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Article Thesis
Sociedad Química y Minera de Chile S.A. (NYSE:SQM) is a leading lithium player that currently trades at a very undemanding valuation and that has a trailing dividend yield that is very high, at 10%. While the lithium markets are volatile and lower profits in the future are possible, the longer-term growth outlook for the industry is compelling thanks to the adoption of electric vehicles and similar technologies.
Lithium: A Volatile But Fast-Growing Market
Sociedad Quimica y Minera de Chile S.A. is not a lithium pure-play, but its lithium business is highly important for the company, which is why it makes sense to take a look at what this market could do in the long run.
Lithium is a chemical element that is used in many modern batteries. Li-ion batteries have many advantages: They are rechargeable, they have a high specific energy (energy per mass) relative to many other battery technologies, they have high energy density (energy per volume), long cycle lives, and so on.
A higher specific energy and high energy density are especially important in use cases where the product that is powered by a battery is movable — think everything from smartphones to electric vehicles. In stationary batteries, e.g. for home systems, that’s less important, but still an advantage. A high cycle life means that Li-ion batteries can be used for a long time, making them more economical, all else equal.
Due to these advantages, many modern products use Li-ion batteries and would not be possible, or only with limitations, if other battery technologies were used.
Since sales of many of the products that use Li-ion batteries are growing over time — smartphones, tablets, notebooks, and so on are seeing rising sales — there is a positive demand picture when it comes to lithium. With the rise of electric vehicles, this already positive longer-term demand picture is seeing a huge additional boost: Not only do EV sales rise at a hefty pace, but since the batteries that are used in EVs are very large (and growing larger with new model introductions), each additional EV sold means a huge boost to overall lithium demand.
It is thus not surprising that the global lithium market is forecasted to grow at a hefty pace in the coming years: Some forecasts see a 20%+ revenue growth rate through 2030, which would translate into a market size of around $90 billion at the end of the current decade. If a commodity market is large and forecasted to grow at a hefty pace, that naturally makes for a positive outlook for companies that are active in this industry. It should be noted, however, that a fast-growing market also attracts competition, which is why a range of companies have entered this space in recent years, with additional market entrants likely arriving in the future.
A market that is growing at a quick pace and that sees many market participants invest in new capacity will be volatile, and that is what we have seen in lithium markets in recent years. Ongoing changes in both the supply and the demand picture have resulted in wide swings in lithium prices, with shortages resulting in buying frenzies, while fears of demand slowdowns have resulted in price crashes.
While lithium players including SQM, Albemarle (ALB), and many more have seen their shares explode upwards during the pandemic when there was a lot of hype surrounding EVs, enthusiasm has cooled in recent months. A price war in the Chinese EV market, worries about EV demand growing slower than previously thought, and worries about the overall strength of the economy have resulted in lithium prices pulling back, and that has resulted in selling pressure for the shares of SQM, ALB, and so on.
SQM: Recent Results
Still, recent results were far from bad in absolute terms. While SQM saw its revenues reject during the most recent quarter, relative to one year earlier, revenues were still around 3x as high as they were two years ago — on a longer-term basis, growth has still been great, even though we have seen a pullback from the ultra-strong results one year ago.
Likewise, profits have pulled back as well. SQM generated earnings per share of $1.68 during the most recent quarter, which was below the level seen one year earlier, but which was still way ahead of the $0.37 per share that SQM earned during the third quarter of 2021. One year before that, i.e. three years ago, SQM had earned $0.14 per share — the per-share profit during the most recent quarter was 12x as high as that. So while the environment isn’t as great as it was one year ago any longer, SQM has still managed to grow its business, its sales, and its profits at a very appealing rate over the last 2 to 3 years — and it isn’t really surprising that lithium prices have pulled back from the sugar-rush highs seen one year ago.
SQM: What’s The Business Outlook?
We can expect lithium markets to be very volatile, thus investors will have to adopt ups and downs in SQM’s profits going forward. For a long-term investor, these quarterly ups and downs don’t have to be dramatic, however.
As noted above, the demand outlook is positive, mainly thanks to the expected growth in the global EV market. New capacity introductions over time will result in shifts in the supply-demand picture — at times, the market will be more undersupplied, while it will be less undersupplied at other times, which will bring about significant price swings for lithium.
Analysts are currently predicting that SQM will earn $7.92 this year on a per-share basis, which would represent a significant pullback relative to 2022. Due to lithium prices having declined from their (potentially rather bubbly) highs last year, that’s not a big surprise. For the upcoming year, analysts are predicting earnings per share of $7.79, which is not a major change compared to the assess for the current year. For 2025, the analyst consensus assess stands at $8.41, which would mean an 8% enhance compared to what is forecasted for next year — nice, but not dramatic. Analyst estimates beyond 2025 should be taken with a grain of salt, I believe, as there is a low number of analysts having publicized estimates this far out, making the consensus assess less reliable.
SQM’s CEO Ricardo Ramos stated the following when the company’s most recent results were presented (emphasis by author):
We continue to see strong fundamentals behind long-term lithium demand growth, supported by strong EV sales volumes and decarbonization targets across the globe. However, the excess of inventory accumulated across battery and lithium chemical supply chains, particularly in Asia, as well as additional lithium supply, have put pressure on lithium market prices and could continue to have a negative impact on lithium prices in the short-term.
While the CEO could be wrong, his statement about long-term opportunities and short-term headwinds from high battery inventory levels makes sense to me. If he is right, then purchasing shares of SQM could pay off for longer-term investors: After all, buying is an opportune choice when temporary headwinds have resulted in a low share price and valuation.
And SQM’s valuation is pretty low for sure — based on current estimates, the stock is trading for just above 6x forward earnings, both when we look at estimates for 2023 and when we look at estimates for 2024. When one buys a stock at a valuation that is this low, not a low of growth is needed — in fact, if profits were to stabilize at this level and never grow again, SQM could still be a pretty nice investment. After all, the low valuation and a high earnings yield of around 16% allow the company to make hefty dividend payments. Based on the dividends that have been declared for the current year, SQM yields around 10%. While the total dividend payout was even higher last year, a 10% yield is pretty attractive.
Takeaway
Lithium markets have been very volatile in the past, and they will most likely remain volatile in the future. Ups and downs in lithium prices and SQM’s profits are to be expected.
That being said, the longer-term outlook is appealing, the valuation is low, and the dividend yield is high — for an investor who is not afraid of volatility and who wants exposure to this growth industry, right now could be a good time to enter or enlarge a position.
