Lithium stocks have cooled off quite a bit in recent months. Then again, there's not much for shareholders to complain about given the awesome gains in recent years. Case in point: Shares of the world's largest lithium producer, Albemarle Corporation (NYSE:ALB), have dropped 25% year to date. But it also treated shareholders pretty well by delivering total returns of 135% in the two years spanning 2016 to 2017.

Therefore, the cooldown might be expected, but that might not stop opportunistic investors looking to build a position in the lithium industry from asking questions. Are there any long-term concerns about the viability of lithium production, or is the current sentiment based on knee-jerk reactions? Is Albemarle stock a buy?

A man standing in front of a giant chalkboard with question marks and money bags drawn on it.

Image source: Getty Images.

By the numbers

Albemarle waded through good, bad, and ugly news through the first four months of 2018. It scored a stock upgrade in January, but that was washed out by a stock downgrade at the end of February from analysts at Morgan Stanley. And it was worse than a run-of-the-mill downgrade.

Well, it was accompanied by a bearish outlook report for the lithium market in general that essentially claimed producers are going to vastly overshoot market demand with production increases. That wouldn't be too surprising. For one, no one really knows how much lithium will be needed in the early 2020's. The general answer is "a lot," but the slightest delay in global battery factory ramp-up could ruin the party. Also, commodity producers are great at ruining favorable market conditions with overexpansion. Why would lithium be any different?

The downgrade was followed the next day by mixed fourth-quarter 2017 earnings, which made some investors skittish. But the operational performance delivered last year wasn't that bad. 

Metric

2017

2016

% Change

Revenue

$3.07 billion

$2.68 billion

15%

Gross profit

$1.11 billion

$970 million

15%

Operating profit

$588 million

$574 million

2%

Net income from continuing operations

$99.5 million

$478 million

(79%)

Lithium segment adjusted EBITDA

$518 million

$363 million

43%

Lithium segment net income

$400 million

$261 million

53%

Source: SEC filing.

The big swing in net income occurred as Albemarle was forced to take a big noncash hit on tax obligations from the new U.S. corporate tax laws. And what appears to be stagnant operating income is really only the product of a $122 million gain in 2016 on the sale of certain businesses, which had the effect of boosting operating income that year. Aside from that, 2017 was pretty smooth sailing for the business and shareholders.

Thanks to rising selling prices for lithium products, the company's financial reliance on the lithium segment continued to increase. This part of the business was responsible for 43% of total revenue and 59% of total adjusted EBITDA last year, up from 36% and 48%, respectively, in 2016. Lithium was also responsible for 50% of total segment net income in 2017, up from 40% the year prior. That dependency could pose a long-term problem if Morgan Stanley's projection for an oversupplied global market comes true. What should investors make of it? 

Well, Albemarle won't have any problem increasing lithium production for the foreseeable future. It has developed a new extraction technology that can double lithium production from its assets in Chile -- where the majority of its output originates -- with minimal changes to the overall process. Even better, the new Chilean government wasted no time increasing the company's annual production quota to up to 145,000 metric tons.

Several pools of brine used to produce raw lithium.

Image source: Getty Images.

To put that into perspective, total global lithium production in 2017 was estimated at 215,000 MT. Therefore, it goes without saying that Albemarle won't be maxing out its quota anytime soon, but it's comforting to know it has the flexibility to expand if needed.

Additionally, if the new extraction technology is widely deployed in Chile, it could allow higher margin production. That could provide an important financial cushion if and when the lithium market cools off, or even experiences a catastrophic downturn. The company might even have the envious option to temporarily shut down production assets in Australia and the United States and weather the storm on the back of its low-cost South American assets alone. 

It's also worth pointing out that Albemarle has two other business segments, bromine specialties and refining solutions, that put up healthy profits year in and year out. In 2017 they delivered net margins of 25% and 22%, respectively. While it would certainly sting if lithium prices come crashing down -- and investors probably shouldn't expect current selling prices to continue forever -- the business would survive. 

In fact, Albemarle sports the healthiest balance sheet in the lithium industry after greatly reducing its debt balance in 2017. Consider how Albemarle stock stacks up to peers FMC Corp and Sociedad Química y Minera de Chile (SQM):   

Metric

Albemarle

FMC Corp.

SQM

Market cap

$10.7 billion

$10.9 billion

$14.5 billion

Forward P/E

16.6

13.1

26.2

Price to book

2.9

4.1

6.6

EV to EBITDA

12.9

22.1

15.9

Dividend yield

1.4%

0.8%

1.6%

Source: Yahoo! Finance.

That table shows the value of Albemarle's diversification -- and, more importantly, diversification into high-margin businesses. It's why the stock has nearly doubled the returns of FMC Corp in the last five years and run laps around shares of SQM. Yet, it's fared the worst of the group in the last year. That strongly hints this is an opportunity sitting in plain sight.

This is the best lithium stock you can buy

Long-term investors looking to cash in on lithium's growing importance in modern civilization should consider Albemarle the best lithium stock on the market. It currently has the clearest path to long-term production growth, the highest degree of diversification, and the cleanest balance sheet among the top three lithium producers.

While lithium demand promises to be strong through the end of the decade, at least, investors do need to be aware of the potential for a mismatch between supply and demand in the 2020s. But for now, Albemarle stock looks to be a buy.

Maxx Chatsko has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.