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Morningstar | Raising Our Lithium Producer FVEs on Higher Electric Vehicle Adoption and Lithium Prices. See Updated Analyst Note from 21 Sep 2018

We are increasing our fair value estimates for Albemarle, FMC, and Sociedad Quimica Y Minera, or SQM, to reflect our updated lithium price forecast. This follows our in-depth analysis calling for above-consensus electric vehicle adoption over the next decade, as well as our re-evaluation of the lithium cost curve. We have raised our long-term lithium carbonate price forecast to $12,000 per metric ton in real terms from $8,500. Our updated lithium price forecast is based on the incentive price needed to bring sufficient production on line to close what would otherwise be a supply shortfall.

We have also reassessed our terminal enterprise value/EBITDA multiples for Albemarle, FMC, and SQM. The updated multiples more accurately account for the companies' midcycle free cash flow conversion from EBITDA, after each company's lithium capacity expansions are complete. Our exit multiples increase to 12 times from 11 for Albemarle, to 11.5 times from 11 for FMC, and to 11 times from 10 for SQM. Accordingly, we've increased our fair value estimate for Albemarle to $135 per share from $125, that for FMC to $90 from $81, and that for SQM to $65 from $55.

Spodumene converters have traditionally set the marginal cost of lithium carbonate production. Over the next couple of years, we expect lithium carbonate prices, on a Chilean export basis, will fall from $12,000 per metric ton in 2018 to $10,000 by 2020. New spodumene production in Western Australia will cause spodumene prices to fall. which will lower the marginal cost of carbonate production . However, this oversupply will be short-lived. By the mid-2020s, demand will outpace supply, creating the need for lower-quality spodumene conversion to set the marginal cost of production. We forecast a $12,000 per metric ton long-term lithium price.

Separately, we have moderated our demand outlook for premium lithium products, which include lithium hydroxide. For Albemarle and FMC, which sell a greater proportion of premium products than SQM, our lower premium partially offsets our increased lithium carbonate price. This leads to smaller increases in our fair value estimates for Albemarle and FMC than for SQM.

In the next month, we'll publish our updated electric vehicle observer. The report will detail our above-consensus outlook for electric vehicles and will include a regional buildup focused on the U.S., EU, and China.

Electric vehicle sales were roughly 1% of global vehicle sales in 2018. We expect electric vehicle sales to reach a 15% adoption rate by 2028, which is above the roughly 11% consensus forecast. In absolute terms, we forecast 18.5 million electric vehicles will be sold in 2028, up from around 1 million in 2017. However, the adoption rates will differ significantly by region. China will continue to lead the electric vehicle market with a 25% adoption rate by 2028. The EU will be second at a 20% adoption rate, while the U.S. will lag the global average at a 12.5% electric vehicle adoption rate. We also forecast a 21% hybrid adoption rate in 2028 (strong hybrids and plug-in hybrid electric vehicles), which translates to nearly 26 million hybrid vehicles. Due to our above-consensus electric vehicle forecast, we project lithium demand will grow from around 220,000 metric tons in 2017 to 1.5 million metric tons by 2028. This represents a 19% annual growth rate over the next decade.

SQM is the most undervalued lithium producer we cover, trading at roughly a 25% discount to our $65 per share fair value estimate. SQM is the lowest-cost lithium carbonate producer, thanks to its crown jewel Salar de Atacama brine operation in Chile, which underpins our narrow moat rating based on cost advantage. Although a recent royalty increase from Chilean regulators has significantly closed the gap between Chilean and Argentinian lithium production, SQM will still have the lowest production costs based on our lithium price forecast.

SQM plans to expand its lithium carbonate production capacity from 50,000 metric tons in 2017 to 180,000 metric tons of capacity over the next several years. SQM is also part of a joint venture operation that will produce around 20,000 metric tons (SQM's share) of lithium hydroxide using spodumene in Western Australia. As a result, lithium profits will quadruple from 2017 to 2027 as lithium grows to nearly 80% of companywide profits.

Albemarle is also undervalued, trading roughly 22% below our $135 per share fair value estimate. Like SQM, Albemarle is a low-cost lithium carbonate producer through its Chilean brine operations at the Salar de Atacama, although Albemarle has a slightly higher unit production cost than SQM. Albemarle is also a joint-venture partner in the Talison spodumene mine, which is the lowest-cost spodumene operation globally. Its geological advantage allows spodumene from Talison to produce lithium hydroxide at the low end of the cost curve. All in all, narrow-moat Albemarle is a cost advantaged lithium producer.

Albemarle plans to expand its lithium production capacity from 65,000 metric tons in 2017 to 265,000 metric tons by the mid-2020s. Of the additional 200,000 metric tons, 120,000 metric tons will come from additional spodumene-based lithium hydroxide, as the Talison mine plans to expand spodumene production. As a result, lithium profits will more than quadruple over the next decade and account for over 80% of total company profits.

FMC is fairly valued, trading around our $90 per share fair value estimate; however, we note that the company's crop chemicals business generates roughly 90% of companywide profits. That said, FMC will spin off its lithium business, which will be called the Livent Coproration, by the end of 2018. FMC's lithium carbonate operation is located in Argentina, and its unit production costs are roughly in line with Albemarle's (after adding in the higher Chilean royalty). It will continue to operate on the lowest quartile of the global cost curve.

Once the spin-off is complete, we expect Livent to expand its lithium carbonate production from 18,000 metric tons in 2017 to over 55,000 metric tons by 2027. Livent will also invest in the conversion of lithium carbonate into lithium hydroxide to take advantage of growing demand for the premium product in new electric vehicle battery chemistries. Livent will increase lithium hydroxide capacity by a greater amount than its lithium carbonate production and will purchase third-party carbonate to make up the difference. While FMC has a cost advantage in lithium carbonate production, we do not think FMC will enjoy the same cost advantage in lithium hydroxide production, especially when sourcing third-party carbonate.