Just_Super
I last covered Li-Cycle (NYSE:LICY) in 2022. I liked the company’s prospects at that time given its exposure to Lithium recycling, the favorable government incentives from the U.S. and European countries for the industry, the company’s differentiated technology which provided higher yield and lesser waste, and the backing from strong strategic partners like LG, Glencore (OTCPK:GLCNF)(OTCPK:GLNCY), Traxys, etc.
While things were going ok for the company till 1H23 and the stock was trading sideways around mid-single digits, the situation took a downturn in the back half of 2023 as the company announced a significant cost escalation for its Rochester hub project.
The company was initially expecting Rochester hub to cost ~$560 mn but that escalated to $850 mn to $1 bn range (including incremental $140 mn in cost of process buildings and warehouses). The company also saw a delay in DOE’s $375 mn loan as a result of it. With a significant escalation in cost and financing not coming, the company announced a pause in construction work on the Rochester Hub project, till it can complete a comprehensive review of the go-forward strategy for this project. The company had already spent ~$301 mn on this project by then.
The investors were worried and the stock corrected sharply as a result.
A positive development occurred on 12th March with Glencore providing $75 mn in convertible bond financing to the company. This improved investor sentiment and the stock jumped from 40 cents on March 11 to the current level of over $1.13. The company had $35 mn of unrestricted cash and cash equivalents around mid-March and coupled with this $75 mn, it now has $110 mn. So, this additional funding is expected to provide a good few quarters runway to the company and help it buy time to work with the U.S. Department of Energy on the conditional commitment of the $375 mn project loan.
While the stock has seen a sharp run-up, I have some concerns.
The company’s estimated project cost for the Rochester hub continues to escalate and there is a potential for further upward revision in estimates. On its recent earnings call, management mentioned that the estimated project cost of the Rochester hub project is $960 mn for the MHP (Mixed Hydroxide Product) scope. The prior estimate of $850 mn to $1 bn included the expected production of nickel sulfate and cobalt sulfate as well and this cost is without that. So, if we account for that the underlying costs have increased.
The company is currently re-engaging subcontractors and as the project restarts, there can be an escalation in prices as subcontractors might rebid at the higher price given the increased risk related to the project and the general upward inflationary trend in the labor market.
In addition, the interest cost on the convertible debt taken to finance the project continues to pile up as the project is delayed.
Another thing I am worried about is the management’s execution track record. After spending more than half of the $560 mn of initial project cost, management abruptly announced a significant increase in the project cost and halted the project work. I could have understood an increase by a few million or even tens of millions but suddenly announcing hundreds of millions increases in a project of half a billion dollars indicated a lack of proper financial control.
I would have appreciated much more transparency in the initial phases of the project and more frequent communication with the investors if management was seeing any such issues. So, the management track record in terms of estimating project cost and executing is not that great. As an investor, I am not very happy about it and I am sure lenders are worried about it too as is underscored by the delay in DOE loan disbursement.
I am also not thrilled about the financing terms.
While the company was in dire need of cash and something is better than nothing, Glencore’s 53 cents conversion price on the $75 mn convertible bond announced 10 days back is significantly dilutive to any shareholder planning to buy at the current share price of $1.13. The interest rate on the convertible bond of SOFR + 5% on cash payment and SOFR + 6% on payment in kind isn’t cheap either but I doubt the company could have had a better deal given its cash situation before this deal. Management only had ~$35 mn in unrestricted cash which could have only provided a few months of runaway.
If we look at the company’s balance sheet, its shareholder equity was $376.4 mn as of Dec 31, 2023. The stock is already trading above the 53 cents conversion price of its new Glencore’s new $75 mn convertible bond. So, assuming its conversion, shareholder equity will increase to ~$451.4 mn. The company posted $138 mn in net loss for FY23 and, in the last two months of 2023, its loss from operations was ~$20.3 mn. Assuming similar levels of losses (~$10 mn monthly, shareholder equity will be $421.4 mn at the end of Q1 2024. The company ended last quarter with a 178.3 mn basic share count, add to that 9.9 mn in RSUs and 3.7 mn in stock options, we have a share count of 191.9 mn. Further, assuming Glencore’s new $75 mn convertible debt gets converted at 53 cents per share, it will add 141.5 mn to the share count resulting in a total of 333.4 mn.
So, we have a diluted book value per share of ~$1.26 per share at the end of Q1 2024 (obtained by dividing estimated shareholder equity of $421.4 mn at the end of Q1 2024 and a diluted share count of 333.4mn, assuming conversion of Glencore’s new convertible debt. I have not taken into account the average conversion price of stock options as the data is not available but it won’t significantly change the results given it is a relatively lower number compared to other figures).
This gives an 11.5% upside in case the stock trades near its book value. However, the book value is consistently reducing as the company is posting losses and there are risks associated with further cost escalations, poor execution track record, and financing on unfavorable terms. I don’t find the risk-reward attractive enough to take a long position at the current levels and hence have a neutral rating on the stock.
There are some upside catalysts for the stock like the company securing a project loan for the Rochester hub and eventually completing the project and starting production. But those events will trigger the conversion of $225.3 mn Glencore’s existing notes (other than the new $75 mn convertible) at a 30-day VWAP +25% premium according to the amended agreement conditions. So, in my opinion, the upside in that case should be limited as well.
Frankly, while I don’t find significant issues with the valuation, the high associated risks are adequately reflected in the current stock levels. Hence, I prefer to remain on the sidelines.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
