Stock Market Information

Recommendation Summary

We have assigned an overweight rating to the stock. TP 2018E US$55.2 (Overweight). 2018E EV/EBITDA 15.6x. WACC (8.5%)

Investment Thesis

• In 2017, global Lithium demand totaled ~260,000 tons. By 2025, we believe demand would reach 758,600 tons, equivalent to a 14.3% CAGR during 2017-2025. For its part, supply would grow rapidly in 2020-2024, generating a surplus with respect to demand, thus we expect Lithium prices to drop during these years. By 2025, a balance between supply and demand would be reached translating to a long-term equilibrium price of US$9,000 per ton.
• Future demand of Lithium will be closely linked to EV (Electric Vehicle) penetration in China and to a lesser extent, Europe and the US. EV autonomy would also represent a determining factor for future demand, as greater range would require a larger battery capacity, implying more Lithium consumption per EV. Along with a greater capacity (Kwh), technological advances would allow for a lower amount of Lithium per Kwh (gr/Kwh). Currently, an average EV requires ~30.1 kg of Lithium (30.1 kg= Capacity (38 Kwh)* 792 (gr/Kwh)), and we estimate this could reach 37.6 kg by 2025 (greater autonomy: higher Kwh; albeit, due to technological advances, lower gr/Kwh). As an example, a Tesla Model 3 has a 50-75 Kwh battery pack (depending on the version) and can cover a range starting at 360 kilometers. We believe the autonomy of more economical models in China will increase, in line with government incentives, which have raised the minimum requirement to qualify for subsidies (previous minimum was 100km; currently range is set at 150km). Due to a higher autonomy of vehicles in general, we have raised Kwh in 2025 to 54Kwh (similar to a Tesla Model 3), the necessary capacity to achieve range over 350 kilometers.
• In the table below, we have included a summary of projected EV demand in China, Europe and the US. This projection contemplates a penetration of EV in the US, Europe and China of 4.5%, 6.6% and 20%, respectively (by 2025 mandatory production quotas will be imposed on manufacturers in China), and an increase of vehicle production, in line with the CAGR of the last 7 years in each market.

• Currently, Lithium requirements from EV (39,167 tons) represent 15% of worldwide demand (2017: 260,000 tons). Due to the strong growth expected in this segment, by 2025 EV demand would increase to 485,000 tons (64% of the total by 2025, see Figure 1). Industrial applications (49% current demand) would grow at a CAGR in line with historic levels (2.6% per year) and household appliances at 5.2% per year. Furthermore, demand from mass storage batteries (grid storage) and a solution to the intermittency characteristic of NCRE could become a relevant factor in the long-term; as long as the cost of development decreases sufficiently to grant an adequate level of ROIC, its ‘massification’ could trigger a new wave of Lithium demand. NCRE penetration in energy grids, grows at an accelerated pace and thus, demand for mass storage batteries could reach 57,713 tons by 2025 (conservative scenario) in hand with the development of wind farms and solar plants (this topic could represent a Lithium demand growt above current market estimates). Overall, we estimate consolidated demand growing at a CAGR of 14.3% between 2025-2018 (EV main driver).

• However, the entry of new supply would outweigh demand growth in 2019-2025, which could translate into a temporary supply surplus weakening Lithium prices starting in 2019 (2020-2024 greater price drops in line with larger surplus). We believe the latter has been more than discounted from the share price of SQM by the market. In Figure 2, we can see the capacity additions from the main suppliers (supply 2025E: 735,500 tons). By breaking down capacity additions by country, we observe these would mainly come from companies within the efficient scale of the industry’s cost curve (Albemarle and SQM). Thus, we expect drops in Lithium prices beginning in 2019 only to achieve market balance towards 2025 (Figure 3), and a long-term Lithium price of US$9,000 per ton. Despite the potential entry of large supply into the Lithium market and the consistent drop in prices, the leadership in costs from favorable conditions in the Salar de Atacama and Olaroz, along with its industry know-how, would allow SQM to maintain gross margins (including royalty) over 40% in the long-term (in Lithium), see Figure 4.

• In Lithium, we expect volumes of 55,000 tons and 80,000 tons in 2018 and 2019 (company guidance) for SQM. Average prices would reach US$15,500 and US$14,577, respectively (in the long-term, we drop Lithium prices to US$9,000 a ton and capacity additions in line with that announced). Growth of installed capacity in Lithium could generate for this business segment to represent 75% of the company’s consolidated EBITDA in the long-term (subject to Lithium prices and expansions over the long-term). Regarding the other lines of business, in SPN (Specialty Plant Nutrition) we expect flat volumes (SQM guidance) and similar prices to last year. In the long-term, volumes would grow in line with the market, due to a capacity expansion in Potassium Nitrate (1.5 million metric tons – Plant load factor LT: 82%). In MOP/SOP (Potassium) our working assumption is a 26% drop in volumes (2018E: 1 million metric tons) due to a greater emphasis in Lithium extraction over potassium products, a baseline we maintain in the coming years. In the long-term, volumes will gradually recover to 1.4 million metric tons. In regards to Iodine, the company has a focus on volumes (capacity expansion to 14,000 tons) and market share (current 35%); the drop in prices bottomed out and began to recover in recent quarters, in line with SQM’s strategy to capitalize on market share acquired after an aggressive pricing strategy in recent years. We expect slightly higher volumes than in 2017 and average prices of ~US$22,000 per ton (long-term US$27,000). Finally, Industrial Chemicals would evidence lower shipments and flat prices. Overall, we expect 2018 and 2029 Ebitda to reach US$930 million and US$1,044 million, respectively.
• Investment projects are mainly focused on Lithium expansions. Maintenance Capex totals US$100 million (proportionally growing with Properties, Plants and Equipment), and this year expansion Capex would reach ~US$417 million, of which US$170 million will be dedicated to expansions in Chile (Expansion 1) and US$157 million towards the early stages of Lithium projects in the Salar Caucharí-Olaroz (25,000 tons) in Argentina and Mt. Holland (20,000 tons) in Australia. The remaining US$90 million would be destined for the expansions announced in Iodine (expansion to 14,000 metric tons) and Potassium Nitrate (expansion to 1.5 million metric tons). After concluding these expansions, SQM will continue to expand in Lithium; projects in Olaroz and Mt. Holland would involve disbursing over US$720 million in total. Furthermore, this is compounded by Expansion 2 in Chile with a unitary Capex of ~US$12,000. We expect the company to maintain the dividend distribution policy at 100% as a maximum until 2020 (or sooner) given the need to finance expansions in Lithium.
• We have incorporated target price sensibilities according to different scenarios for long-term Lithium prices (see table below). In all scenarios, Lithium prices drop between 2019-2025, particularly in years when the supply surplus is greater (2020-2024). By 2025, demand and supply would balance and the price of Lithium would stop dropping, reverting to levels of US$9,000 per ton.

Risks

(+/-) Operational performance above/below expectations, subject to variations in commodity prices.

(+/-) Nutrien must sell its 32% stake on SQM, which could affect its stock performance.

(+/-) Battery capacity greater/less than expected. Technological advances favoring less use of Lithium (gr/Kwh) than estimated.

(+/-) Greater/less government incentives towards EV (mainly from China)

(-) Bottlenecks in extraction of complementary materials in the manufacture of lithium-ion batteries (cobalt, nickel).

(+) Inflows from Chilean pension funds (AFP). SQM is a strategic and discounted asset in an industry that could very well become one of the most relevant in the coming technological revolution.

(+) Technological advances in storage batteries and adoption by NCRE.

(-) High relative weight in valuation from perpetuity (any LT risk significantly impacts the Target Price)

(-) Substitution Risk.

(+/-) Higher or lower entry of new supply in the Lithium market than expected.

(+) Joint-Venture with Codelco to extract Lithium in Maricunga.

Fernando Errázuriz

[email protected]

Operational Estimates (USD mn)

Company Description

SQM operates in the soft-commodities and non-metallic minerals industry through Potassium Fertilizers, Iodine, Lithium and Industrial Chemicals. SQM’s exposure to Lithium stands out, representing over 60% of its consolidated gross margin in 2017. Revenues would reach US$2.041mn in 2017. Its mining operations are concentrated in Chile and will expand to Argentina and Australia.