Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
After soaring more than 50% last year on the back of reports that China might ban the production of gas-fueled cars (forcing a switch to lithium-battery-powered cars), Albemarle (ALB 2.70%) hit a bump in the road. Since achieving their high north of $140 in November, shares of the lithium producer have tumbled more than 20% as investors began to worry the lithium market was overheating.
And yet, one analyst thinks the market for electric cars, lithium batteries, and lithium still has room to run. Here's what you need to know.
All aboard Albemarle
This morning, UBS announced it is upgrading Albemarle stock from neutral to buy and maintaining a $150 price target, predicting the stock will return to its previous highs -- then zoom right past them. And it could all happen this year.
But why did Albemarle shares sink in the first place? And why does UBS believe they will bounce right back, and so quickly?
Why Albemarle tanked
Despite what you may have heard, there has actually been "no change to the outlook for lithium," reports TheFly.com, which covered UBS' upgrade this morning. Rather, what has changed is investors' impression of the market.
UBS argues that the pullback in Albemarle's stock price can be traced back to other companies' announcements that they are expanding their lithium mining efforts, and to resulting fears that the lithium market is getting flooded with an "oversupply" of the metal.
Earlier this month, for example, Reuters reported that Chile's Corfo development agency had struck a deal with Albemarle's lithium-supplying rival Sociedad Quimica y Minera de Chile (SQM 0.81%). As a result of this deal, Sociedad Quimica y Minera can now apply to increase its production quota for lithium. On the one hand, this will permit SQM to reap a larger share of the profits from a booming market for the lithium needed to manufacture rechargeable electric car batteries. On the other hand, though, by increasing the overall world supply of lithium, it may undermine pricing power and hurt profits for all players, Albemarle included.
Why Albemarle could bounce back
That's what happened to Albemarle's stock price late last year. UBS estimates that the market is pricing in a long-term trend of "10% annual realized price declines for Albemarle over the next few years" and discounting the value of Albemarle stock accordingly. However, UBS argues that "[w]hile spot prices may decline," Albemarle has secured long-term, fixed-priced supply contracts "for the majority of its battery grade volumes." This should protect Albemarle's profits even if the larger thesis of falling lithium prices proves correct.
What's more, UBS is predicting that by 2025, demand for lithium will triple off of today's levels. If that proves correct, supply is going to have to expand very fast indeed just to keep up with demand for lithium, much less create enough oversupply to squeeze prices and hurt Albemarle's rate of profits growth.
Currently, analysts surveyed by S&P Global Market Intelligence estimate that Albemarle should be able to grow profits at better than 11% annually over the next five years. Relative to Albemarle's trailing price-to-earnings ratio of 14, and its 1.1% dividend yield, this suggests Albemarle stock is still slightly overvalued today, even after the recent sell-off.
On the other hand, though, if UBS is right (and the naysayers are wrong), well, a tripling of lithium demand creates the potential for prices to be squeezed (and for Albemarle's profits to grow faster than projected) in the event that supply fails to keep pace with demand. Should Albemarle grow its profits at anything better than 13% or so, today's price could prove to be a bargain -- and UBS will be proven right to have recommended buying Albemarle stock.