Nick's Pick of the Week: Albemarle

Folks, I hope to make this gloomy Tuesday a little brighter for you with another one of Nick’s Picks! Try your best to contain your excitement (it’s hard, I know)!

I must give a shoutout to one of Ticker Talking’s valued readers (and a stellar investor, I might add) for putting me on to this stock. This particular individual mentioned that he’s a big fan of lithium-producing Albemarle Corp (ticker: ALB), and after reading up on it a little bit, I thought it would be a great stock to highlight as the stock-of-the-week.

So what even is lithium, anyway? Well I wasn't much of science man back in highschool, so Google told me that it's a chemical element and the least dense metal on the periodic table. It has several real-world uses, but arguably the most important application is rechargeable batteries for things like mobile phones and electric vehicles. The latter is the key—lithium is quite literally the driving force behind electric vehicles.

The lithium market was at somewhat of a standstill in the late 2010s and into 2020 as producers like Albemarle started to ramp up production in anticipation of demand for EVs. However, the EV market was still in its early days and demand was slow, so in accordance with basic supply and demand principles, the price of lithium carbonate was low for a few years (sitting at about its marginal cost of production). For Albemarle, this meant negative free cash flow (the money a company has left over after paying its operating expenses and capital expenditures) during this period.

The turning point for the lithium industry occurred in 2021, as EV sales grew by 100% YoY. Looking ahead, demand for EVs (and by extension, lithium) will continue to increase at considerable rates, due in part to regulation set by governments across the world attempting to meet lofty emissions goals. Earlier this month, President Biden found some time in between his rigorous napping schedule to announce an agreement with the auto industry that aimed to have 50% of car sales by 2030 be EVs. Furthermore, just last week California announced a ban on the sale of new gasoline cars by 2035, which is very significant for the auto industry as the Golden State’s economy is considerably large (for reference it would rank as the 5th largest in the world if it were a sovereign nation). As such, current lithium carbonate demand is projected to increase from its current mark of 0.5 million tons to 1.5 million in 2025 and 3.2 million in 2030.

Today, producers can’t keep up with the demand, so we’re seeing high lithium prices due to an undersupply. It’s a far cry from the lithium market of the late 2010s when prices were quite low due to a large oversupply. It’s common for various metals to have significant fluctuations in price, which can have very large impacts on the companies’ profitability. High commodity prices tend to reward producers—just look at what we’re seeing with oil and gas, oil companies are reaping the benefits of high oil prices by raking in record profits. In this case, many lithium producers have enjoyed similar success over the past couple of years.

With prices at the current level, Albemarle projects to be free cash flow positive this year, two years before the company’s initial 2024 target. Now, this begs the question of sustainability - will lithium prices continue to hover around these record highs and bring in historic revenues for companies like ALB? The answer depends on the supply-side; from now until 2026, the lithium market is forecasted to be undersupplied (See Exhibit A), therefore prices should remain relatively high until then. In 2026, supply is expected to catch up to the demand, with firms working hard to bring increased capacity online, and it is at that time where the market may shift back to being oversupplied. That presents ALB with a rather large 4 year window of massive cash generation, which I expect the company to take full advantage of.

Exhibit A

Looking at the stock price itself, ALB currently sits at around its all-time high, which isn’t typically music to value investors’ ears. Additionally, the stock’s trailing P/E Ratio is a whopping 133x - it appears that the growth potential is already priced in. The forward P/E is expected to normalize somewhere in the 13-15x range as earnings start to climb, which is more in line with the P/E of the chemicals industry at large.

I must say that I like ALB’s chances to capitalize on high lithium prices over the next few years with tremendous free cash flow. Unfortunately for lithium producers (and investors for that matter), it’s unlikely that prices will sustain that level forever as Albemarle and other producers bring new supply to the market. Beyond the 2026 window, while prices may decline, I would still certainly entertain owning the stock given the rapid growth of EVs and expected demand for lithium batteries. My concern is just how expensive it looks at the moment, so I might suggest keeping a close eye on it, especially over the next few weeks/months as the market is expected to sink as interest rates continue to rise. If ALB does dip in price in the coming months, you may want to consider adding it to your portfolio, certainly with a medium-term time horizon in mind, and potentially longer depending on how the EV and lithium markets shape up.