The element lithium has had a resurgence in public awareness -- and investment popularity. Originally, it was an ingredient in pharmaceuticals and later an additive used in all sorts of manufacturing. Lithium-ion batteries have begun riding around in our pockets over the last two decades, thanks to the smartphone industry. Now, a great deal of work is being done to apply that same battery technology to electric vehicles (EVs) and the energy grid to help make global energy consumption more efficient.
Lots of new lithium projects have been fired up in the last few years to meet this growing demand from EVs and other big battery applications. Two companies just merged to create a new leader in the lithium market: Arcadium Lithium (ALTM -2.27%).
On Jan. 4, 2024, the product of the tie-up between Australian lithium mining company Allkem (OROCF) and U.S. lithium refining outfit Livent (LTHM) will move up the ranks as one of the largest lithium suppliers around.
2023 was a rough year for the lithium industry, though. Is Arcadium Lithium stock a top buy for 2024?
An ideal pairing for a new era in energy?
Livent, which spun off from agricultural chemicals producer FMC in 2019, is a refiner of raw lithium into products usable by various manufacturers. Additionally, Livent has a mining and refining operation under development in Quebec, Canada (the Nemaska Lithium project).
Allkem is primarily a raw lithium miner, with projects cranking out the chemical in Argentina and Western Australia, a new project in development in Quebec, and a small refinery wrapping up construction in Japan.
So, what's the rationale behind this merger into the new business entity Arcadium Lithium? Development and extraction (mining) of raw materials can be a very lucrative business model. However, it's highly volatile, with revenue and ultimate profitability tied to the wild fluctuations in commodity prices (a commodity like raw lithium is an undifferentiated product easily substituted by a similar offering from a competitor).
This was evident when the EV market started to take off in 2020, and insufficient lithium supply sent pricing on the raw material soaring. But as new EV demand has moderated just a bit, and new lithium supply has come online, lithium pricing sunk back nearly to pre-pandemic levels in 2023. That kind of volatility can make revenue and profits go haywire for a pure mining business.
In contrast, a refining business can smooth out some of this volatility, especially if it can create some differentiation with its materials science and applied chemistry technology. Consistently higher profit margins can be realized, too. A higher price can be charged on products at every step in the supply chain (as work is done to increase the value of any good or product, or when trade and distribution of a product is undertaken, a take-rate is charged).
Long-term supply agreements with manufacturers can also ease boom-bust cycles. That said, refiners rely on miners to fill the funnel and keep their factories busy, so the volatility and cyclicality aren't completely removed.
Combining Allkem's lithium supply with Livent's refineries could allow the newly minted Arcadium to control its financial fate. All on their own, though, Allkem and Livent have done pretty well during the ramp-up of the EV industry, hauling in lots of new sales and churning out double-digit-percentage operating profit margins. Not even the lithium market downturn in the back half of 2023 has taken either company down.
Data by YCharts. TTM = trailing 12 months.
Keep an eye on lithium market cyclicality
As industry leader Albemarle (ALB 1.65%) demonstrated in the second half of 2023, integrated lithium production from mining to refining isn't a cure-all against wild swings in supply and demand. Albemarle is currently working through a lag between a large chunk of raw lithium inventory and the final sale of that inventory as a refined product to battery manufacturers.
An early test of Arcadium Lithium's operation will be the aftereffects of the lithium market meltdown of 2023. Investors should keep an eye on the company's ability to recognize revenue and maintain its profitability as it integrates the various assets from Livent and Allkem into a cohesive whole.
On a stand-alone basis, Livent and Allkem were each trading for about 10 times trailing-12-month (TTM) earnings per share. That's a bit of a premium, given that raw material mining stocks tend to trade for single-digit earnings multiples (Albemarle currently trades for 5 times TTM earnings per share).
The market is assuming Arcadium can grow at a faster rate than its lithium peers in the coming years, unlock some operating efficiency with its vertical integration, and maintain profitability through good times and bad.
Given this situation, I nibbled a bit more Livent stock at the end of 2023 and plan to purchase a bit more Arcadium during the first quarter of 2024. Important note: This is a small position, one I expect to keep small, given the wild volatility inherent in lithium stocks. However, if the lithium market stabilizes and growth resumes in support of EVs and other manufacturing applications, Arcadium Lithium could have big gains in store.
