Lepidico — Phase 2 coming into view

On 20 May, Lepidico announced a pro rata renounceable entitlement offer (effectively a rights issue) on the basis of one new share plus half an option (exercisable at 2.6c/share) at a combined price of 1.3 Australian cents per share for every seven existing shares held to raise A$9.6m.

Prior to the announcement, there were 5,187.9m shares in issue and the maximum number of shares to be issued under the terms of the entitlement offer was 741.1m with the funds raised being applied to fast-track initial development activities for the Phase 1 project in order to keep it on schedule for mining to start in the September 2022 quarter (Q123) and chemical plant commissioning in the March 2023 quarter (Q323) – thereby positioning Lepidico as a first mover for the new lithium price cycle – as well as advancing the Phase 2 growth project.

The pricing of the offer was at a 19% discount to Lepidico’s volume weighted average share price in the 10 days prior to the announcement of the offer and eligible directors indicated that they intended to participate in it.

Subsequently, owing to the strong demand demonstrated for Lepidico’s equity from both investors and existing shareholders at the time of its entitlement/rights issue, on 15 June, Lepidico announced that it had also authorised a placement of an additional 223.1m (plus 111.5m options) at a price also of 1.3c to raise a further A$2.9m.

Prior to these two fund-raising announcements, we had assumed that Lepidico would fund the equity portion of its development capital via an issue of shares to raise A$27.5m in FY22. In the aftermath of the announcement, we have assumed that it will fund itself via this A$9.6m rights issue and A$2.9m placement in FY21 plus a further issue of shares to raise A$18.0m in FY22 (note: we have increased the total equity being raised by A$2.9m, from A$27.5m to A$30.5m, to account for a second pilot plant campaign plus product R&D work in FY22, see below), ie we estimate that Lepidico has already raised 41.0% of the total equity required to develop its Phase 1 Plant project.

Lepidico has a three-pronged marketing and offtake strategy. The three initiatives – representing three different types of potential customers – are as follows:

On 13 April, Lepidico revealed that it had signed a non-binding letter of intent to supply China’s BJR with lithium, caesium and rubidium salts from the Phase 1 plant for both industrial use and/or conversion into fine speciality chemicals, thereby marking progress on the third of these three initiatives to build a customer base for an expanding business with the objective of supporting longer-term growth (including, ultimately, a Phase 2 plant). In this case, BJR operates three manufacturing sites in Hubei Province in China (capital Wuhan) and Lepidico will supply it with lithium hydroxide, caesium sulphate and rubidium sulphate for both industrial use and synthesis into fine speciality chemicals for both domestic and international customers.

Subsequently, on 28 April, Lepidico announced that it had entered into a non-binding letter of intent with Bisley & Co Pty (an Australian multinational marketer and distributor of industrial raw materials to the Anzac region, South-East Asia, the Middle East and North America) for the supply of up to 2,000tpa lithium hydroxide, sulphate of potash (SOP) and amorphous silica, as well as other products from the company’s planned Phase 1 Project to long-term strategic customers – thereby marking progress with the second of its three initiatives.

At the time of the announcement of its share placement (see above), Lepidico also announced that it had been in further (unsolicited) offtake talks with a counterparty connected with the electric vehicle sector that had requested material samples of lithium hydroxide from Lepidico. While the company released relatively few details about its counterparty, it seems logical to conclude that it is likely to be a cathode manufacturer seeking security of supply of raw materials for batteries to be directed towards the electric vehicle market – thereby marking progress for Lepidico with a new prospective lithium customer. Anecdotally, the fact that Lepidico is in such talks and that they were unsolicited suggests, among other things, that the lithium chemical market has been transformed compared to its state even just six months ago. It also suggests a high level of commitment to the future production of batteries in quantity in Europe and/or North America – not least as a result of the new Biden administration’s recently announced twin initiatives of a network of charging stations for electric vehicles and a US$2tn climate plan. Inevitably, however, it will take time for the supply-side consequences of such commitments to translate into medium- to long-term physical demand. Based on recent discussions with industry participants, we understand that demand for new sources of supply for 2023 and 2024 is at a relatively early stage and we would therefore expect to see the effects of such long-term strategic planning begin to manifest themselves in new contracts from the second half of this calendar year. In the meantime, however, with its Phase 1 Plant project on schedule for production in 2023, we believe that Lepidico is well positioned to benefit from early mover advantage in the new lithium price cycle.

Three immediate consequences of the improvement in market conditions for lithium chemicals are pertinent to Lepidico – two direct and the other indirect:

Our previous reports on Lepidico have noted the upside potential to our valuation via the eventual development of a full-scale, Phase 2 plant, but have declined to attempt to quantify it. Recently, however, Lepidico has published its estimate of the capital intensity involved in developing such a plant. In the light of its announcement that it has now commenced Phase 2 mineral resource expansion drilling, this note therefore attempts for the first time to ascribe some value to this project (although investors should note that the resources to support such a project have yet to be identified by Lepidico).

According to its Phase 1 Plant project DFS (see Valuation update post-feasibility study, published on 20 July 2020), Lepidico will mine c 0.5Mt ore pa at a strip ratio of 3.8 in order to produce c 60kt of concentrate pa at an average grade of 3.23% lithium oxide after a (lithium) recovery to concentrate of 80.6%. The chemical plant will then process c 56,700t concentrate (dry) pa to produce 5,600tpa lithium hydroxide monohydrate at a concentrate grade of 4% lithium oxide. As a result of progressive debottlenecking, from year five of the project, the target throughput rate will increase to 66,577tpa concentrate to result in ongoing lithium hydroxide production that is within 11% of 4,900tpa plus a range of by-products to take total output to c 7,800t lithium hydroxide equivalent per year. By contrast, a Phase 2 plant could have the capacity to produce 20,000tpa of lithium carbonate equivalent, or 22,717tpa lithium hydroxide monohydrate equivalent – ie a scale-up factor of approximately 2.9x.

In formulating our valuation of a Phase 2 plant, we have therefore made the following assumptions:

On the basis of the above assumptions, we calculate an income statement for the Phase 2 Plant project in a typical year approximately as follows:

Discounting 20 years’ worth of cash flows of this order of magnitude back to present value at a discount rate of 10% and subtracting US$362.8m in initial capex yields a preliminary theoretical value for the Phase 2 Plant project of US$594.7m at the start of capex, or US$0.097/share (post-FY21 equity funding).

Two methods of adjusting the above valuation to reflect risk occur to us.

The capital intensity estimate for the Phase 2 plant is quoted as being performed to ‘scoping study design parameters’, while the operational cost estimates are compiled to a DFS standard – albeit there is no guarantee that either the mining or the chemical cost portions of a Phase 2 Plant project would approximate those at Karibib and Abu Dhabi, respectively. As such, a preliminary economic assessment (PEA) level risk factor applied to our valuation (above) could be appropriate in formulating a risk-adjusted valuation for a conceptual Phase 2 Plant project. Alternatively, it could be stated that we believe our valuation to be correct in the event that the assumed parameters are confirmed in a PEA or scoping level study. In our report Gold stars and black holes, we calculated a mean enterprise value for companies with projects at the PEA or scoping study stage of development of 11.7% of project net present value (NPV). This would imply a valuation for the Phase 2 Plant project of US$70.8m, or 1.15 US cents per share (1.53 Australian cents per share) post-FY21 equity funding.

In order to achieve its targets of supporting both a Phase 1 chemical plant in Abu Dhabi and a Phase 2 plant perhaps in Abu Dhabi but also, potentially, elsewhere in the world, Lepidico has adopted a two-pronged strategy at Karibib (with the two prongs being conducted in parallel):

In order to support a 20,000tpa LCE chemical plant operation, we estimate that a 1.7Mtpa ore processing capacity would be required. Over 20 years, this would imply a required ore reserve of c 34Mt (at a similar grade to the current ore reserve) which, at the existing reserve:resource conversion ratio at Rubicon 1 and Helikon 1 of 74.3% (by tonnage), would imply a minimum resource of 45.9Mt at an acceptable minimum grade in order to support a Phase 2 plant. This compares with a current resource at Helikon 2–5 of 2.2Mt, as shown in the table below:

At 0.41% lithium oxide, the average grade of Helikon 2–5 compares well with the average resource grade of Rubicon 1 and Helikon 1 combined of 0.43% and the average reserve grade of Rubicon 1 and Helikon 1 combined of 0.46%. Self-evidently, however, the current resource of 2.2Mt is only 4.8% of that required to support a 20,000tpa LCE chemical plant operation for 20 years and, as such, this percentage could be invoked as an appropriate measure to apply to the valuation of US$594.7m (above) to reflect the risk surrounding the development of the project. In this case, the appropriately risked valuation of US$28.5m equates to 0.46 US cents per share (post-FY21 equity funding) or 0.61 Australian cents per share (post-FY21 equity funding).

After more than two years in a bear market, between mid-2018 and late 2020, the spot price of lithium carbonate has begun to recover strongly.

The price of lithium carbonate is extremely sensitive to general economic conditions in China as well as those pertaining to the electric vehicle (EV) market in particular. Initially, demand for EVs in China softened from Q2 CY18 on account of a more stringent Chinese policy towards EVs that supported higher battery energy density and range. As a consequence, the price of lithium carbonate in China, which had previously traded at a c 100% premium to the world market level, began to decline to the point at which the China CIF price and the China spot price were at close to parity by Q219. This trend of a weakening price was then further exacerbated by a slowdown in the domestic Chinese economy throughout 2019, coupled with rising trade tensions with the United States, to result in the domestic Chinese market undergoing a long period of destocking throughout 2019 to the point at which China had become a net exporter of lithium carbonate by the end of the year. This destocking occurred despite attempts by the Chinese authorities to implement generally favourable policies in support of the EV industry (which it regards as a strategic priority), including penalties, in the form of higher taxes, on the production of internal combustion engine cars and new emissions standards on cars in the provinces. The period of destocking in China also coincided with a period of restocking the rest of the world, to result in a situation in which stocks were high in the rest of the world by the end of 2019, but optimism was also high, despite the relatively low price, on account of the perceived long-term effect of a major shift in the world economy away from fossil fuels, in particular, and towards electrification and battery technology. Then coronavirus hit and, although it hit the prices of all base metals initially, the effect on lithium was generally much greater than on any of the others, owing to its much greater dependence on the EV sector. Thus, whereas the prices of other base metals recovered from approximately March 2020 onwards, the price of lithium carbonate continued to decline until late October and barely recovered to finish the year close to its low (rather than high as for most other metals) for the period. Unsurprisingly, exploration and mine development was severely curtailed in the period 2018–20, with the result that the long-term thesis in support of lithium remains, to all intents and purposes, unchanged (ie EV demand to account for nearly half of all cars sold by 2030, battery power to increase 13x relative to today and lithium demand to sextuple from 2019 to 2030), but after two years of ‘lost’ time and investment in the interim. As a degree of normality has returned to the world economy in 2021, therefore, there has been a period of restocking – especially in China – superimposed onto a background of previously depleted inventories throughout the supply chain, causing lithium prices to bounce sharply, if also belatedly. Anecdotally, we understand that prices as high as US$13,000/t have been achieved on the spot market in China and that, selectively, the price of lithium carbonate has traded at a premium to lithium hydroxide recently. Similarly, we understand that cathode manufacturers have increased order volumes by 10–20% and, as contracts roll over and new contracts are agreed for 2022 and 2023 (typically in the September to November period), we would naturally expect to observe contract pricing increases on a quarter-by-quarter basis.

Where before we had assumed a long-term price for lithium carbonate of US$10,000/t, we are now predicting a long-term lithium carbonate price of US$12,000/t, supported not only by long-term demand trends but also inflationary price pressures that have acted to increase the cost curve (and therefore the level below which it is difficult for the price to drop).

We first adopted US$14,021/t as our long-term lithium hydroxide price forecast in February 2019 (see LiOH production beckons, published on 25 February 2019). At the time, both the lithium carbonate price and the lithium hydroxide price were relatively high (see Exhibit 3, below) and the premium of the latter over the former relatively low (Exhibit 4):

Our February 2019 long-term lithium hydroxide price was derived from a long-term lithium carbonate price of US$12,000/t and an anticipated lithium hydroxide premium of 16.8% per tonne. As discussed previously, the price of lithium carbonate declined after February 2019 and, while the price of lithium hydroxide initially declined in tandem, its premium widened materially. As the reverse has happened since October 2020 and the price of both has risen, the premium of hydroxide over carbonate has once again narrowed (Exhibit 4). Note that in terms of lithium metal units alone, all other things being equal, lithium hydroxide monohydrate would be expected to trade at a discounted price relative to lithium carbonate in the ratio 74:84 based on the different masses of the two salts per mole of lithium ions. The fact that it trades at a premium to lithium carbonate and that it has a lower volatility is, to some extent, indicative of its attractiveness as a raw material for lithium-ion battery manufacturers. It also reflects the fact that the majority of lithium hydroxide production has historically been derived from lithium carbonate produced from brines.

One potential interpretation of this apparent behaviour is that the lithium hydroxide price premium (in percentage terms) is inversely correlated with that of lithium carbonate (ie a high lithium carbonate price correlates to a low lithium hydroxide price premium and vice versa) and this is borne out by statistical analysis. A regression analysis between the two (Exhibit 5, below) reveals a Pearson product moment (correlation) coefficient of -0.62 which, given the number of data points in the analysis, is statistically significant at the 5% level (ie there is less than a 5% chance that the observed relationship occurred by chance).

However, if data points prior to February 2016 (when the market might be said to have been immature) are excluded, the correlation coefficient improves to a much more significant -0.88, as shown below. Note: effectively, this knocks off the ‘spur’ observed in the lower left of Exhibit 5:

As can be seen from the above regression analysis, a long-term lithium carbonate price of US$12,000/t corresponds to a lithium hydroxide price premium of 25.8% and therefore a long-term lithium hydroxide monohydrate price of US$15,091/t. Note that the curve entitled ‘Required’ shows the premium required for the lithium hydroxide price to be US$15,091/t at the lithium carbonate price shown. Thus:

One risk to this analysis is the potential for the lithium hydroxide price to diverge from its historical relationship with the lithium carbonate price. Currently, lithium hydroxide may be formulated either from brines (with the production of lithium carbonate as an intermediate product) or via the alkaline conversion process from spodumene concentrates. Production of lithium hydroxide from brines and therefore via lithium carbonate necessarily requires lithium hydroxide to command a premium price given the expense of the conversion. However, direct production of lithium hydroxide from spodumene concentrate does not. In the event that the market bifurcates into lithium carbonate production from brines for mass-market lithium battery applications (eg mass-market cars) and lithium hydroxide production from spodumene (eg for prestige cars with greater battery power density), the current (close) relationship between lithium carbonate and lithium hydroxide prices may break down and a new relationship be established between the lithium hydroxide price and the price of spodumene concentrate. Note however that the cost to convert spodumene concentrate into lithium hydroxide is currently estimated to be in the order of US$2,500/t lithium carbonate equivalent alone and that the overall AISC for spodumene concentration and conversion into lithium hydroxide is much higher than for brine so, from a margin perspective, it is still entirely possible that lithium hydroxide will maintain its pricing premium relative to lithium carbonate. As discussed previously, readers should note that in terms of lithium metal units alone, all other things being equal, lithium hydroxide monohydrate would be expected to trade at a discounted price relative to lithium carbonate in the ratio 74:84 based on the different masses of the two salts per mole of lithium ions. On the other hand, lithium hydroxide remains a ‘premium’ product appropriate for use in higher-specification, higher-power density batteries destined for use in premium automobiles.

Until any reconfiguration of the market therefore and as a consequence of the above analysis, we have increased our long-term lithium hydroxide price to US$15,091/t (cf US$14,021/t previously) to reflect a long-term lithium carbonate price of US$12,000/t (cf c US$10,000/t previously). Note that this compares to the pricing assumed in its Phase 1 Plant project DFS (dated 28 May 2020 and provided by BMI) of US$13,669/t lithium hydroxide over the life of the project, reverting to a long-term real price of US$12,910/t from 2030.

Project

Lepidico’s DFS (see our note, Developing to the (L-)Max, published on 29 May 2020) calculated a project NPV8 for the integrated Karibib mining and chemical plant operation of US$221m, or A$293m (5.7c/share on a pre-funding basis and 4.8c/share on a post-FY21 equity funding basis) at the current foreign exchange rate of A$1.3267/US$ (cf A$1.2831/US$ at the time of our last note in April 2021).

In our report Gold stars and black holes, published in January 2019, we calculated a mean enterprise value for companies with projects at the DFS stage of development of 30.9% of project net present value (NPV), ranging up to 133.5%. This alone would imply a pre-funding valuation for Lepidico of 1.7c/share (ie subscribers to the rights/entitlement offer at 1.3c/share bought into the project at a below average price) and a post-FY21 equity funding valuation for Lepidico of 1.5c/share, ranging up to 6.4c/share (excluding cash).

Company

Our valuation of Lepidico varies from our value of the integrated Karibib mining and chemical plant project in that it takes into account Lepidico’s 80% interest in the Namibian mine (but 100% of the Abu Dhabi chemical plant), which will give rise to both a tax-paying position in Namibia and a minority interest in the profits generated from mining operations. It also assumes ongoing corporate costs in the order of A$3.1m per year.

Our company model assumes that Lepidico will raise the balance of the required equity of A$18.0m (cf A$15.1m previously) at a price of 2.9c/share (as set out in our report Valuation update pending feasibility study, published on 6 April 2020). This price is at a 142% premium to the current share price of 1.2c. However, given that Lepidico’s shares reached 2.8c in March 2021 and 3.4c in January 2021 and that they have nevertheless appreciated by 100% from their level of 0.6c in June 2020 and by 20% from their level of 1.0c in December 2020, we do not believe that a medium-term share price of 2.9c is unreasonable, especially in the event of the successful conclusion of additional offtake negotiations and/or US DFC debt funding on preferential terms (see our note Enter the US government, published on 5 November 2020). In addition, management has indicated that it would be unlikely to commit to raising new equity at much below this price. Hence, we continue to show the results of our analysis on this basis. However, we also show the results of the analysis with equity raisings conducted at a series of different prices under ‘Future equity funding price’ in the ‘Sensitivities’ section of the note, below.

In our last note on the company (see Fine tuning the mine and chemical plant, published 21 April 2021), we calculated a value for Lepidico’s shares of 4.48c plus 0.29c for the value of an envisaged loan to the minority shareholders in the upstream Namibian operation to give a total valuation for the company of 4.76c/share. We have now updated our valuation to take account of the following in our financial model:

In the wake of these changes, our (discounted) valuation of Lepidico’s future (maximum potential) dividend stream to shareholders has increased by 4.9% to 4.70c/share in FY21, rising to a peak of 6.89c/share in FY25 when we estimate that the company could pay a maiden dividend, as shown in the graph below:

To this valuation of 4.70c/share should then be added the value of Lepidico’s envisaged future loan to the minority shareholders in the Namibian mining and concentrating operation, which we estimate to be 0.26c/share to result in a total value for Lepidico’s shares of 4.96c/share (cf 4.76c/share previously), based solely on its Phase 1 project. A ‘bridge’ chart, showing the transition in valuation from 4.76c/share to 4.96/share by component is shown below.

Future equity funding price

Our financial model assumes that Lepidico will raise the balance of the equity required of A$18.0m in FY22 (cf A$27.5m previously) at a share price of 2.9c in order to achieve an (unchanged) future, maximum net debt:equity ratio of 66:34. Exhibit 9 demonstrates the sensitivity of this valuation to variations in the price at which this future equity is raised.