Is this still the cheapest lithium stock in the market?

Over the past two years, lithium has overthrown buy-now-pay-later darlings to become the sexiest topic in the market. 

In fact, the top-performing IPOs in 2021 were for the most part lithium players, while lithium-affiliated companies like Novonix (ASX: NVX), Liontown Resources (ASX: LTR), and Pilbara Minerals (ASX: PLS) soared a respective 659%, 388% and 268%, making them some of the bourse's best performers. 

So much was the hype surrounding lithium, that back in November last year, one smart fund manager dubbed Mineral Resources (ASX: MIN) the "cheapest lithium stock in the market". It seemed investors agreed, and in the space of just over two months, its share price pushed 70% higher to reach a new all-time high.

However, since then, Mineral Resources' share price has cascaded nearly 30% on the back of the weakness in the iron ore price, with around 19% of that decline following the miner's troubling first-half result. 

While revenues dropped 12% at Mineral Resources, smaller up and coming producer Pilbara Minerals saw a 394% increase. And while EBITDA and operating cash flows slipped at the more established player, they soared at the emerging miner, reporting its first period of profit. 

So is Mineral Resources still the cheapest lithium stock in the market? Or is Pilbara Minerals the better play? 

We spoke to Tim Serjeant of Eley Griffiths Group for his thoughts on these two stocks' latest results, his outlook on the lithium sector, and of course, his thoughts on which of these two players can help power investors' portfolios over the years to come. 

Mineral Resources key results H122

• Revenues down 12% to $1.4 billion
• EBITDA down 80% to $156 million 
• Diluted EPS down 96% to 10.17 cents per share
• Operating cash flow down 123% to a loss of $120 million
• CAPEX up 15% to $403 million 
• $800 million cash on its balance sheet, down 51%

Pilbara Minerals key results H122

• Revenues up 394% to $291.7 million
• EBITDA up 4622% to $151.1 million 
• Diluted EPS of 3.81 cents per share (previous period was a loss)
• Operating cash flow up 1813% to $116.7 million
• CAPEX up 2150% to $38 million 
• $191.2 million cash on its balance sheet, up 92%

Note: This interview took place on Wednesday 23rd February 2022. 

What were the key takeaways from each of these results?

In the case of Mineral Resources, it was three things. One was how unprofitable the iron ore business was in the half. The market was aware that iron ore prices had corrected significantly to the tune of 40% in the September quarter, but it was the discounts that MIN, as a relatively lower grade producer, attracted to its ore type. That was the fundamental reason for that part of the business reporting a significant loss. That was a surprise and I think largely why it was sold off. 

The other developments for MIN were also just strategically what has been developing on the lithium side of the business. So two things there, one was their Mt Marion asset looking to increase throughput by 10-15%, but also, taking their offtake rights back off their partner, Ganfeng Lithium Co. Effectively, MIN is looking to go further downstream so they're initiating a tolling arrangement with Ganfeng where they will receive lithium hydroxide pricing as opposed to spodumene pricing. That's just another step in the value chain essentially. 

The other part of their lithium business is the Albemarle joint venture, another leading global player in the lithium space. They're looking to do a couple of things there. The current structure was a 60/40 share in favour of Albemarle for both the Wodgina asset and the Kemerton downstream lithium hydroxide plant. MIN is looking to change things slightly, so move the mine back to a 50/50 share and keep the hydroxide plant at the 60/40 share. And also looking to expand the joint venture potentially into other markets. Albemarle has quite an active downstream in China. And Wodgina, as the source of spodumene, is looking for a home. So I would envisage those two pairing up, taking that spodumene to conversion facilities in China. 

The thing for both results was the cost escalation and the cost inflation. We are seeing that right across the sector, particularly for assets located in Western Australia, which in both cases these are. 

There were two major takeaways in the Pilbara Minerals result. One was the second production downgrade in the space of a couple of months. They have cut their output guidance for FY22 again, and so that's essentially just over 20% over the last couple of months. So it's about 100,000 tonnes less of production than they envisaged a couple of months ago and that would equate to 4-5% of the total global market. So it's significant in that sense. And then the other thing was that Ken Brinsden, the CEO, who has been there for the ups and downs, is stepping down at the end of the year.

What was the market’s reaction to these results? Do you think this was an overreaction, underreaction, or appropriate?

I think the reaction to MIN's result was appropriate. The stock was back towards its highs. It was $60 prior to the iron ore correction and got picked off the low $40s and then rallied pretty much all the way back there. And that was in line with the iron ore market and expectations. 

Lithium hasn't skipped a beat and prices continue to accelerate upwards and the iron ore price has stabilised and is starting to recover. So the market was emboldened by that. But what they weren't anticipating was, as a standalone division, how much money the iron ore business would lose. 

So that was a shock and I think the reaction in that sense was appropriate. And the market more generally has been under pressure since. 

PLS had intimated somewhat in their quarterly release three weeks ago that they were looking to review their production guidance for this year. So a downward revision wouldn't come as a surprise today necessarily. And the stock had been selling off into that. So in some respects, there was a little bit of "buy the rumour, sell the fact", a bit of a relief rally, around that today. And the fact that the sector is going better today, having been under pressure for the best part of the week. 

The reaction to PLS probably happened in the three weeks leading up to today, post the quarterly update, when they intimated looking at guidance again. So today's probably not really a fair indication. 

Were there any major surprises in these results that you think investors should be aware of?

I've talked about the pricing discounts that MIN's iron ore business attracted. That was a surprise. That's just a reminder of how much leverage there is in that business model. As a lower grade iron ore producer, there's significant leverage both ways in that part of the business. 

We saw how profitable that was in CY21, and equally, we saw how unprofitable it can be in the first half of FY22. 

I think the other thing with MIN is their willingness to continually invest and back themselves and it's a feature of the business model, but there are some very lofty targets. They're looking to essentially take their iron ore business from 15 million tonnes to over 80 million tonnes in the space of four or five years. In the deck, there was a reference to 100,000 tonnes of lithium hydroxide production attributable to them through both their endeavours with Ganfeng on the Mt Marion asset and Wodgina with Albemarle at Kemerton. So that is another subtle reminder of the growth ahead for MIN. 

PLS has downgraded their production ambitions issue by 100,000 tonnes. That's 4-5% of global supply this year. But it's probably more like four or five times that amount in terms of the incremental supply that was anticipated. All of a sudden, that's not there. 

And we've seen the interplay between volumes and pricing and so, already in the second half of this financial year, the price that PLS is receiving is basically double what it received in the first half. So the two are interrelated. Whilst the production volume was cut by 20%, they are basically going to more than get that back on the other side of the equation. 

If that was a gold producer, which essentially has a flat pricing environment with higher costs, cutting production 20%, they'd be destroyed. And that highlights how important PLS is currently in that global demand-supply equation, for spodumene particularly. 

Would you buy, hold, or sell Mineral Resources and Pilbara Minerals following these results?

I think MIN is a hold and PLS is probably a buy. 

I think in the shorter term, PLS is a clean 100% exposure to that raw material shortage in lithium, through spodumene. For me, given the pricing backdrop, I think in the shorter term that's probably where you want to be. 

MIN is a hold today but their position in the value chain - being further downstream - means there is a lot of embedded growth to come over the next three to five years. 

It all depends on how well the iron ore business is doing because the mining services business is stable and growing. But if iron ore is struggling, like it did in the first half, lithium becomes more prominent. If iron ore recovers, it grows again and everything gets re-rated a bit. 

But over time, MIN's lithium business is going to be a bigger proportion. They are better placed from a value chain perspective to exploit that sustainably over the medium term. 

So hold on MIN on the back of its result, but if you are looking for a better opportunity in the shorter term, PLS can probably recover some of the ground it's lost. 

Which is the cheapest lithium stock in the market? Look, it's how adventurous you want to be. I think today, PLS has the best exposure to current pricing dynamics. As a reminder to readers, it is incredibly challenging to bring these assets into production. And I think that reinforces the positions of the incumbents. 

So I don't think there is sufficient incentive to take on risk with emerging players, as there was maybe six or nine months ago. But that may reemerge again. If those stocks continue to underperform like they have been and the producers hold up a little bit better, then names like Core Lithium (ASX: CXO) and Liontown (ASX: LTR) may be worth a look. That said, I think the lithium industry is going to prove that you want to back one of the incumbents as opposed to backing smaller players outside of that. That's how I expect it will play out.

(For other stocks Eley Griffiths Group backs, check out this wire on 10 small caps to ride the rally once hysteria passes). 

What are your expectations and outlook for PLS and MIN and the lithium sector? 

I think we will see a continuation of the dynamics that have been in place for a while. Last year, post-COVID, we saw widespread genuine adoption of electric vehicles. They are here to stay and that thematic is well and truly entrenched. I think the number of EVs last year more than doubled from three million to more than six million units. That trend is going to continue for the next five to 10 years. 

Right now, where the shortages are, is upstream - which is raw material supplies and PLS and MIN are right in the crosshairs of that, in terms of being existing producers who have the ability to expand supply in a market that's currently short. So the outlook for them over the short to medium term remains incredibly strong.

The key question now, as it has been for a little while, is what's priced in? And obviously, the prices we're currently enjoying are unsustainable over the medium term. But, in the shorter term, it's equally hard to see where else that incremental supply could come from. 

And then the other thing to keep in mind too is a lot of the incremental supply at the moment is coming out of Australia - particularly Western Australia. The issues with reopening, COVID-19 and labour shortages are just going to exacerbate that supply issue over the coming 12 months. So whilst prices have risen strongly, they're probably going to stay elevated for a period of time as well - and that's going to play into the hands of PLS and MIN. 

I think you can be confident in the shorter term given the asset bases that both MIN and PLS possess. And with the enduring nature of the thematic, you've got the ability to be optimistic about what the medium-term holds as well. 

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