Sigma Lithium’s Expansion In Lithium Market: A Hold Through Opportunities And Challenges

Sigma Lithium Corporation (NASDAQ:SGML) is one of the leading producers of low-cost, high-purity lithium, fueling the growth of electric vehicle technologies. Remarkably, SGML’s commitment to green practices with the Quintuple Zero Lithium initiative highlights its focus on sustainability and allows it to keep customers like eco-friendly Glencore. Likewise, securing a credit line of $90 million to fund a planned $100 million investment in Grota do Cirilo project expansion proves that financial institutions support the company’s strategic vision. However, valuation issues and additional financing led me to temper my optimism on the stock, which is why I rate the stock a “hold” at these levels.

Lithium Mining Play: Business Overview

Sigma Lithium is a Canadian company that is one of the world’s largest lithium producers. SGML was founded in 2011 and is based in São Paulo, Brazil. Initially, it was Sigma Lithium Resources Corporation, but in July 2021, the name was changed to Sigma Lithium Corporation. The company employs approximately 196 people. Since SGML is a pure play on lithium, it is tightly linked to electric vehicle demand and related OEMs requiring lithium.

SGML explores and develops lithium deposits, mainly in Brazil. It has properties with a total area of around 185 square kilometers in the Araçuaí and Itinga regions of Minas Gerais, including assets in Grota do Cirilo, Genipapo, Santa Clara, and São José. The company contributes to the growth of the electric vehicle [EV] industry by supplying the lowest-cost, highest-purity, environmentally sustainable lithium.

As you might imagine, SGML is positioned as a leading lithium supplier to the EV industry due to the increasing demand for this mineral as an essential part of batteries. An advantage for SGML is that Brazil, the world’s second iron ore producer, has a strong mining infrastructure and an established power grid with renewable energy sources, such as a hydroelectric plant. Also, the producing area is served by a highway leading to a port located by a river. These existing facilities allow efficient logistics with low construction and operating costs and a reduced need for additional investment. Additionally, the company claims that Brazil is a low-cost environment, leading SGML to become a company with the second-lowest operational costs for lithium producers.

SGML’s operations mostly center around extracting lithium from hard rock mines. However, it has developed a refined, sustainable process that minimizes environmental impacts. The “Quintuple Zero Lithium” initiative combines zero toxic chemicals, zero carbon, zero drinking water, zero tailing dams, and zero dirty power. This might help alleviate some ESG concerns that some investors might have, so it’s a positive, though mining operations are undoubtedly not the favorite for certain investors.

Nevertheless, SGML’s environmental and social impact programs align with the United Nations Sustainable Development Goals due to the company’s commitment to green mining, from extraction to lithium processing. It is also notable for its community engagement in considering the rights of the local population in protecting natural water resources for residents’ use in their daily needs and agriculture.

Financing and Production Ramp-Up in Brazil’s Lithium Hub

Furthermore, on March 08, the company announced that it had obtained finance credit lines for $90 million from the following institutions: Citibank: $10 million, Santander: $20 million, Banco do Brasil: $10 million, and XP Inc.: $10 million. The company plans to invest $100 million in the expansion of the Grota do Cirilo project, with an audited mineral resource of 109 million metric tons. This financial backing reflects the institution’s confidence in the SGML’s capacity to expand its operations. This considerable audited lithium reserve underscores the richness of SGML’s mining sites and their potential for producing this mineral. Since SGML only holds roughly $28.1 million in cash and equivalents today, these credit lines will likely be vital to fund mining operations.

Additionally, on the same date, SGML preloaded 22,000 tonnes of lithium concentrate for Glencore, which prepaid 85% of the shipment at premium prices, 7.5% above the standard rate. This shipment shows the SGML’s capability to reach and maintain an annual production of 270,000 tonnes of Quintuple Zero Lithium. Also, the arrangement with Glencore indicates a strong market demand for the high-quality lithium produced by SGML. Lastly, in March, Spark Energy Minerals Inc. announced an expansion of its exploration in the same region as SGML, in Minas Gerais, Brazil, often referred to as Lithium Valley. SGML’s Grota do Cirilo project has contributed to the area’s recognition and is an indicator of the area’s potential for extracting high-purity lithium.

Therefore, the overall picture shows that SGML is on the course to expand its operations and will need financing for it. Such funding will likely come from debt, which I suspect will make SGML into a relatively levered play in lithium. For context, the company currently holds approximately $115.3 million in total debt and obligations on its balance sheet. At the same time, its report on January 2024 shows a notable 27% increase in audited mineral resources to 109 tonnes, which elevated its Grota do Cirilo industrial pre-chemical lithium beneficiation complex to among the top 4 in the world in its class. Moreover, it’s undeniable that SGML’s resources and focus on the Brazilian market can be a promising strategic selling point for investors, with future plans to expand production to meet the growing lithium demand.

Baked In: Valuation Analysis

From an investment perspective, SGML’s business should have secular tailwinds for the foreseeable future. Even though lithium is mostly driven by the electric vehicle market today, the commodity’s supply side is also relatively limited. Bringing up additional capacity online is challenging due to the related CAPEX investments, so the fact that SGML already has a foothold with increasingly promising resource deposits is great news for investors. This is why, on balance, S&P Global remains relatively optimistic about the lithium market overall, which is great news for SGML.

At the same time, it’s vital to understand that the market seems to have taken a more tempered view of EV growth overall. The KARS ETF tracks investor sentiment relatively well in the EV sector, but is still down roughly 32% from its highs in July 2023. But this is likely more akin to taking a breather after a rush of optimism in the sector than underlying fundamental issues. After all, S&P Global still forecasts strong double-digit topline growth for BEVs across international markets. So, the underlying demand driver is hardly in a down cycle. So, in my view, the lithium market remains promising, and SGML is perfectly positioned to seize on it as long as it executes and deploys its capital judiciously.

However, looking at SGML’s multiples does suggest that the stock is already pricing in such promising secular tailwinds. Currently, the stock’s market cap is about $1.60 billion, which, compared to its underlying book value of $161.0 million, implies a high P/B ratio of 9.93. Moreover, sector peers trade at a P/B ratio of about 1.67, so a valuation premium is already baked into SGML. Plus, as I previously suggested, there’s a relatively high likelihood that SGML will tap into its credit lines to fund future expansion, so this only increases its risk profile. Lastly, the company burnt roughly $22.4 million in Q3 2023, which annually implies a yearly burn rate of $89.6 million. I obtained these figures by adding up the company’s CFOs and CAPEX and annualizing them. Such a cash burn rate implies additional financing is imminent because its current cash holdings are just $28.1 million.

Thus, I think the company’s already high valuation multiple and somewhat strained balance sheet mitigates its investment appeal. Of course, I don’t think it’s time to be bearish on lithium or miners by extension, but overall, I feel SGML is a “hold” for now.

Hold: Conclusion

As a whole, I think the company’s underlying business will likely do well. Lithium seems poised for continued growth across all international markets, mostly fueled by EV demand. These fundamental secular tailwinds should translate into successful expansion for SGML. Yet, its valuation already has a high premium embedded, and it’ll likely take on debt soon. So, I think it’s appropriate to rate it a “hold” today.