Arcadium Lithium Stock: Don’t Get Excited, Stay Long (NYSE:ALTM)

Almost five months ago, I wrote to that patient Arcadium Lithium plc (NYSE:ALTM) investors would be rewarded in the long run. Since then, ALTM stock is up over 45%, testing the patience of the Arcadium bulls, including mine. There were some positive news last week as China’s CATL, the world’s largest lithium producer, revealed a plan to cut productionwhich may lead to an increase in lithium prices. Arcadium Lithium jumped 10% on the news. While I welcome this positive development, it is hard to ignore that many of the growth challenges I discussed in my previous article are still prevalent. Some of these challenges include slowing electric vehicle sales and increasing supply. After reviewing the outlook for Arcadium Lithium, I continue to believe the company is a best-in-class bet in the lithium market, but only for investors who are willing to stay long term.

There’s no reason to get too excited about a reversal in lithium prices

Arcadium’s poor market performance this year (down 64%) stems from macroeconomic headwinds facing the lithium industry. As I discussed in depth in my previous article, most of the factors that contributed to record lithium prices in 2022 have reversed, putting pressure on the profit margins of lithium producers. Arcadium was no exception.

Figure 1: Arcadium operating margins

Last week’s production cuts announced by CATL could have a positive impact on lithium prices in the short term. While this is good news, a closer look at inventory levels, demand trends and supply chain dynamics suggest that lithium prices are unlikely to sustain these gains over the next 6-12 months.

Let’s look at inventory levels first.

Lithium hydroxide inventory levels have been rising recently, including a 7% month-over-month increase in August. These rising inventory levels are a clear indication that demand for lithium products is still lagging supply – not good news for lithium prices. From a lithium producer’s perspective, the build-up of inventories is a warning sign of lower potential demand for lithium products in the current period. End users often delay signing new contracts to benefit from expectations of lower prices in the near future.

Figure 2: Monthly lithium hydroxide inventory levels

The build-up of lithium hydroxide stocks is a clear sign of slowing demand in the EV sector. Close monitoring of these inventory levels can help investors identify potential inflection points in lithium prices.

Let’s now look at supply and demand trends. Simultaneous analysis of recent supply and demand trends should help us understand where lithium prices are headed. According to Statista, lithium demand will grow by just over 22% in 2024 to 1.129 million metric tons of lithium carbonate equivalent. This momentum is expected to continue next year, with demand for lithium exceeding 1.4 million metric tons.

Figure 3: Lithium demand

The ongoing transformation of the auto industry to embrace electric vehicles is at the heart of these lithium demand growth forecasts. While demand growth is expected to be stellar, so is supply growth. According to S&P Global, the lithium surplus is expected to reach 38,000 tonnes this year. Even more worryingly, demand is not expected to exceed supply until 2028.

Figure 4: Lithium market surplus

This oversupply, as you can imagine, is not the result of a major slowdown in demand, but of substantial new supply coming online.

• China is expected to add 39 new refinery assets in the coming years. According to recent estimates, China will add 874 kilotons of LCE by 2025 alone.
• Arcadium is expected to increase lithium hydroxide production volumes by 40% this year to a production range of 50,000-54,000 LCE tonnes.
• Australia’s Finniss lithium project is expected to add 11,000 tonnes of LCE in 2024.
• Other notable projects expected to come online in the coming months include Argentina’s Cauchari-Olaroz Project, Nevada’s Thacker Pass Project, Nevada’s Rhyolite Ridge Project, and expanding Greenbushes production in Australia.

In light of this expected oversupply, Fitch Ratings recently lowered its long-term price targets for lithium.

Figure 5: Fitch Ratings target prices for metals and mining

Recent commentary from Citi analysts captures what’s happening in the lithium market perfectly. Here’s an excerpt from the Market Talks segment published by the Wall Street Journal on September 12.

Expect a near-term rally in lithium prices as investors cover their shorts, Citi analysts say, raising their 0-3 month price targets for carbonate to $14,000/t and hydroxide to $14,200/t . Analysts had a previous forecast of $10,000/ton for each of these products. “With a 6-12 month outlook, we don’t expect the rally to have ‘follow-through’ as ​​higher prices could very well trigger a supply response that could lead to weakening lithium stocks,” they say. Analysts cut their carbon forecast for that time horizon to $13,000/tonne, from $14,000/tonne previously. Their hydroxide forecast is going to $13,200/t from $13,000/t previously.

If lithium producers delay supply expansion projects, there is the potential for a near-term rally in lithium prices. However, as I mentioned earlier, I am skeptical about the sustainability of such a rally.

Arcadium Lithium is positioning itself for the future

As I discussed in my previous article, I believe lithium demand will exceed supply in the coming years. Thereafter, demand is likely to remain consistently above supply, driving lithium prices higher. Arcadium, as a low-cost producer, will be a big winner in a sustained lithium price recovery. Increasing affordable electric vehicle options for the consumer will be a key driver of lithium demand.

I believe Arcadium is strategically aligning its businesses to benefit from the expected recovery in lithium prices. It is investing in expanding production capacity while making necessary spending adjustments to push back some capital spending plans to coincide with the expected recovery in the lithium market. I appreciate the company’s continued interest in expanding its production capacity despite rising lithium hydroxide inventories. This positions the company to benefit from a dramatic increase in lithium prices resulting from an unforeseen lithium shortage that may result from underinvestment in mining projects by its peers.

Some strategic decisions taken by the company to take a cautious but optimistic path towards production expansion include discontinuing the Galaxy project in Canada while continuing to invest in the Nemaska ​​project. The company’s decision to review the completion dates for the Fenix ​​project and the Sal de Vida project to ensure sequential completion to avoid a supply overload is also commendable.

ALTM’s stock valuation is attractive

Arcadium is currently valued at a forward P/E of 12.5, compared to the materials sector’s median P/E of 16. After reviewing the company, I have updated my cash flow model to reflect earnings growth expectations double digits over the next four years, but a modest single-digit decline in 2028. Other notable assumptions include a terminal growth rate of 3% and a WACC of 9%. I expect EBITDA margins to improve from around 35% this year to just over 50% by 2028. Based on these assumptions, my intrinsic value estimate for Arcadium Lithium comes to $7.43 per share, implying a potential of 204% increase from the current market price.

Take away

Shares of Arcadium Lithium may benefit from a short-term rally in lithium prices in the coming months, but I do not expect such a rally to be sustainable over the next 12 months given the adverse market developments highlighted in this article. However, in the long term, I expect lithium prices to rebound sharply. Arcadium Lithium, which is attractively valued today, is well positioned to benefit from this expected reversal in lithium prices. I’m comfortable with less than 5% exposure to ALTM in my portfolio because I think the risk-reward profile is strong in favor of long-term investors, despite the lack of a catalyst to push the stock higher.

Editor’s Note: This article discusses one or more securities that are not traded on a major US exchange. Please be aware of the risks associated with these stocks.