58% Of World’s Lithium Reserves In Chile, Time To Buy?

Lithium miners, suppliers, and manufacturers have been scrutinized in recent years as a result of the massive boom in electric vehicles, and it has led some to explore one of the world’s deepest lithium reserves controlled by Sociedad Química y Minera de Chile (NYSE:SQM), or SQM.

For an industry with so many tailwinds, it’s perhaps surprising that SQM has had a particularly awful performance this year, down 41.7% at last count. It’s even more surprising when you discover that around 58% of the world’s lithium deposits can be found in Chile’s Atacama Desert.

So what’s been going on at SQM that has sustained such a pronounced share price decline?

Why Is SQM Stock Down?

A dramatic reversal in revenues from fast growth to rapid year-over-year declines is the primary reason for SQM stock dropping.

The Latin American company posted astonishing growth almost every quarter for the past few years before a sharp reversal last quarter.

For example, between Q4 2021 and Q4 2022, the top line percentage YoY growth was reported as 111%, 282%, 342%, 347%, and 189%, respectively.

Is it any wonder that such a massive growth spurt couldn’t be sustained? As it turns out, revenues did slide backwards in Q2 2023 by 21.1% and investors shunned the stock for the apparent reversal in fortunes.

We should highlight that, while revenues did take a U-turn, they remain outstanding when compared over a slightly longer time frame. Just three years ago, the top line was about 80% less than today’s number, even after the percentage decline.

It appears that SQM simply couldn’t keep pace with the astronomical growth it had reported for so long but by no means are the absolute numbers disappointing. 

For investors, the selloff provides an interesting and potentially compelling opportunity to buy a stock at bargain-basement prices.

Is SQM Worth Buying on the Dip?

We took a deeper dive into the numbers and found the valuation to be particularly appealing. Based on a discounted cash flow forecast analysis, SQM has upside potential to $92 per share. If fair value were realized, that would translate to 63.9% upside.

Comparing to analysts expectations, we are in lock-step, because the consensus among 16 analysts sits at $87 per share.

One compelling factor in favor of SQM realizing its intrinsic value is its return on invested capital (ROIC), which is sky high.

Keep in mind that ROIC is theoretically the return an investor can expect to earn if a stock is held long-term, and for SQM that number is an extraordinarily high 49.0%.

Better yet, the company’s P/E ratio is a minuscule 4.5x, so no matter how we slice and dice the financials it appears to be a good deal.

With each layer of the financial statements that we pulled back, they appeared to be ever more compelling. For example, SQM even offers an attractive 3.37% dividend now and that’s with a 65% payout ratio, implying the dividend is sustainable. 

Beyond the yield, SQM has a 30-year track record of paying dividends, making it a trustworthy income opportunity for more conservative-minded investors.

So what’s the catch?

What To Look For?

If there were factors to make investors think twice, they can be found on the balance sheet, in market share and margin declines, as well as analysts’ downward price targets.

The balance sheet is perhaps the least of the concerns given that it is burdened with $3.45 billion of total debt against $2.0 billion in cash and $562 million in short-term investments. For such a capital intensive business, however, this debt level is not excessive.

Another knock against the stock is the views of analysts, who have revised their estimates downwards for the upcoming period following a recent earnings shortfall.

Furthering investor concerns is SQM’s operating margin erosion, which showed a dip to 20%. The decline is primarily attributed to an increase in production costs, which grew by approximately 15% year-over-year.

SQM’s market share in the global lithium market dropped from 25% in 2018 to around 20% last year. A Goldman Sachs report suggests that the market share could shrink further to 17% by 2025 as competitive pressures grow.

Lastly, it’s worth mentioning that supply chain issues have led to an estimated 6% decline in revenue during the second quarter of 2022, and it’s not showing much signs of abating if a McKinsey analysis is to be believed. The consulting giant estimated that SQM could be anchored by these pressures through the end of the year.

Wrap-Up

There is lots to like about SQM right now, including a compelling valuation analysis, an attractive dividend streak and high yield, and a rock bottom price-to-earnings ratio.

Another factor in favor of SQM shareholders is the expected growth in the global lithium market, forecast to rise at a CAGR of 10.9% through 2028. 

Counterbalancing the tailwinds, though, are a bunch of headwinds including regulatory fines for environmental violations, supply chain bottlenecks, downwards revisions in analysts’ guidance, and compressing margins.

If you boil the pros and cons down to a timeline consideration, the outlook leans neutral to pessimistic short-term and perhaps even in the medium term, but the longer term is much rosier, and for conservative-minded investors a generous passive income stream can smooth the rocky road until then.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.