Pilbara Minerals (ASX: PLS) – Reasonably Priced In Context of What’s In Store

Today we’ll look at why we think Pilbara Minerals shares (ASX:PLS) has good upside potential in our PLS share price forecast and analysis.

Pilbara Minerals Ltd (ASX: PLS) is one of the largest pure-play lithium producers with roughly 8% of global production. After a fabulous acquisition of Altura Mining, the company currently owns one of the best operational lithium assets globally at Pilgangoora. Since the acquisition, the company has largely focussed on execution, expansion, and capturing more of the value chain. Recent financial performance has been stellar, showcasing the company’s frugal cost structure and opening of global markets for spodumene. Investors were also awarded an inaugural dividend in 1H’23.

The lithium market has been budding with activity, showing clear signs that the global economy and major corporations are betting big on its prospects. Chile recently nationalized lithium assets, Allkem and Livent entered a merger to become a major player in the sector while Albemarle failed to secure Liontown Resources despite a multi-billion dollar bid. Major carmakers are upping the ante with LG, Ford, and BMW announcing major battery production facilities while GM invested $650M in Lithium Americas.

Despite the slight weakness in lithium prices, Chinese economic weakness, and contractionary macro environment, the company has largely held steady and weathered the storm with record financial performance. At the current PLS share price, Pilbara Minerals shares (ASX:PLS) has returned 28.45% YTD against the ASX200’s paltry 2.80%.

About Pilbara Minerals Shares (ASX:PLS)

Pilbara is an Australia-headquartered company engaged in lithium mining. The company owns two mines in West Australia’s Pilgangoora region. The company’s primary product is lithium spodumene and it is aggressively gravitating towards a downstream value-added strategy.

Lithium spodumene, the natural hard rock ore of lithium is the raw material for processed forms of the metal that go into batteries. Pilbara is on the cusp of completing its P680 expansion program which will bring capacity to 680ktpa by September ‘23 (Q1 2024). It has also recently approved its P1000 expansion which will bring production to 1M mtpa by Q3 FY25.

Source – Pilbara Minerals 1H Results

At the current PLS share price, Pilbara Minerals shares (ASX:PLS) currently have a market cap of A$13.94B.

Solid Outlook With Operating Leverage

Pilbara’s strategy at present revolves around solid execution, downstream value addition, ramping up the current asset base to full capacity, and diversifying its asset base.

Source – Pilbara Minerals 1H Results

The primary advantage of Pilbara Minerals (ASX:PLS) lies in the promising outlook for its primary resource, lithium spodumene. In recent years, a combination of factors, including advancements in electric vehicles and increased environmental consciousness, has sparked a bull run for lithium. Lithium, renowned for its high energy density, plays a pivotal role as a crucial component in electric vehicles and electronic batteries. Over the next few years, experts claim that lithium demand will almost certainly lag its supply, leading to a substantial price increase. It is expected that lithium production will lag the demand base case by 2.6Mt by 2040, representing a huge opportunity for the company.

Source – Pilbara Minerals 1H Results

It must be noted that the EV trend is here to stay as consumers have shown no inhibitions to adopting the new technology. This can be seen in 25% YoY EV sales growth in China despite a downturn and EV models such as the Tesla Model Y/3 becoming overall best-selling models in various regions. Economies of scale are also kicking in as the starting price of the Tesla Model Y is now below the average new car price in the US.

The rapidly growing energy storage sector is a major growth driver for Pilbara Minerals (ASX:PLS) as renewable sources have largely reached cost competitiveness with fossils. The only Achilles heel for renewables such as solar lies in storage. Chinese suppliers of solar panels such as Longi (the world’s largest) have entered a brutal price war with a 31% cut in prices earlier this this week as silicon prices corrected. This is matched by a rapid increase in solar supply chain production capacity, driving prices even lower. As solar becomes more affordable, the value proposition of battery-backed solar parks becomes more viable at the grid level and at the residential level, which could open the floodgates on stationary battery pack demand.

A high-demand scarce commodity combined with a high-quality asset base is a boon for a company like Pilbara due to the massive operating leverage built into the business. At prices of US$4840/ton for spodumene in 1H’23, the company incurred an all-in operating cost of just US$747/ton (A$1,144/ton), highlighting massive operating leverage at higher prices. Realized prices are expected to improve substantially over the next few quarters as the Chinese economy exits its slowdown.

Further, lithium prices were hit hard over the past few months in China due to the heavy discounting of ICE vehicles held in inventory to meet new emissions standards that come into effect in July.  At the same time, costs are coming down for the company as freight rates continue to normalize sharply while economies of scale from new production coming online push unit costs lower for the company.

Pilbara Minerals (ASX:PLS) had a significant chunk of initial pre-acquisition production in off-take contracts with major battery manufacturers and refiners in China and other Asian markets such as Gangfeng, General Lithium, POSCO, and CATL, thus giving it some stable demand in down cycles.

Single Product Portfolio Is A Weakness for Pilbara Minerals shares (ASX:PLS)

One of the biggest weaknesses of Australian lithium companies was the overconcentration of the lithium supply chain in China. However, this is now changing rapidly as major economies such as the US and Canada are now heavily incentivizing clean energy and materials supply chains. For example, Pilbara will be a major beneficiary of the US Inflation Reduction Act which includes nearly US$400B in incentives for clean energy transition providers in the US and those from free trade partners such as Australia. This can be a big strength for the company as there is currently a big divergence between China’s lithium prices and global prices. The development of domestic supply chains in other countries will lead to bigger markets and more pricing power for big producers such as Pilbara, at least in the medium term until supply grows substantially.

Further, recent nationalization developments in Chile will rattle investors and lenders interested in lithium as there are very few developed economies with natural resource ecosystems like Australia. The bulk of other lithium deposits outside of the US, Canada, and Australia are in Latin America and Africa, where governments may follow Chile’s decision.

While the bright future of lithium is one of the company’s biggest strengths, its complete dependency on it, as a single product, is a potential weakness.

Lithium is a very exotic metal and thus very expensive for grid-based energy storage and cheap vehicles/electronics, which is another reason why vigorous attempts are being made at designing battery chemistries based on abundant materials.

For example, China has been very aggressive in battery technology R&D and has outpaced the US in post-lithium-ion battery patents. Chinese companies such as CATL have bet big on sodium-ion batteries which will be cheaper and of comparable performance. CATL and BYD will ship cars with sodium-ion batteries later this year after unveiling prototypes in 2021. While performance still lags behind lithium ion and these batteries still use some lithium, both companies are confident that pure sodium-ion batteries are not far. This is just the tip of the iceberg, substantial efforts are being made by companies and research teams all over the world to build high-performance batteries based on new chemistries involving aluminum, iron, silicon, etc.

Any innovative and successful technological breakthroughs in favor of lithium alternatives can damage Pilbara’s prospects.

Value-Added Opportunity Can Boost Earnings Tremendously

Value addition is a core pillar of the company’s corporate strategy at the moment, which it hopes to achieve through a lithium hydroxide processing JV with POSCO and a mid-stream plant with Calix.

Moving down the lithium supply chain is a strategic initiative that Pilbara is pursuing. Lithium spodumene is essentially lithium ore, which needs to be processed chemically into lithium hydroxide that goes into making lithium anodes for lithium-ion batteries.

The current lithium hydroxide price is in the $45,000/ton while the cost of processing spodumene into lithium hydroxide ranges between $2,500-$4,000/ton, depending on factors such as ore costs and transportation, etc. Moving lower down the supply chain into spodumene processing could help the company significantly boost its margins, increase its pricing power and cater to a wider market.

Pilbara Minerals (ASX:PLS) and POSCO have made huge strides towards their JV since the last time of writing. The plant is under construction and production is expected to commence by Q4’23. It will have a production capacity of 43000 mtpa of lithium hydroxide. Pilbara owns 18% of the JV with an option to increase it to 30%. The company has allotted nearly half its current production run rate (315000 mtpa) as feedstock for the project which unlocks a larger part of the value chain and pricing power while ensuring demand.

Source – Pilbara Minerals 1H Results

Pilbara Minerals (ASX:PLS) also recently experimented with a new tolling structure with a lithium processor under which the company receives lithium hydroxide in proportion to the spodumene provided based on market prices of both, net of processing costs. While the company admitted in its earnings call that suppressed hydroxide pricing meant that the deal did not yield much value add, it is a very capital-light and scalable way of pursuing the value-add strategy. However, it only works when lithium hydroxide prices are in an uptrend.

The second pillar of the company’s value-add strategy is mid-stream processing ability, for which it had partnered with Calix for a pilot plant at Pilgangoora. Under mid-stream, the company is essentially aiming to concentrate lithium into salts with far higher concentrations than spodumene, further processing is still required for end uses. However, this pursuit comes with multiple benefits. For starters, the Calix technology is electrical, which allows higher utilization of solar assets at the plant while adding value. Secondly, it is much less carbon-intensive as the processed salts occupy far less volume than unprocessed spodumene in terms of lithium content, which reduces carbon impact and shipping costs while increasing realized value.

Source – Pilbara Minerals 1H Results

Tail Risk of Supply Shocks and Recession are Threats

There are two major threats facing the company, competition, and the cloudy macro backdrop.

As mentioned above, decarbonization has created a modern-day gold rush for lithium. Until very recently, Australia was one of the biggest and most reliable geographies for lithium mining.

However, natural resource-rich countries in Africa, South America, and Asia are rapidly engaging in lithium exploration and aggressively pursuing investment in the same for energy independence along with economic development. For example, India recently discovered two major lithium deposits in the Kashmir region and Rajasthan which puts their lithium resource above Australia’s based on initial exploration.

There is also an aggressive push in developed economies such as the US or Canada where lithium deposits to date are considerable and the scope for more deposits is high. These opportunities are being pursued aggressively by governments and major corporations such as carmakers and could lead to an underestimation of the long-term supply, an assumption that has pinned valuations in the sector. However, it must be said that Pilbara has a reasonably clean run over the next few quarters as most projects across the world have some time to completion.

The second threat is that central bankers may overshoot quantitative tightening requirements for reigning in inflation and plunge the global economy into a recession, which would be terrible as quantitative easing would not be as effective as it has been in the past, due to fragile supply chains. Signs of this are already emerging as Germany has officially entered recession and other European countries are likely to follow. China’s economic recovery post-reopening has largely fizzled out too.

Business is Maturing With Dividends and Operating Leverage is Kicking In Hard

In 1H’23, Pilbara Minerals shares (ASX:PLS) delivered revenues of A$2.18 billion (up 647% YoY), EBITDA of A$1.81 billion (up 1081% YoY), and NPAT of A$1.24 billion (up 989% YoY). Production was 82% to 309.2k tonnes while shipments were up 68.5% to 286.8k tonnes. The average realized price for the first half was up 400% to US$4,993/ton.

Source – Pilbara Minerals 1H Results

Pilbara saw an operating cash inflow of A$1.8 billion, up about 10x YoY. The company had a net cash position of A$2.078 billion in the first half. In Q3’23, the company reported a cash balance of A$2.68 billion. In Q3, realized prices dropped 15% YoY, operating costs grew 9% YoY, and net costs dropped 2%. The company reported some elevated costs due to maintenance work and other one-offs. Overall, dropping shipping rates and moderating inflation in some segments are driving costs lower. However, wage inflation remains sticky. The company added two new debt facilities in the quarter, a US$460M non-recourse facility for its POSCO JV and a A$250M facility from the EFA (Export Finance Australia) and the NAIF (Northern Australia Infrastructure Facility) for mine expansion. Senior Secured Debt still stands at about US$100M.

Pilbara Minerals (ASX:PLS) maintained full-year guidance of 600k-620k spodumene production, albeit at slightly lower purity to expand production as the cash flow needed is high to fund projects. Operating cost guidance was hiked about 5% to A$610-A$640/ton. Expansion capex for the year is to be between A$373 million – A$393 million on account of mine expansion, solar investments, and waste mine development while sustenance capex is to be A$72 million.

Lastly, the company rewarded shareholders with an inaugural fully franked dividend of 11 cents a share on the back of record 1H performance.

Pilbara Minerals Shares (ASX:PLS) Valuation

Since Pilbara Minerals (ASX: PLS) has substantially matured to become a major player since last writing, we will compare it to Albemarle (NYSE: ALB) and Livent Corporation (NYSE: LTHM), both of which are major lithium producers in the US and make up a considerable part of the global lithium supply chain. (Note: Livent is yet to undergo its stock-for-stock deal with Allkem)

Metric	Pilbara Minerals	Albemarle	Livent
Price/Earnings	7.93	6.51	12.66
Price/Sales	4.35	2.73	4.6
Asset Turnover	1.23	0.61	0.54
Net Margin	54.9%	41.89%	36.3%

As can be seen, Pilbara has the highest margin and the highest asset turnover due to its lean operations. At the curren PLS share price, Pilbara Minerals shares (ASX:PLS) are comparable to Livent and slightly cheaper in terms of price ratios despite a higher growth runway. It is slightly more expensive than Albemarle but has significantly higher growth opportunities.

It must be noted that the lithium hydroxide JV with POSCO will add a substantial part of the value chain to Pilbara and dramatically lift margins, ROE, and revenues when combined with its cheap feedstock.

Pilbara Minerals Well Placed to Cash In

To summarize, Pilbara Minerals Shares (ASX:PLS) has a strong asset base on a lean cost structure in a jurisdiction with no sovereign risk. The company’s operations are extremely competitive with market access to Asia, China, and the US. It is well placed to benefit from clean energy supply incentives in the West due to Free Trade Agreements. The company also has a bit of a free run for at least a year as most new lithium projects are in their infancy, while Pilbara is experienced and firing on all cylinders.

Pilbara’s value add strategy can transform earnings due to broader capture of the value chain and these projects combined with mine expansions will kick in later this year, not to mention economic recoveries in China will do wonders for the company. Overall, the sector outlook is strong due to the intense focus on decarbonisation.

The company does face some tail risks due to new battery chemistries, abrupt supply shocks over the long term due to over-investment, and of course the gloomy macro environment. However, for an investor staying invested in the market through the current turmoil, decarbonisation is a trend that cannot be missed and Pilbara is a solid play in that regard. Its valuation is reasonable and its project pipeline/expansions can deliver growth far better than what is priced into its multiple.