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Questor: the electric car industry needs lithium, so buy this cash-generative Chilean miner
Despite the fact that Tesla’s market value now eclipses that of Ford, the electric vehicle market is still very much in its infancy.
Electric cars currently account for around 1pc of car sales worldwide. But that share is sure to multiply, driven by emissions regulations, falling costs and the increased usability of electric cars day-to-day.
Bloomberg New Energy Finance, which produces an annual report on the state of electric vehicle adoption, has predicted that electric vehicles will account for 54pc of new car sales and 33pc of the global car fleet by 2040.
But picking a winning stock among the carmakers is difficult. For now the established players still depend on sales of vehicles powered by fossil fuels. Some are also exposed to consumer credit risks through large finance divisions. Tesla, meanwhile, has been struggling to produce its latest model in large enough numbers.
One way to play the electric car growth story is to invest in a firm involved in providing materials for the lithium-ion batteries at the heart of every electric car.
The Chilean lithium miner Sociedad Quimica y Minera (SQM) has been operating since 1968. Its shares can be bought on the New York Stock Exchange via an “American depository receipt”, although its main listing is in Chile.
Rather than digging to reach the metal, SQM extracts lithium from brine lakes, which contain various elements.
The firm has recently resolved a dispute that will allow it to increase production in return for payments to a Chilean regulator.
Rob Marshall-Lee, manager of the Newton Global Emerging Markets fund, has 4.8pc of his portfolio in SQM. He first invested in 2011 with a small position, but has had “higher conviction” over the past two years.
He said SQM’s extraction method was far cheaper than conventional mining, making the business “highly cash generative, with a good return on capital”, and more defensive.
A decade ago it was predominantly a fertiliser business, but lithium now accounts for 60pc of its profits.
“The fertiliser market is still in the doldrums, although it could come back, but it’s the potential for both lithium volume and price growth that is attractive,” said Marshall-Lee.
In the past, corporate governance and a non-business-friendly Chilean government posed a problem, but he said this had been changing.
“Chile has a very developed pension system. When you have an asset with high value to a country and sophisticated pension funds with a big stake, these things tend to get sorted out,” he said.
SQM is said to be in talks with Tesla, which is looking to secure long-term lithium supplies.
“Manufacturers are clearly concerned about the availability of lithium on a five to 10-year horizon, and battery-grade lithium is not easy to produce,” Marshall-Lee said.
This means that established producers that can be relied on to get lithium of the right quality to market “are going to be in hot demand”.
A number of established businesses, such as SQM and its competitor Albemarle, are signing long-term contracts as a result. Customers are willing to pay above market prices to secure lithium, Marshall-Lee said.
“Lithium is a small part of a battery’s cost, and they pay higher prices as an incentive for production to increase,” he said.
But despite the obvious potential, the risks are clear. Technological change, regulatory problems, new emissions rules, political risk in Chile, an ecological disaster or a production failure are all potential dangers. This one is at the speculative end of our stock tips.
Questor says: speculative buy
Ticker: NYSE:SQM
Share price at 5pm: $54.50
Update: Gama aviation
Gama Aviation, tipped at 193.5p in August last year, has announced plans to raise £48m by selling new shares. Gama’s existing partner in Hong Kong, Hutchison Whampoa, has committed £32.7m for 21pc of Gama’s enlarged equity.
“This is a coup for Gama, giving it the financial firepower to take the company to the next level,” said Nick Hawthorn of Downing, who holds shares in the group.
“Since we invested, management have done everything they said they would. It’s only a matter of time before the true potential of this business is realised. The shares continue to look cheap at only 8.8 times 2019 earnings.
“We believe that they deserve to be rated at least in line with peers at 12.5 times earnings, which would imply a share price of 370p.”
Questor says: buy
Ticker: GMAA
Share price at close: 256p