Massif Capital – Lithium Americas: Why We Still Own LAC And LAAC
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Summary:
- Investing in the Lithium mining and processing industry has gotten very tricky.
- Currently, we remain, at a small size, invested in two lithium mining firms, Lithium Americas and Lithium Argentina.
- We view LAAC as a compelling value play with a de- risked producing asset and the potential to reinvest capital at high rates of return via the development.
- LAC has many strengths: strong management, strong backing, a first-of- a-kind flow sheet.
D3signAllTheThings
The following segment was excerpted from this fund letter.
Lithium Americas (NYSE:LAC)
Lithium Overview and Position Update
Investing in the Lithium mining and processing industry has gotten very tricky; this is perhaps no surprise; after all, the sector was nascent just a few years ago and is now taking center stage in a global transportation transition. Furthermore, for those who do not follow these things as closely as we do, the spot price sold off roughly 75%-80% in 2023, depending on what price index you are looking at, having risen close to 800% from the 2021 low to the 2023 peak. At the same time, the contracted prices that key producers received in 2023 were higher than those received in 2022. A significant divergence has emerged between the transparent but little-used spot price and the opaque but industry-standard contracted prices.
As an industry still in its early stages of evolution, there are few management teams worth investing in, geopolitical risk, and significant medium to long-term potential. The cost of entry for such opportunities is considerable volatility. As usual, we are unsure where the market is going in the short term, but we have a sense of the general direction in the medium to long term and are investing on that basis. What follows is a wide-ranging discussion of the commodity, the supply and demand situation, our current investments and positioning, and our thoughts for the year ahead.
What We Own and What We Are Short
Currently, we remain, at a small size, invested in two lithium mining firms, Lithium Americas (LAC) and Lithium Argentina (NYSE:LAAC). Both companies were part of a single entity (Lithium America Original) as recently as October. That entity was a long-time Massif Capital Investment initiated in March 2020 at roughly $2.5 per share. At the time, the firm was in pre-production at two assets, an Argentina-based lithium brine deposit and a US-based clay deposit, to which we attributed little value because of the state of processing technology.
We used the stock’s volatility to great advantage throughout 2020, 2021, and 2022 as we repeatedly sold both puts and calls on the company, reducing our entry cost below zero via premium earned on those options trading activities. In 2021, the stock peaked at roughly $39 a share, a roughly 1,460% gain on our purchase price. Given the state of the firm’s assets, we should have cut the entire position instead of just trimming. We had confidence in the management team, and momentum and enthusiasm for all things EV and battery were strong, offering the potential for the market to run the price well past any reasonable value. Furthermore, at the time, the lithium prices we were seeing implied a fair value of the two development assets well north of $40 a share, and we were having trouble understanding how long the trend of sky-high prices would last.
We have written about our misstep in not selling the whole position in the past, so we will not belabor the point. The stock traded down after that initial peak, regaining its highs again in 2022 before selling off, bouncing to more than $30 a share, and then falling precipitously to the current combined share price of both companies of roughly $6 to $8 a share, still a 150% gain from our initial share price but also a fall of 69% from the first time we trimmed the position.
In October of 2023, the company split in two, creating a standalone entity focused on operations in Argentina (Lithium Argentina or LAAC) and a standalone entity focused on operations in North America (Lithium America or LAC). We currently have small positions in both, totaling 6% of the portfolio in total. We are taking advantage of the latest LAAC self-off to add to our position and are in the due diligence stage on a third potential lithium investment at a similar development stage as LAC, hence a decision not to add to the position currently.
On the short side of the book, we engaged in two types of Lithium shorts throughout 2023. The first is a traditional alpha-focused company short. Specifically, we assessed Piedmont Lithium (PLL), a junior developer with exposure to assets from Canada to Ghana, which is helmed by a management team that, while capable of selling a story, cannot achieve its lofty goals in the real world.
Piedmont is a classic mining stock promotion with little chance of becoming anything substantive. During 2023, we generated a 23% return on the short before exiting it during the 4th quarter. We re-entered the short recently and are currently up a further 50%. We have also partially hedged out long positions in LAC and LAAC via a short in LIT, the Global Lithium X ETF. The hedging position, which we also exited in the 4th quarter, generated a 12.2% return during 2023, and we have re-entered this position based on a combination of weak sectoral internals, continuing negative trend, and momentum throughout the sector and a continued slide in Lithium prices.
The reestablished LIT short position is currently up roughly 17%. In the case of both the alpha-generating company short and the sectoral hedge, timing and holding periods were guided by our evolving execution approach that prioritizes momentum/trend and market internals. Together, our short activities within Lithium were our most successful short activities in an otherwise disappointing year for the short book and represent what we expect to be the case study for how we manage the short book in the future.
Why Do We Still Own LAC and LAAC
In the case of LAAC, we view the business as a compelling value play, with a de-risked producing asset (Cauchari-Olaroz) and the potential to reinvest capital at high rates of return via the development of its Pastos Grandes assets. The company trades at a discount to its fundamental value, a gap that could close in the near term as the company continues to ramp up production. With 40 ktpa in Lithium Carbonate Equivalent (LCE) production that is 90% contracted under a market price offtake agreement, the firm appears well-positioned to have a successful 2024.
Our fundamental value is based on a net present value of the Cauchari asset, with no upside associated with the potential development of Pastos Grandes. We have slightly adjusted the 2020 Definitive Feasibility Study (‘DFS’) production levels and significant adjustments to our expected operating costs. Then, we valued the asset at various lithium carbonate price levels.
We run our valuation at lithium carbonate prices of $15k per ton, $22.5k, and $30k vs. the current reported South American Lithium Carbonate FOB Swap price of $16.0k per ton, which is down 43% or so in the last three months. The primary difference between the DFS asset level operating model and our own is in the operating cost of the asset. The DFS indicates that in 2020, the firm expected an operational cost of roughly $3,500 per ton of lithium carbonate. Of that, approximately 51% of the cost was for reagents involved in the chemical conversion of lithium brine to battery-grade lithium carbonate.
The reagents used in the production process include chemicals such as soda ash (sodium carbonate), which is up 25% since the DFS publication. Labor and power account for a further 13.4% of projected CapEx; based on conversations with industry participants, both costs have increased. We assess that the projected cost of production is thus unlikely to be achieved. Based on a review of industry data, we believe that the operating cost of brine assets is closer to $5,500 a ton. As such, we ran our valuation at that level.
We expect the gap between the current market price and our fundamental value to close soon as the firm ramps up production this year. Total production capacity is anticipated to be achieved by mid-2024, as is a battery-grade lithium carbonate product. During last year’s initial ramp-up and in this year’s first half, the lithium sold is technical quality lithium, which falls short of battery quality. In addition to reaching the asset’s commercial run rate in 2024, management is focused on stage 2 of the assets, which is expected to add 20ktpa of capacity to Cauchari.
At the current time, the firm looks expensive in comparison to peers, but that changes rapidly as the firm ramps up production in the coming years:
|
EV/Target Production Capacity ($/t LCE) |
|||||
|
Ticker |
Current EV |
2023E |
2024E |
2025E |
2026E |
|
ALB US Equity |
$17,191 |
$106,411 |
$93,835 |
$77,901 |
$68,131 |
|
AKE AU Equity |
$5,128 |
$105,491 |
$48,312 |
$30,195 |
$25,564 |
|
LAAC US Equity |
$935 |
$230,345 |
$32,906 |
$28,793 |
$23,034 |
|
LTR AU Equity |
$3,017 |
N/A |
$132,895 |
$66,447 |
$66,447 |
|
LTHM US Equity |
$2,743 |
$73,496 |
$48,806 |
$40,046 |
$40,046 |
|
MIN AU Equity |
$13,755 |
$131,088 |
$131,088 |
$131,088 |
$131,088 |
|
PLS AU Equity |
$7,907 |
$106,934 |
$99,137 |
$99,137 |
$67,498 |
|
SGML US Equity |
$3,171 |
$120,437 |
$46,907 |
$42,848 |
$42,848 |
|
SQM US Equity |
$15,498 |
$77,364 |
$67,693 |
$55,073 |
$53,796 |
|
Source: Company Reports, Bloomberg, TD Cowen & Massif Capital Estimates |
|||||
At the current spot price for South American Carbonate, we believe LAAC will produce an attributable average annual EBITDA of roughly $350 million per year for the first ten years of the firm’s operations. The peer group above has a mean EV/EBITDA of 6.1x, implying an EV of $2.1 billion, suggesting a Market Capitalization of $2.0 billion, a per-share value of roughly $13 a share. The relative valuation is a little punchier than our NAV-based valuation but is in the same ballpark.
This analysis does not consider any potential upside from the firm’s Pastos Grandes project either. It is still early for this project, so we do not need to include it in our valuation until we have further information, but it is highly prospective. It is unclear how long it will take to accumulate sufficient information to start thoughtfully including the project in our valuation. Still, we are optimistic that it will occur over the next 12 to 18 months. Currently, we find the project more useful or helpful in evaluating the management team’s capital allocation skills.
As some detractors have pointed out, the management team that made Pastos Grandes acquisition differs from the team currently running the business. Key players decamped to the new Lithium Americas, but we would respond by noting that the team that ran South American operations during the acquisition is the same team currently running LAAC and, thus, is likely to have had significant input into capital allocation decisions. This is encouraging as the firm’s acquisition of Millennial Lithium, which is how the business acquired the Pastos Grandes project, was highly economic.
Based on our analysis of a handful of recent lithium acquisitions, we believe the LAC/LAAC team paid 75% less per ton of resource basis than peer transactions.
|
(LCE) |
|||||
|
Oct-21 |
Zijin Mining Group Co Ltd |
Neo Lithium Corp |
$737 |
7.63 |
$97 |
|
Nov-21 |
Lithium Americas Corp |
Millennial Lithium Corp |
$390 |
5.3 |
$74 |
|
Dec-21 |
Rio Tinto PLC |
Rincon Mining |
$825 |
11.8 |
$70 |
|
May-22 |
Zijin Mining Group Co Ltd |
DunAn Holding Group |
$1,125 |
2.14 |
$526 |
|
Jul-22 |
Ganfeng Lithium |
Lithea Inc |
$962 |
3.6 |
$267 |
|
Dec-22 |
Lithium Americas Corp |
Arena Minerals Inc |
$227 |
0.6 |
$378 |
|
Sep-23 |
Albemarle Corp |
Liontown Resources Ltd |
$4,359 |
5.4 |
$807 |
|
Average |
$317 |
||||
|
Source: Company Reports, Bloomberg, TD Cowen & Massif Capital Estimates |
|||||
Time will tell if the current team allocates capital as well as the prior team but given the instrumental role they must have played in Pasto’s Grande’s acquisition, we are comfortable betting that they will. Currently, we have a 5% position in the company and are adding when it trades down. While unsure of our final target allocation weight, we are theoretically comfortable allocating as much as 7% of the portfolio to LAAC.
Unlike LAAC, which is ramping production and selling lithium, even if it is still just technical grade, LAC is developing an asset that the management team hopes to turn on towards the end of 2026, with initial construction starting last year. Although we are confident that management will be successful in the fullness of time, a sentiment shared by management at GM, who is footing the bill for a big chunk of the construction cost and has 100% of the offtake from the mine for the first ten years, we favor allocating additional available capital to other opportunities.1
If we don’t intend to add to the position in the short term and believe there are better opportunities, why continue holding? At 1%, our de minimis position is a toehold that has to be added to in the future but need not be added to in a rush. On the surface, LAC has many strengths: strong management, strong backing, a first-of- a-kind flow sheet that appears likely to deliver a cash cost per ton of LCE at roughly $7,000 vs. current US spot prices of $17,000, and an opportunity to be the largest producing lithium mine in North America. These are all critical variables, but the assets’ real strength lies below ground in the deposit’s geology.
Although, in geological analysis terms, we are still in the early days of understanding the nature of claystone lithium deposits, a recent journal article published in Science Advances by a trio of volcanologists suggests that the McDermitt Caldera, which houses the Thacker Pass deposit, could be among the largest lithium deposits in the world.2 Only time will tell if the geological model the team (which included a LAC geologist) can be used to explain other examples of hydrothermally enriched lithium deposits and thus justify the claim that the deposit is one of the world’s largest, but it is promising.
One of the challenges with mining firms, especially when discussing tier 1 assets like Thacker Pass, is that the actual value of the asset cannot be fully captured via an NPV calculation as the future cash flows extend far beyond the point at which discounting them back implies little or no value. At the same time, we know those future cash flows are not worthless but distant. We are sure that some finance professors somewhere will find this line of thought dubious, but we stand by the idea that there is value in assets with lives that can stretch to 50 or more years that cannot be captured via discounting cashflows.
|
Footnotes 1Based on material intensity estimates from BNEF and Benchmark Materials, Thacker Pass phase 1 should produce enough LCE for roughly 800,000 EVs annually. Illustrative 60 kWh batteries use between 45 kg and 50 kg of Lithium Carbonate per battery depending on chemistry (LFP vs. NMC). GM sells roughly 2.2 million cars a year in the US. 2Hydrothermal Enrichment of Lithium in Intracaldera il-lite-bearing claystones, 30 Aug 2023, Science Adances Opinions expressed herein by Massif Capital, LLC (Massif Capital) are not an investment recommendation and are not meant to be relied upon in investment decisions. Massif Capital’s opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is limited in scope, based on an incomplete set of information, and has limitations to its accuracy. Massif Capital recommends that potential and existing investors conduct thorough investment research of their own, including a detailed review of the companies’ regulatory filings, public statements, and competitors. Consulting a qualified investment adviser may be prudent. The information upon which this material is based and was obtained from sources believed to be reliable but has not been independently verified. Therefore, Massif Capital cannot guarantee its accuracy. Any opinions or estimates constitute Massif Capital’s best judgment as of the date of publication and are subject to change without notice. Massif Capital explicitly disclaims any liability that may arise from the use of this material; reliance upon information in this publication is at the sole discretion of the reader. Furthermore, under no circumstances is this publication an offer to sell or a solicitation to buy securities or services discussed herein. |
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