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Bull Of The Day: SQM (SQM)

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Demand for rechargeable batteries is soaring as we enter the digital renaissance of the Roaring 20s, with the pandemic having pulled forward digital adaptation by 10 years in a matter of 10 months. Lithium is the key battery ingredient fueling the electric vehicle (EV) revolution. The global economy's boundless penchant for advancing technologies will drive an insatiable appetite for lithium's power harnessing abilities.

The world's second-largest lithium producer (19% market share), SQM SQM, is a Chilean conglomerate that has become a global authority in battery materials and has leading operations in specialty plant nutrition and several other 'sustainability-focused' minerals. As the price of lithium swells to record levels, analysts are getting increasingly bullish on SQM's outlook, pushing up EPS estimate across the board and propelling the stock into a Zacks Rank #1 (Strong Buy).

According to Benchmark Mineral Intelligence, the leading price reporting agency (PRA) for EV materials (accounting for over 90% of global transaction data), lithium prices have soared 240% year-to-date, reaching a record high, and it looks like this moon-bound trajectory is only going to continue.

The supply & demand imbalance for regardable batteries is expected to significantly deplete lithium sources in the coming years, and technology producers are racing to secure this diminishing lucrative commodity. Lithium is not as rare material on Earth as its current price level would suggest, but the lithium glut in 2019 forced a shortage of new ventures in this niche mining sector.

Strategic Investments

SQM has been investing in strategic projects in Chile, which holds the largest lithium reserves, and Australia, standing second to Chile in reserves but first in production by a mile. Its Chilean projects are anticipated to grow its lithium carbonite and hydroxide production by 50% & 40%, respectively, by mid-2022, while management estimates its joint venture in Australia will nearly double its lithium hydroxide production by 2024. Below is an investment breakdown from the company's latest investor relations presentation.

SQM Investor Relations
SQM Investor Relations

Image Source: SQM Investor Relations

Lithium hydroxide is the preferred lithium compound due to its lower decomposition temperatures, allowing producers to make their rechargeable batteries more efficient and longer-lasting. It's the most suitable lithium source for EVs because it provides the range and durability these next-gen automakers are looking for.

SQM entered into an 8-year contract with LG Energy Solutions (a subsidiary of LG Chem) at the start of 2021, solidifying LG as this lithium producer's largest customer throughout the Roaring 20s. LG Energy is the battery supplier for EV startups like Lucid (LCID) and established automotive conglomerates like Stellantis (STLA) looking to charge into this rapidly growing space head first.

SQM will have no problem finding eager buyers (assuming its lithium production exceeds its LG agreement) in the years to come.

EV Revolution

Electric vehicle companies are popping up left and right with euphoric investors pouring $10s of billions into this nascent industry. There is now a race among EV giants like Tesla TSLA, Volkswagen VWAGY, Rivian RIVN, Lucid LCID, and countless other players to secure lithium as its supply outlook dwindles in the face of boundless demand for next-generation autos.

Volkswagen recently announced 3 strategic partnerships with Vulcan Energy, Umicore, and 24M Technologies, to guarantee battery supplies for the coming years. Tesla managed to secure a lithium supply contract with Ganfeng Lithium, which is currently the leading global producer of lithium hydroxide and lithium metals (highest quality battery material). Still, SQM is hot on Ganfeng's tail once its latest growth ventures begin paying dividends.

The Setup

SQM has fallen into bear territory (20%+ off recent highs) in less than a month of trading, as the latest Omicron-variant coupled with global monetary fears in the face of persistent inflation compresses growth-focused public equities. SQM is now coming down to its 50-day moving average of around $53 a share, which should provide some support. If the stock breaks that, we have another fib-derived support level around $50.70, which appears to be quite robust.

TradingView
TradingView

Image Source: TradingView

SQM is trading a 17.7x forward P/E, which is sizably below any of its peers, and even the S&P 500 for that matter, despite earnings appreciation expectation of 90% this year and another 88% in 2022. When you adjust the P/E for growth (aka PEG), it comes out to 0.42x, an extreme discount considering that 1x is generally the standard of equitability with this valuation multiple.

Final Thoughts

Every angle I look at this stock, it's a buy, and the recent valuation compression has created an excellent entry price for us to get in on the already booming lithium rally at a discount.

SQM has a broad spectrum of profit-driving segments on top of its lithium production (30% gross profit), which include specialty and nutrition (30% GP), iodine & derivatives (27%), potassium (9%), and industrial chemicals (4%). Each of these segments saw sizable year-over-year growth between 20% and 94% (46% overall) this past quarter in the face of inflationary pressures and supply chain bottlenecks, as the company unveils its largest quarterly revenues in nearly a decade.

SQM is significantly ramping up lithium production to meet skyrocketing demand. Prices for this now precious commodity are soaring, which I expect its share price will soon reflect. I am looking at a Fibonacci-derived price target north of $67 a share (a 25% upside).


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