Lithium producer Albemarle (ALB -2.26%) is getting hit across its diversified portfolio today. The impact of widespread COVID-19-related shutdowns is set to linger into the second quarter, and likely the rest of the year. The stock is down roughly 50% from its 2017 peak. But that just makes it an even more interesting opportunity for investors that believe the electrification of automobiles is set to take off.
A tough market
In 2017 investors decided that lithium was a hot commodity, bidding the price higher and higher on the expectation that the world's automobiles would be shifting from gasoline to electricity. As is so often the case on Wall Street, investors got a little ahead of themselves. Lithium prices rose faster than actual demand for the key battery-making metal. Capital investment in the sector, meanwhile, took off because of high lithium prices. That led to a glut of lithium, and prices collapsed. This is a pretty common scenario in the commodity space.
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Albemarle was able to handle the falling price environment in relative stride because it usually locks in sales with long-term contracts. Falling prices were a headwind, but one that would only start to impact the company's top and bottom lines as existing contracts rolled off. Meanwhile, about 60% of its revenue comes from its non-lithium businesses, bromine (a fire retardant) and catalysts (used in the energy industry). Those two divisions initially held up relatively well while lithium prices fell.
And then COVID-19 started its march across the globe.
The economic shutdowns that were enacted to slow the coronavirus' spread hit Albemarle across all three of its businesses. The first quarter saw top-line sales drop 11% and the bottom line decline by 19%. The bromine division's sales were off by 7%, though management attributed that to logistics issues that will push sales into the second quarter. The catalysts operations witnessed an 18% sales drop largely related to COVID-19, which depressed demand. Lithium was hardest hit, with a 19% revenue decline, led by a mixture of soft demand and lower lithium prices working their way through the company's contract book. All three segments are likely to struggle until the world reopens in a meaningful way again.
Albemarle is taking steps to deal with the issues it faces. That includes cost cutting, reducing capital spending plans, and maintaining its financial strength while protecting the dividend. Basically, it's doing exactly what you would expect in the face of material headwinds. With earnings of $1.00 per share in the first quarter and adjusted EBITDA margins of 27%, flat with the previous year, management appears to be muddling through this rough patch in relative stride. It may not be pretty for a bit, but Albemarle seems strong enough to ride it out.
So, looking at Albemarle today, here's the real question long-term investors need to ask: Is the lithium story dead?
The electric future
The shift away from carbon-based fuels is a big-picture story that hasn't really changed. Burning oil and natural gas, in their various forms, to create energy has a nasty side effect -- it produces greenhouse gases and other pollutants. Although global warming has taken a backseat to COVID-19 today, the issue has hardly gone away. And the long-term shift toward electrification hasn't stopped, it's just receded from the headlines. Major automakers, for example, are still looking to ramp up their electric vehicle operations, even though they have been forced to pull back (or shut down) because of the coronavirus. In fact, before COVID-19, it looked as if 2020 could be a pivotal year for electric vehicle demand.
Albemarle provides some numbers here. Before the coronavirus, the company expected lithium demand to increase by 24% annually between 2019 and 2025. Putting that a different way, on average across that five-year period, lithium demand will increase 24% each year. That's an extremely large number. The vast majority of the increase is expected to come from electric vehicles.
An important factor here is that building an electric vehicle is very different from building a gasoline-powered one. You can't just mix and match parts between gasoline engines and electric motors -- automakers have to make material preparations, change manufacturing processes, and then commit to a long-term plan. Automakers are going down that path for a variety of reasons, and it would be hard -- and expensive -- to change direction. Perhaps COVID-19 has slowed the trend because companies, including automakers, are being shut down, but that's more likely to extend the time frame than change the direction of this story. In other words, more lithium will still be needed, and Albemarle will still be there to supply it. And once the world eventually emerges from the COVID-19 crisis, the rest of its businesses should pick up as well.
The stock's deep decline over the past few years, then, is a statement to the conditions that the company is operating in today. But it could also be an opportunity for investors with a long-term time horizon to pick up the stock at a discounted price. Note that the company's dividend yield is at the high end of its historical range, suggesting that it could be cheap today. That dividend, meanwhile, has been increased annually for 26 consecutive years, and it is the company's number-one capital allocation priority today. With a quarterly run rate of $0.385 per share, the dividend was still well covered by earnings despite the weak first quarter.
For the right investors
The investment thesis behind Albemarle hasn't really changed. The big-picture need for more lithium to support the shift to electric cars is still there, even if COVID-19 has perhaps delayed things a bit.
Still, lithium is a commodity and the price can swing quite a bit, as the last few years have shown. So anyone investing in Albemarle will need a strong stomach to handle the inevitable ups and downs. But with the stock down so much from its recent highs, it could be a good option for more aggressive long-term investors today.
