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Is the bottom of the lithium industry gradually emerging with the reproduction of major acquisitions?

In early October, the global mining giant $力拓 (RIO.US)$ announced plans to acquire lithium resource producer for a premium of 6.7 billion USD in cash $Arcadium Lithium (ALTM.US)$ . This transaction has been approved unanimously by the boards of directors of both parties, and if successfully implemented, is expected to be completed by mid-2025.

Rio Tinto stated that considering the significant adjustment of lithium prices compared to the peak period, this countercyclical acquisition has significant long-term upside potential. The company is confident in the long-term prospects of lithium, with a forecasted annual compound growth rate of demand exceeding 10% by 2024, potentially leading to supply shortages in the future.

Following the announcement, Arcadium's stock price surged, closing near the transaction price offered by Rio Tinto ($5.85 per share) on October 14. Other companies in the industry also rebounded.

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Is the bottom of the lithium industry gradually emerging with the reproduction of major acquisitions? -1

As a essential raw material for electric vehicles, lithium is widely seen as the 'white petroleum' of the new era. Since the end of 2020, a severe mismatch has emerged between strong demand and limited supply, causing lithium resource prices to skyrocket, at one point rising over 10 times from the low point.

However, with a significant increase in supply released, lithium prices have been continuously declining since early 2023. According to Benchmark Minerals, the global weighted average price has fallen to around $10,000 per ton in October this year.

Is the bottom of the lithium industry gradually emerging with the reproduction of major acquisitions? -2

At the bottom of the previous cycle, the industry experienced large-scale consolidation and clearance. In 2020, Australian lithium miner Altura was $Pilbara Minerals Ltd (PLS.AU)$ Acquisition, Chinese lithium resources companies. $TIANQI LITHIUM (09696.HK)$ Under debt pressure, it also sold part of its stake in Australian Greenbushes lithium mine to. $IGO Ltd (IGO.AU)$ Now that the industry is in a downturn again, can rio tinto once again sound the alarm for a turnaround?

Capacity clearance is gradually emerging, while inventory remains high.

In a sluggish market environment, many producers choose to reduce or shut down production capacity. In July of this year, the largest lithium resource producer globally $Albemarle (ALB.US)$ Announced the reduction of lithium production and the suspension of capacity expansion in Australia. Albemarle stated that a comprehensive evaluation of its costs and operational structure will be conducted, including halting the construction of new production lines and maintaining the shutdown of existing partial production lines.

And before this, some smaller and higher-cost miners, including $Core Lithium Ltd (CXO.AU)$ Have all cut output.

In September, the lithium battery giant $Contemporary Amperex Technology (300750.SZ)$ also stopped production at a major mine located in China. UBS Group analyst mentioned that, after lithium prices faced continued downside risks, they have seen the supply response from marginal cost producers, which will alleviate concerns about oversupply in the market.

Morningstar believes that the equilibrium level of lithium resources is $0.02 million per ton, which is also a mid-term price benchmark. With supply and demand rebalancing, lithium prices will rebound significantly in the coming years.

However, there are different views in the market. In a report released at the beginning of the month, Goldman Sachs believes that the recent stock price rebound is more sentiment-driven, and the fundamentals have not significantly improved. Despite some producers taking action, the global lithium market will continue to experience oversupply. As the largest demand center, lithium compound inventory in the Chinese market remains high. Large projects are still contributing capacity to the market from the supply side.

Is the bottom of the lithium industry gradually emerging with the reproduction of major acquisitions? -3
This chart is for reference only and does not constitute any investment advice.

Goldman Sachs states that the cost curve of global lithium resources is concentrated between $9000-$10000 per ton, while current prices are still above $10000. This means that although higher cost marginal producers have thin profits, they are still positive, thus continuing to stimulate supply. The institution predicts that lithium resource prices will remain weak at least until the end of next year.

How to invest in lithium resources?

World lithium resources are mainly distributed in Australia and South America, in the forms of spodumene and salt lakes, with top industry participants having a presence in these regions.

According to Benchmark statistics, if the acquisition is successfully completed, Rio Tinto will become the world's third largest lithium resource producer. The top two positions are still held by Albemarle of the USA and Sociedad Quimica y Minera de Chile.

Is the bottom of the lithium industry gradually emerging with the reproduction of major acquisitions? -4
This chart is for reference only and does not constitute any investment advice.

Albemarle ( $Albemarle (ALB.US)$ ):

Albemarle has extensive investments in lithium resources globally, with mining projects not only in Australia and South America but also in the USA. The smelting capacity of lithium resources is distributed more widely, especially with smelting plants built in multiple regions in China.

In the second quarter of 2024, the company's revenue from lithium resources accounted for approximately 60% of total revenue. The remaining portion is from specialty chemicals (bromine products used in flame retardants, etc.) and catalyst business, both of which show relatively small fluctuations.

In the second quarter, Albemarle's total revenue was 1.43 billion USD, a 40% year-on-year decline. Adjusted EBITDA was 0.386 billion USD, a significant 75% year-on-year decrease, primarily due to the decline in lithium prices.

The company stated that although lithium resource sales volume in the quarter increased by nearly 40% year-on-year, due to a sharp price decline, revenue from the lithium sector still declined by over 50%, significantly impacting profitability.

Sociedad Quimica y Minera de Chile ( $Sociedad Quimica Y Minera De Chile (SQM.US)$ ):

The company's main production area is the Salar de Atacama in Chile. Atacama is currently the salt flat with the highest lithium content and the largest lithium resources among all explored salt flats globally, with a very abundant potassium content.

Relying on salt flat resources, SQM has developed businesses in lithium and potassium fertilizers. There are also businesses related to iodine and its derivatives, mainly provided by iodine ore deposits in northern Chile. In recent years, SQM has also expanded outside Chile, acquiring lithium mines in Australia and smelting factories in China.

SQM's performance is also under pressure. In the second quarter of 2024, total revenue was $1.294 billion, a 37% year-on-year decrease, and adjusted EBITDA was $0.413 billion, a 53% year-on-year decline.

Due to the distribution of lithium resources, many local lithium resource manufacturers are not listed on the US stock market. Companies like Pilbara, IGO, and Core Lithium mentioned earlier are currently only traded in Australia.

If you do not have investment access to the local market but want exposure to relevant companies, industry-related ETFs may be an option.

ETF Database shows that there are ETFs investing in global lithium resource companies in the current US stock market, including $Global X Lithium & Battery Tech ETF (LIT.US)$$Amplify Lithium & Battery Technology Etf (BATT.US)$ and $ISHARES LITHIUM MINERS AND PRODUCERS ETF (ILIT.US)$In addition to investing in the target stocks listed on the US stock market, companies listed in Australia and China markets are also involved.

However, it is important to note that due to poor industry performance in recent years, the size of these ETFs has also significantly shrunk, with LIT and BATT in the tens of millions of dollars and ILIT only a few million dollars, requiring attention to liquidity risks.

In addition, ILIT mainly focuses on the upstream of the industry chain, but LIT and BATT also include relevant links of batteries and complete vehicles, such as automobile manufacturers, which are also among the components of the two ETFs. $Tesla (TSLA.US)$ - Algorithm layer: represented by big models, it has made rapid progress in technology but has not yet matured in business. $BYD Company ADR (BYDDY.US)$ also Among the components of the two ETFs.

Cyclical Phantom

Lithium, as a key battery metal, is driven significantly by downstream market demand, showing typical cyclical characteristics. From the end terminals of complete vehicles, to batteries and battery materials in the midstream industry, and then to resources in the upstream, demand information across the entire industry chain will be magnified step by step.

This is also known in economics as the 'Bullwhip Effect', where minor changes in downstream demand trigger significant fluctuations upstream. In the past few years, the violent fluctuations in lithium resources have vividly explained this.

Is the bottom of the lithium industry gradually emerging with the reproduction of major acquisitions? -5
Image Source: Bloomberg. This chart is for reference only and does not constitute any investment advice.

Renowned investor Peter Lynch has provided valuable insights for investing in cyclical stocks. Investors in cyclical stocks easily fall into the valuation trap: for most stocks, a low price-to-earnings ratio (PE) usually indicates undervaluation, while a high PE implies overheating risks. However, for cyclical stocks, their valuation ratios often differ from expectations, with lower PEs typically occurring at high stock price points, and high PEs often appearing during low stock price periods.

Taking SQM as an example, during the peak of the stock price in 2021-22, the PE ratio kept falling. If by the end of 2022, you felt excited about single-digit valuations and invested, you would have faced a long bearish path. After a long decline, as of the close on October 14th, SQM's PE ratio reached over 400 times.

Is the bottom of the lithium industry gradually emerging with the reproduction of major acquisitions? -6
The cases are for illustrative purposes only and do not constitute any investment advice or guarantee.

Why does this characteristic exist? When the industry is at a low point, product prices are low, profits are meager, and this shrinks the denominator of the PE ratio (market cap/net profit). Even if the market cap is not high, the value can rise significantly. When the industry is at a peak, profits are significantly higher, causing the PE ratio of cyclical stocks to often drop sharply.

Compared to the current financial performance, investors may need to determine the overall industry trends and supply and demand situation more. Peter Lynch also pointed out that compared to other types of investments, cyclical stocks require you to truly gain some kind of advantage to succeed, such as working directly in the industry you are investing in.

Risk disclosure: This content does not constitute a research report, is for reference only, and should not be used as a basis for any investment decisions. The information involved in this article is not a comprehensive description of the securities, markets, or developments mentioned. Although the information source is considered reliable, the accuracy or completeness of the above content is not guaranteed. In addition, no guarantee is given for any statements, opinions, or forecasts provided in this article.

Disclaimer: The above content does not constitute any act of financial product marketing, investment offer, or financial advice. Before making any investment decision, investors should consider the risk factors related to investment products based on their own circumstances and consult professional investment advisors where necessary.

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