarle ALB
- Morningstar Price/Fair Value: 0.35
- Morningstar Uncertainty Rating: Very High
- Morningstar Economic Moat Rating: Narrow
- Trailing Dividend Yield: 2.02%
- Sector: Basic Materials
Albemarle is the cheapest dividend aristocrat: The stock trades a whopping 65% below Morningstar’s fair value estimate of $225. We assign the world’s largest lithium producer a Very High Uncertainty Rating, thanks to the volatility of lithium prices. Morningstar strategist Seth Goldstein calls the company’s dividend policy “easily manageable,” as dividends have averaged just 17% of net income over the last five years.
Business strategy and outlook
Albemarle is one of the world's largest lithium producers, 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 large resource, though it has a higher cost versus Talison. Albemarle also owns resources in the US 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 in the coming decades.
As electric vehicle adoption increases, we expect double-digit annual growth in global lithium demand. However, global lithium supply is also growing rapidly in response. Albemarle is growing its lithium volumes through the buildout of new lithium refining plants, but has largely paused new expansion plans in light of cyclically low lithium prices. As prices recover, we expect Albemarle will increase its lithium refining capacity largely through brownfield expansions at existing operations.
Albemarle is the world's second-largest producer of bromine, a chemical used primarily in flame retardants for electronics. Bromine demand should grow over the long term as increased demand for use in servers and automobile electronics is partially offset by a decline in demand from TVs, desktops, and laptops. Over the long term, we expect Albemarle to generate healthy bromine profits due to its low-cost position in the Dead Sea.
Albemarle is also a top producer of catalysts used in oil refining and petrochemical production. These chemicals are highly tailored to specific refineries. However, this business, has been structured to run separately from the rest of Albemarle and may be divested in the future.
Moat rating
We award a narrow economic moat rating to Albemarle for the company’s strong and durable cost advantage in lithium and bromine production.
Globally, lithium carbonate is produced from either lower-cost evaporation of brine or 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, which produce lithium at the lowest cost globally, excluding royalties.
Two factors make the Salar de Atacama the lowest-cost source of lithium in the world: dry conditions and high lithium concentration. The Salar de Atacama is one of the driest places in the world and the largest salt flat in Chile. It has an extremely high evaporation rate and low rainfall. Snow from the Andes Mountains melts and flows underground into pools of brine, which have the highest concentration of lithium globally. This high concentration makes the company one of the lowest-cost lithium producers even among brine-based producers. The company pumps the brine above ground into a network of large evaporation ponds. Water evaporates from the ponds over the course of approximately 18 months, leaving behind concentrated lithium brine, which is then processed into lithium derivatives, including lithium carbonate and lithium hydroxide for batteries. Albemarle has a long-term contract through 2043 with the Chilean government to extract around 80,000 metric tons of lithium per year.
Albemarle’s lithium carbonate produced from the Salar de Atacama has the lowest cash cost in the world. However, the Chilean government implements one of the highest royalties globally, in a progressive scheme that at the highest bracket sets a 40% rate on prices over $10,000 per metric ton. At $20,000, which is our current view of the marginal cost of production, this amounts to a 27% royalty rate. Because of the royalty expense, neither Albemarle nor SQM, which also operates at the Salar de Atacama, is the lowest-cost producer if lithium prices are $20,000 per metric ton or higher. However, for a cost advantage moat source, we look at an operation’s ability to generate an excess return on invested capital when prices are at the bottom of a cycle. When lithium prices are below $14,000 per metric ton, the royalty is greatly reduced, and the geological advantage of the Salar de Atacama puts both Albemarle and SQM firmly at the bottom of the cost curve. As a result, we view Albemarle’s Chilean brine as having a durable cost advantage.
Albemarle also has lithium brine assets in Silver Peak, Nevada. While not as advantaged as the prime Chilean asset due to lower lithium concentration, this Nevada asset still sits on the lower half of the lithium carbonate cost curve.
Albemarle owns a 49% joint-venture interest in Talison's operations in Greenbushes, Western Australia. The Talison mine produces spodumene, a hard rock mineral extracted through traditional mining methods, that is the feedstock converted into a downstream lithium product. Albemarle produces lithium hydroxide from two vertically integrated low-cost spodumene mines.
Lithium hydroxide can be produced directly from spodumene, whereas brine-based operations must first produce carbonate and then convert to hydroxide. Although lithium hydroxide has traditionally made up a small portion of total lithium demand, electric vehicle batteries will increasingly use lithium hydroxide as hydroxide-based battery chemistries generally allow EVs to have a greater range than lithium carbonate. As a result, we expect lithium hydroxide demand will see strong growth as EV adoption increases.
The Talison operation is the highest-quality spodumene deposit in the world and sits on the low end of the lithium hydroxide cost curve, owing to its geological advantage. Talison's spodumene has roughly double the lithium concentration of other high-quality spodumene deposits around the world. Given that Albemarle is a fully integrated producer using Talison spodumene as its feedstock, we view its lithium hydroxide business as moatworthy based on a durable cost advantage in lithium hydroxide production.
Albemarle has a second spodumene operation in Western Australia in a joint venture with Mineral Resources. This is also fully integrated, with Albemarle producing hydroxide from its Wodgina spodumene. Wodgina spodumene is high-quality with a low-cost position, albeit above Talison. Accordingly, while hydroxide made from Wodgina spodumene will not be as low-cost as hydroxide made from Talison spodumene, the Wodgina operation will still sit on the low end of the lithium hydroxide cost curve.
Albemarle's advantaged position in bromine comes from its low-cost and long-lived asset in the Dead Sea and Arkansas. Production costs are largely determined by concentration, as higher concentration mean that less water needs to be evaporated to produce bromine from brine. The Dead Sea is the lowest-cost bromine source, with concentrations of 10,000 parts per million, while Arkansas has concentrations of 5,000 parts per million. These assets have 2.5-5.0 times the concentration of the next-best reserves in India and 25-50 times the concentration of producers in China. Albemarle's Arkansas asset has more than 70 years of reserves remaining. The Dead Sea, for all intents and purposes, is an inexhaustible asset, given its enormous reserves compared with production volume. Albemarle's Dead Sea production comes from its 50% interest in Jordan Bromine, which it operates with Arab Potash.
We do not think the Ketjen refining catalyst business is moatworthy on its own. The refining catalyst market is fairly concentrated, with the largest three producers making up the majority. We see traces of switching costs in this business as Albemarle’s refining catalysts are often 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. Catalysts used in fluidized catalytic cracking help refiners reduce costs by processing heavier crudes or realizing higher prices through more-refined products. Variations in regional crude oil quality and refinery specifications require Albemarle to work closely with customers to formulate customized catalysts for each refinery. 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.
However, this business was accused of bribery and corruption by the US Department of Justice and US Securities and Exchange Commission. The complaint accused Albemarle of bribing foreign officials between 2009 and 2017 to secure refining catalyst contracts. Albemarle paid a $218 million settlement related to the dispute. Further, the business has been slow to rebound from the pandemic, even though oil refining has generally recovered, which signals the business may have lost some market share. While Ketjen may ultimately prove moatworthy, we are not confident that it commands pricing power from strong customer switching costs, as the past practices that led to bribery allegations may have resulted in inflated historical profits. This gives us less confidence that future profits following the pandemic recovery will look like historical results.
All in all, we think Albemarle’s strong and durable cost advantage in lithium and bromine makes it more likely than not that the company will outearn its cost of capital over at least the next decade.
Fair value estimate
We're recently reduced our fair value estimate to $225 from $275 following Albemarle's second-quarter results. 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.
Lithium will remain Albemarle's largest business. We expect lithium prices will remain at cyclically low levels in 2024. Lithium carbonate spot prices, which tend to be a leading indicator of contract prices, are currently around $12,700 per metric ton (based on published indexes), down from $75,000 at the end of 2022. Prices fell due to slowing lithium purchases as a result of inventory destocking. However, as demand growth remains strong and we expect prices will rise in 2025.
Longer term, we expect lithium prices will remain volatile, but average selling at roughly the marginal cost of production, which we estimate to be $20,000 per metric. Our price forecast is based on our forecast for the marginal cost of lithium production on an all-in sustaining cost basis. We expect lithium demand to grow at nearly a 20% annual rate from over 900,000 metric tons in 2023 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.
In response to lower near-term prices, Albemarle has drastically cut its lithium growth plans. We forecast Albemarle's lithium sales volumes will grow a little less than double 2023 levels by 2030, well below management's goal at its 2023 investor day for at least 500,000 metric tons. We think management will likely cut long-term growth spending over the next few years in response to lower prices. Regardless, Albemarle's focus on cost reductions should allow it to benefit tremendously from additional volume sold and we expect lithium will remain Albemarle's highest-margin segment even with lower prices.
We forecast specialties (bromine and nonbattery lithium) will see a near-term decline due an an economic slowdown but should grow in the low to mid-single digits over the long term. Brominated flame retardant demand should see growth from an increase in 5G devices, Internet of Things technology, servers, and increased content per vehicle in automobile electronics. Combined with Albemarle's cost reductions, we expect specialties EBITDA margins will fall to the low 20s in the near term but then return to the mid-30s over the next decade.
After a covid-related decline saw Ketjen's profits fall 60% from 2019 to 2021, we expect a gradual recovery as fluidized catalytic cracking sales grow broadly in line with transportation fuel demand and hydroprocessing catalyst sales recover from trough levels. Our valuation does not include a potential divestiture of the business.
Regarding the preferred equity shares, based on our fair value estimate being well above the maximum conversion price of $131.268, we assume the preferred shares convert at the maximum conversion price in March 2027. For every $1,000 in preferred shares, this results in 7.618 shares of common stock. The preferred shares will trade on a depository basis, with each depository share being equal to 1/20 of a preferred share. The preferred shares will carry a 7.25% annual dividend.
Given the wide range of potential lithium prices, we see a range of outcomes for Albemarle. In lower-for-longer pricing scenario, we forecast lithium prices to average $15,000 per metric ton in 2024 real terms over the next decade. In this scenario, our fair value estimate would be $90 per share, as Albemarle would realize lower prices and profits and likely see little long-term volume growth.
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Terms used in this article
Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.
Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.
Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn more about how to identify companies with an economic moat, read this article by Mark LaMonica.
Uncertainty Rating: Morningstar’s Uncertainty Rating is designed to capture the range of potential outcomes for a company. An investor can think of this as the underlying risk of the business. For higher risk businesses with wider ranges of potential outcomes an investor should consider a larger margin of safety or difference between the estimate of what a share is worth and how much an investor pays. This rating is used to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating is aimed at identifying the confidence we should have in assigning a fair value estimate for a stock. Read more about business risk and margin of safety here.