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Morningstar | Continued Strong Lithium Demand Highlights Our 4Q Earnings Takeaways; All Three Stocks Undervalued

From a valuation standpoint, all three lithium producers we cover are trading at a discount to our fair value estimates. We view SQM and Albemarle as our top picks as they trade at price/fair value ratios of 0.61 and 0.67, respectively. Livent is still attractive but currently trades at a price/fair value ratio of 0.75. Regardless, all three narrow-moat stocks are trading in 4-star territory.

Our bullish long-term outlook assumes that lithium prices will recover. Additionally, we assume that the attractive unit costs offered by Albemarle and SQM in both carbonate and hydroxide production from geologically advantaged resources will persist.

Amid market speculation throughout 2018 that lithium prices would fall, all three of the lithium producers we cover realized higher prices year on year. However, we expect carbonate prices to fall from an average of $13,095 per metric ton (on a Chilean export LCE basis) in 2018 to roughly $12,000 per metric ton in 2019 as new supply comes online. Regardless, lithium demand remains strong and we forecast demand growth in the high-teens this year.

While we forecast declining lithium prices over the next few years, we expect the price declines to occur at a more gradual rate. Our outlook for only modestly lower prices is supported by SQM's soft production guidance. Limited production growth from SQM will incentivize production from high-cost, non-integrated lithium producers to continue. These high-cost players typically use lower-quality spodumene and non-battery quality carbonate as a feedstock to produce battery-quality lithium.

Additionally, we emphasize to investors that there will continue to be low-quality lithium volumes sold in the market below our price forecast. However, we do not think these volumes are indicative of battery-quality lithium prices. The lower quality product does not meet battery specifications and must be further refined, which comes at an additional cost.

Albemarle reported an encouraging outlook for 2019, guiding to higher volumes and flat lithium prices. Albemarle's strategy of selling the majority of its lithium under long-term price contracts somewhat insulates the company's realized prices from more volatile market movements. At current prices, we view Albemarle as materially undervalued, trading at roughly a 33% discount to our $130 per share fair value estimate.

Livent expects 2019 realized prices to be flat year on year. The company will begin selling more of its battery-quality lithium outside of China and will incur higher expenses due to a VAT export tax in China, where it produces most of its battery-quality lithium. Livent will also see margins compress from the purchase of third-party lithium carbonate used as a feedstock to produce lithium hydroxide. The purchased carbonate will carry a higher cost than Livent's own carbonate. This exposes the company's profits to the prevailing spread between carbonate and hydroxide regardless of lithium price movements. We also note that FMC completed its full divestiture of Livent in early March. Livent is now fully independent of FMC, with the spin-off complete. At current prices, we view Livent as undervalued, trading at nearly a 25% discount to our $18 per share fair value estimate.

SQM is the lithium bellwether for short-term prices as the company generally sells lithium on short-term contracts and reports volumes and prices each quarter. In its outlook for 2019, management guided to modestly lower prices. The company also guided that sales volumes will grow only slightly year on year. At current prices, we view SQM as materially undervalued, trading at nearly a 40% discount to our $64 per share fair value estimate.

For more information on our lithium outlook, please see our Nov. 30 report, "Put the Pedal to the Metal for Lithium Stocks."

For more information on our electric vehicle forecast, please see our Sept. 24 Observer, "Electric Vehicle Sales in China and Europe Will Leave U.S. in the Dust, Driving Above-Consensus Global Adoption Rates."