Albemarle: More of An Opportunity Than a Value Trap

One of the great lessons to emerge out of various gold rushes in the 19^th and 20^th centuries was this: Sell supplies to the miners rather than prospect for gold.

In the 21^st century, a new gold rush focuses on electric vehicles. Over the past couple of decades, dozens, if not hundreds, of companies have spent billions of dollars trying to build competitive, emission-free cars and trucks.

Tesla Inc. (TSLA, Financial) appears to be leading the race now, but can it continue to hold that position? The major automakers at home and abroad are all building their own models, while small private companies are creating niche vehicles.

While we do not know which of these companies will survive and thrive over the next several decades, we can hedge our investment bets.

Albemarle Corp. (ALB, Financial) is one of the world’s largest, if not the largest, lithium producer. That chemical is an essential ingredient for electric vehicle batteries and the headline story.

In 2022, the company operated through three segments: Lithium, Bromine and Catalysts (the categories have since been changed and renamed). According to its fourth-quarter and full-year earnings release, Lithium is by far the biggest contributor to revenue. Last year, it accounted for $5 billion of the company’s total sales of $7.32 billion.

What’s the problem?

The GF Value Line warns that Albemarle is a potential value trap, a stock that looks enticingly low priced but might not survive for long.

After hitting a high of $325.38 on Nov. 11, 2022, it has fallen by more than $100 in a little less than five months. At midday on Thursday, April 6, it was trading at $195.91.

That loss of investor confidence reflects the belief Albemarle is simply a lithium producer--and the price of lithium is falling.

The price has fallen for several reasons. First, recent high prices attracted new suppliers, increased the output of major producers and made previously uneconomic projects feasible.

Second, electric vehicle sales in China began declining in late 2022 when the government warned that it would stop subsidizing the industry (and perhaps discounting what the American federal government is doing to subsize it).

So should we write off Albemarle as a victim of cyclical factors, or should we see it as a potential opportunity?

A look at its fundamentals, especially before the price of lithium soared, should indicate an appropriate direction.

Debt

The idea of a value trap usually implies debt could be a problem, but I see no serious issues here. Its interest coverage ratio is respectable at 20.19, meaning the company has lots of operating income to cover off its interest payments. It will not have to borrow more to keep up with its debt.

There are similar assurances from the Piotroski F-Score and the Altman Z-Score. The former, which assesses how well a company manages its finances, comes in at 6 out of 9, which is in the medium range (a score of 7 out of 9 would give it a “good” or “high” score).

The Altman Z-Score is strong at 3.83, indicating it is not in danger of going bankrupt anytime soon.

Second, Albemarle is using its debt productively, though that has not always been the case.

Currently, the weighted average cost of capital is 10.36%, while its return on invested capital clocks in at 20.52%. That makes it a value creator.

Third, we need to recognize the type of company this is, one that mostly mines or "manufactures" lithium through solar evaporation. It also operates research centers that focus on creating and improving lithium-based products. All of this means the company must make investments in advance of sales and revenue. Companies like this are normally going to have to carry some debt.

I believe the company needed debt to get started and keep operating. Further, it has used that debt responsibly and productively.

Profitability

To handle the cost of debt, Albemarle must be profitable on a continuing basis. And it has been every year for the past 10 years. What’s more, its margins and returns have been industry-leading.

In turn, profitability means more cash flow that can be used to keep growing the business. Once again, we see industry-leading results:

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Given the serious decline in lithium prices, we should expect a decline in its profitability, right?

Apparently not. For its full-year 2023 outlook, which was disclosed in the most recent earnings release, Albemarle expects net sales to shoot up even further this year. It noted, “Full-year 2023 guidance remains unchanged from the January update, and reflects strong growth with an increase in net sales of about 55% to 75% from 2022 primarily driven by market demand and continued favorable pricing for lithium.”

Despite the slump in lithium prices, they are still high enough to boost sales this year and demand should increase as well.

Look for dramatically higher earnings, too, as the company notes “Adjusted Ebitda is expected to increase 20% - 45%, with adjusted diluted EPS up to 50% year-over-year.”

The company expects to have positive cash flow this year, despite increasing its capital expenditures to something between $1.7 billion and $1.9 billion. That would be up from $1.26 billion in 2022.

Part of the reason for this counterintuitive outlook is that Albemarle does not entirely depend on the electric vehicle market. It also makes highly engineered specialty chemicals, and to me, the words "highly engineered" indicate pricing freedom and higher margins. In the 10-K for 2022, it reported:

“The end markets we serve include energy storage, petroleum refining, consumer electronics, construction, automotive, lubricants, pharmaceuticals and crop protection. We believe that our commercial and geographic diversity, technical expertise, access to high-quality resources, innovative capability, flexible, low-cost global manufacturing base, experienced management team and strategic focus on our core base technologies will enable us to maintain leading positions in those areas of the specialty chemicals industry in which we operate.”

Valuation

Now that we have reviewed some key fundamentals, it seems unlikely Albemarle is a value trap. It is a company that has its debt under control and is profitable, despite the falling commodity and share prices.

Conclusion

Albemarle is good company, one that benefited from the earlier uptrend in lithium prices and is now feeling the effects of a market responding as it usually does to negative information.

But investors selling their shares now may take unnecessary losses—at least if they bought near the top. Albemarle is more than just a supplier of lithium for batteries; it has a range of other, higher-margin products that should act as shock absorbers this year and for the next few years. The bottom line is Albemarle is more of an opportunity than a value trap.