Allkem Ltd (ASX:AKE) is a Premier Lithium Producer Rallying Off 6 Month Lows

ALLKEM (ASX:AKE)

Henry Fung

Henry is a co-founder of MF & Co. Asset Management with over 19 years of experience as a trader, investor and asset manager. Henry is the instructor of the Professional Trading Course, which is a free 5-day course on how to become a profitable trader.

March 9, 2023

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Today we will look at why we think Allkem shares (ASX:AKE) have great upside potential with our AKE share price forecast and analysis.

Allkem (ASX:AKE) is Argentina’s largest pure-play lithium miner with a global portfolio of lithium ore and processing assets.

The company has benefited significantly from the recent lithium bull run amidst the burgeoning demand for battery metal.

The company reported bumper results recently for 1H23 with multifold profit growth driven mainly by a price surge of its product.

The company, however, is on the cusp of multiplying the scale of its business substantially as new assets come online over the next couple of years.

At the current AKE share price, Allkem shares have rallied back up above the ASX 200 and are outperforming the ASX200 by 7.07%.

About Allkem Shares (ASX:AKE)

Founded in 2007, Allkem was previously known as Orocobre and was born out of the latter’s merger with Galaxy Resources.

The company owns multiple lithium ore and processing facilities in South America, Asia, and Australia.

Its portfolio includes both lithium carbonate and lithium hydroxide, which are end forms of lithium used in batteries.

Its operating assets include mines in Australia (Mt. Cattlin) and Argentina (Olaroz) that produce lithium carbonate and spodumene concentrate.

It also owns a recently completed lithium hydroxide processing facility in Japan (Naraha) and three mines under development across Canada and Argentina.

Other than Olaroz and Naraha, which are 66.5% and 75% owned by Allkem, all assets are 100% owned by it.

It is currently trading at a market capitalization of A$7.23 billion.

Allkem Ltd(ASX:AKE) - AKE locations
Source – Allkem.com

Strong Product and Operations But Single Product Portfolio A Weakness

Allkem’s biggest strengths are its geographical diversification, proximity to key markets, and its integrated product portfolio.

With a footprint across Argentina, Canada, Australia, and Japan, the company is located close to the biggest lithium consumption markets in the world.

Argentina and Canada are both in close proximity to the US market, which is one of the largest EV makers and markets globally.

The United States Government is on the offensive to establish reliable supply chains of key raw materials for defense and energy security.

Meanwhile, the country’s largest EV and electronics makers have announced big domestic expansion plans which will drive huge lithium demand.

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Secondly, Allkem’s units in Australia and Japan are in close proximity to the Chinese and Japanese markets, which are also the biggest electronics and vehicle makers in the world.

Allkem (ASX:AKE) plans to triple production by 2025 with aggressive cash flow reinvestment in growing capacity.

While the company’s Olaroz phase 2 is 97% complete, Naraha is complete with full production expected over the second half of FY23.

Sal De Vida in Argentina is expected to come online in 2024, and the James Bay JV project in Canada is in the initial stages.

Plans include adding downstream capacity and increasing the quality/purity of downstream products.

Another major strength of the company is its integrated product portfolio, comprising raw lithium ore as well as downstream processing into carbonate and hydroxide for direct use in batteries.

This downstream capability puts a new spin on its business economics as processed lithium carbonate/hydroxide has an entirely different demand profile.

Apart from the overall mismatch in demand and supply as far as lithium is concerned, processed carbonate and hydroxide suffer from deep deficits and therefore command much higher prices and margins.

For the record, lithium carbonate and hydroxide were trading at nearly US$63000 and US$69000 per ton at the end of last week while spodumene commanded a spot price of just US$6000.

Having captive sources of lithium for processing downstream can result in tremendous operating leverage once the lithium industry really takes off.

Allkem’s cost per ton of lithium carbonate at Olaroz is just $4617/ton while spodumene at Mt. Cattlin is just $907/ton.

Allkem Ltd(ASX:AKE) - AKE Growth Pipeline
Source – Allkem 1H’23 Results Presentation

However, Allkem’s weakness is its razor-focused single-product lithium portfolio which is entirely dependent on the current global preference for lithium-ion batteries as an energy store for vehicles and electronics.

However, due to the burgeoning mega-trend of green tech and the boundless demand for cheap energy storage, a tremendous amount of research and investment is going in towards making cheaper batteries based on new chemistries and more abundant elements such as iron, zinc, and aluminum.

Any significant breakthroughs in battery chemistries that don’t involve lithium or breakthroughs in other energy sources such as fuel cells could have a severe impact on the economics of the company’s projects.

Big Japanese EV Opportunity But Macro Backdrop and Sovereign Risk Present Threats

The biggest opportunity for Allkem (ASX:AKE) is the successful maiden year of operations of its Naraha lithium hydroxide processing plant.

The company plans to use lithium carbonate from its Olaroz sites as feedstock to make battery-grade lithium hydroxide which commands the highest price as far as downstream lithium products are concerned.

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The timing is apt as Japanese automakers are now gearing up big time to make up for lost ground in the EV race.

All major Japanese automakers such as Toyota, Honda, Suzuki, and Nissan have announced $10-$20 billion CAPEX plans for this decade and will require high-quality processed lithium for use in batteries.

This represents a serious opportunity for Allkem to secure some big supply deals or perhaps raise equity/investment from a major automaker to grow capacity, which has been a popular trend of late.

Allkem will definitely be of interest to EV makers due to its stellar track record of production and execution.

Allkem Ltd(ASX:AKE) - AKE Market and Demand
Source – Allkem 1H’23 Results Presentation

However, two threats face Allkem shares (ASX:AKE).

Due to the recent rate hiking cycle, consumer spending and big-ticket discretionary spending is almost certainly at risk and this could have a big knock-on effect on demand for electronics and big-ticket purchases such as EVs.

While the company has a sizable cost advantage, a drop-off in demand for end-use products could significantly erode margins and lead to a conservative revaluation of the stock.

The second threat, a geopolitical one, is the poor economic health of Argentina – Allkem’s headquarters and home to the majority of its operations.

The country is reeling under massive debt and high double-digit inflation.

Hence, a situation of big social unrest cannot be ruled out, which could interfere with the company’s operations.

Allkem Shares Financials – Operating Leverage A Massive Advantage, But Also A Double-Edged Sword

Allkem shares (ASX:AKE) reported bumper results in 1H’23 that were mainly driven by substantially higher realized prices on lithium and spodumene.

Allkem Ltd(ASX:AKE) - AKE Profit and Loss - Business Performance
Source – Allkem 1H’23 Results Presentation

In 1H’23, the company reported revenues of US$577.9 million (up 209% YoY), an EBITDA of US$401.5 million (up 311% YoY), and an NPAT of US$219.2 million (up 1592% YoY).

The majority of the growth in EBITDA, about 91.2%, came from higher realized prices.

Revenues and earnings were also boosted by US$54.4 million worth of low-grade ore sales due to record demand.

At Olaroz, where the company produces lithium carbonate, the company reported sales growth of 16%, realized prices of US$43,326/ton, and a gross margin of 89%.

Olaroz grew revenues by 351% due to a 290% jump in prices.

At Mt Cattlin, the company saw 48% lower production YoY and 62% lower revenues.

Costs grew by 159% YoY while realized prices stood at record highs.

Production was hit due to the transition between pits and ore quality issues.

Mt Cattlin operated at a gross margin of 76%.

The Operating Cash Flow in 1H’23 grew by about 690% YoY while the company spent US$194.6 million on CAPEX towards the expansion of Olaroz, Mt. Cattlin, Sal de Vida, and James Bay.

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The company currently has a debt of US$209.8 million and a net cash position of US$552 million.

Notably, though lithium prices have severely corrected in recent months, Goldman Sachs has maintained a bullish view of the stock.

Goldman states that Allkem shares (ASX:AKE) have one of the best production/growth outlooks across its entire coverage of lithium stocks and expects the company to quadruple its production by end of 2027.

Goldman sees an upside of 29% in the stock price from current levels of A$11.87.

Allkem Shares (ASX:AKE) Valuation

We will compare Allkem to Pilbara Resources (ASX: PLS) and Livent (NYSE: LTHM), both of which are lithium producers from Australia and the United States.

Livent is also engaged in downstream processed lithium for use in products and has a global footprint, making it a very relevant comparable.

On the other hand, Pilbara is primarily a spodumene producer but is getting into downstream processing through JVs but these efforts are in an early stage.

MetricAllkemPilbara MineralsLivent
Price/Earnings10.778.0415.73
Price/FCF12.816.4136.52
Price/Book1.645.292.98
Source – Investing.com

As can be seen, at the current AKE share price, Allkem shares lie between Pilbara and Livent in terms of P/E.

While it is relatively more expensive in terms of P/FCF than Pilbara, it should be noted that Allkem uses debt very minimally and depends mainly on operational cash flows to fund capex which could explain why it looks more expensive in terms of FCF.

Lastly, at the current AKE share price, Allkem shares are by far the cheapest in terms of book value as it has many assets/projects in the pipeline which it is in a very good position to finance and bring online.

Allkem shares (ASX:AKE) are off 23% from November 2022 highs and rallying: An opportunity for lithium investors

The stock has been punished in line with the decline in lithium prices.

Over the last six months, At the current AKE share price, Allkem shares have lost 22.01%, while the ASX200 has gained 6.06% but has rallied 11% in the past 2 weeks.

Investors have shrugged off the company’s blockbuster 1H23 results, driven primarily by high price realizations.

The long-term projections for the demand for both EVs and lithium are compelling, and this is confirmed by recent reports of automakers scrambling to assure supply by investing in, or acquiring lithium miners.

Allkem, on the other hand, will address this future opportunity with a quantum jump in strategically located production volumes that cater to the customer’s requirement for all forms of lithium products.

The current selloff in Allkem shares (ASX:AKE) and subsequent rally, therefore, presents a buying opportunity.

Are you looking for more stocks to buy? In our opinion, buying the right stock at the right time is just half the battle – knowing how to manage the position and risk is just as, if not more important. Take our free 5-day trade like a professional course, it give you the foundational knowledge required to become a profitable trader.

This is general advice only. MF & Co Asset Management has not considered your personal financial needs, objectives or current situation. This information is not an offer, solicitation, or a recommendation for any financial product unless expressly stated. You should seek professional investment advice before making any investment decision.

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MF & Co. Asset Management

MF & Co. Asset Management is a boutique investment firm offering Equity Capital Markets and derivative general advice & trade execution services.

We are specialists in advising and trading in Australian and US Equities, Index & Equity Options and Options on Futures.

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