This week we look at two stocks that are growing through strategic acquisition plans and are set to benefit from Australia’s imminent reopening and easing of restrictions. While they are both in very different industries, they have been performing well and we believe they are good companies to own heading into the reopening tailwinds.
The stocks in question are Healthia and People Infrastructure.
Healthia (HLA.ASX)
Healthia is an integrated allied healthcare organisation that includes networks of optometry, podiatry, and physiotherapy clinics across Australia. The physio/podiatry industry is a fragmented one that has allowed Healthia to grow through an aggressive acquisition strategy, giving them a strong presence throughout Australia. Following their most recent acquisition of Back in Motion (BIM), HLA is now positioned as the largest provider of physio services in Australia with 122 clinics.
Reopening Tailwind
Authors: Ron Shamgar
Most of Healthia’s clinics have remained essential services, which saw them continue operations throughout lockdowns. The lockdowns would’ve caused many people to delay visits to a lot of Healthia’s clinics; we can see there being a huge backlog of people waiting for restrictions to ease to go to one of Healthia’s broad range of health services.
Acquisitions
As mentioned, HLA has been undertaking an aggressive acquisition strategy to grow the business. They have been rolling up clinics throughout Australia which have all been earnings accretive. Their most recent acquisition of BIM, for a consideration of $88m, was a transformative one. Simply, it gave HLA a presence in new markets; BIM had a presence in New Zealand and Western Australia. BIM will add 64 clinics to the group and generated $12.3m of EBITDA, increasing the group EBITDA by approximately 57%. The acquisition is earnings accretive and was bought for circa 7x EV/EBITDA.
Source: HLA company filings
Healthia are typically paying in the range of 3-7x EBITDA for their acquisitions, which have been conducive to their growth strategy and enhancing value for shareholders. Bad acquisitions are an investor’s pet peeve and can destroy shareholder value if they don’t compliment the core business or are done at too high a price.
Valuation + Outlook
We recently saw 1300 Smiles, which ran a similar strategy to HLA except with dental clinics, get taken over by Abano Healthcare for approximately 15.5x EV/EBITDA. At below 8x EV/EBITDA, we see significant upside in HLA and the potential for multiple expansions on the back of their aggressive acquisition strategy. Heading into a post-covid world, we expect to see a backlog of people that will be booking appointments at HLA’s clinics. We like businesses like HLA that have good earnings visibility, their clinics typically have around 85% client retention and are pretty essential services. Buying a quality business like HLA on the back of a transformative acquisition at below 8x EV/EBITDA looks cheap heading into the country reopening.
We can see HLA trading at $3+.
People Infrastructure (PPE.ASX)
People Infrastructure Ltd is an outsourced recruitment management business dedicated to the growth of Australia’s infrastructure and construction sector. Services provided by the group include recruiting, on-boarding, contracting, rostering, timesheet management, payroll, and workplace health and safety management. The four main sectors PPE is targeting include healthcare, community services, industrial services and information technology. People Infrastructure has a track record of successfully acquiring and growing businesses through leveraging its core capabilities in the sourcing, skilling, deployment and management of workforces.
Source: PPE company filings, 2 June 2021
Reopening Tailwind
PPE was well placed heading into the lockdowns given the diversity of their clients, low client concentration and the critical nature of many of the services that their clients provide. While construction has mostly continued through lockdowns, it hasn’t been at full capacity and, as a result of labour shortages and lack of overseas workers, human capital is in high demand. When you combine these factors with easing restrictions, demand for PPE’s services could lift considerably. With healthcare making up a huge chunk of PPE’s EBITDA we can also see the pent up demand for elective surgeries being a huge driver of PPE’s business when restrictions ease. As well as this, there are huge fiscal stimulus plans in play where a lot of the money will go towards infrastructure development, another tailwind for PPE.
Acquisitions
PPE has a strong pipeline of acquisitions and is well funded to pursue them with $50-70m of available funding through debt and free cash; given their strong funding the strategy is non-dilutive to shareholders. Their past acquisitions have been earnings accretive and have expanded the industries PPE operates in. Their most recent acquisitions, Techforce Personnel and Vision Surveys, increased earnings per share by 19% and the combined deal was done on a valuation of circa 3.7x pro forma EBITDA. Their acquisition strategy opens up new regions for PPE to capitalise on and creates a much bigger addressable market for the group, as seen by their move into the healthcare recruitment space.
Source: PPE company filings, February 2021
Valuation + Outlook
PPE has been a consistent performer since listing in the backend of 2017; they beat their initial forecasts and have grown their earnings significantly. The company has strong cash flows and isn’t capital intensive. They are well funded to execute their acquisition strategy which, to date, has proven to be accretive to earnings growth.
Souce: PPE company filings
PPE is currently trading at an EV/EBITDA of 10x. The company has proven they can grow through their acquisition strategy and expand their services into new industries. Heading into a post-covid environment, PPE will gain from the current labour shortages and upcoming infrastructure spending. As mentioned above, the pent up demand for elective surgeries is huge and PPE is now a top two provider of healthcare recruitment in Australia, benefiting from the demand in healthcare workers due to covid-19.
Source: PPE company filings
We see PPE as a company that is not only cheap but also well placed to benefit as the country opens back up. Our valuation for PPE is $5.
Disclaimer: Both HLA and PPE are currently held in TAMIM portfolios.
This week we thought it may be pertinent to revisit our thesis around iron ore and in particular look at the big three players given the brutal nature of recent sell-offs of all three. Is it perhaps time to buy?
A Little Context
Author: Sid Ruttala
We’ve previously – late last year – made the bull case around the spot prices for iron ore (when the ore was trading at approx. 120 USD/T). Our reasoning here was summarised in a twofold explanation; 1) demand due to the likelihood of steel output staying consistent due to flooding in China; and 2) the increased fiscal expenditure globally, largely on infrastructure, which should see a disentanglement of the spot prices from Chinese demand.
Recent price action, however, suggested otherwise with spot prices tumbling from a peak of 228 USD/T in May to now trading at 117 USD/T (at the time of writing). So, what’s happened and why the decline?
The elephant in the room remains China. With China accounting for 70-75% of iron ore imports globally, any changes in demand have outsized impacts upon the global market. Beijing recently imposed caps on steel output as a result of and in the lead up to the 2022 Winter Olympics in the hopes of cutting emissions and controlling pollution. With domestic output having been allowed to expand beyond these caps through 1H21, we are likely to see continued declines until at least February of next year when the Winter Olympics are to be held. Combine this with some production coming back online in the form of Vale (Brazil), we have what may be considered a perfect storm.
Let’s now return to the second part of our argument; the disentanglement of spot prices from Chinese demand. Here we are seeing signs of reprieve. Take, for example, German import prices released by the Federal Statistics office, which saw the largest increases in import prices in close to forty years. Although this may be a result of supply bottlenecks, we are seeing increased demand for raw materials, with iron ore cost and end steel rising 95.8% in August, a period in which China’s imports of the product also hit peak. This indicates to us two things; first, Beijing may have coordinated a scenario where first half production was intentionally pushed above caps to taper off in the second half in the lead up to the Winter Olympics and, second, there is still surging global demand for the product on a longer term basis. This second aspect seems to be at play here. Major steel-producing provinces and regions are seeing inventory declines even during the offseason, with higher transaction volumes than would typically be the case in off-season markets this time of the year.
All this is to say that we are likely to see demand pick up with a vengeance coming out of the Winter Olympics and a rather messy situation in the lead up. This may be somewhat mitigated by shorter-term supply issues in the form of Vale, the most recent of which being 39 miners getting trapped in an underground mine at Totten. Nevertheless, we are still likely to see negative price action in 2H21 (or at the very least a consolidation pattern sideways) with 90 USD/T a great possibility.
Looking to the Longer-Term
Looking to the longer term, however, our thesis broadly remains intact. That is, the continued fiscal impetus globally should see a rather massive tailwind for raw materials and steel. The oft touted Green New Deal Stateside is, in our view, likely to gain momentum in some form despite the recent gridlock in Congress. The more liberal wing of the democratic party may get its way with the stimulus bill despite facing an uphill challenge in the Senate. Why do we say so?
The political imperative remains strong. Think for a moment about the voting patterns of the so-called Rust Belt and where US steel production is likely to take place should some semblance of the expansive infrastructure package be rolled out. These remain key and decisive swing states, Pennsylvania being one and Indiana, a key Republican stronghold and the largest producer of US steel, being another. All things equal, we are likely to see some incentive and political consensus especially when it comes to this aspect. What does this have to do with iron ore? Simple, we are likely to see further demand increases from the US.
Looking more globally, other key players continue to be the EU, where the marked shift to renewables is gaining traction for better or worse (most recently it has been in the news because of supply bottlenecks in traditional fossil fuels and an inability to cope with increased demand during winter). Nevertheless, we continue to see increasingly aggressive targets set by the Commission which formulated a directive to have 32% of energy consumption come from renewables by 2030. This came with a clause for upward revision in 2023 and carbon neutrality by 2050 (i.e. Renewable Energy Directive 2018/2001). Looking to emerging markets such as India where, notwithstanding recent cyclones that have buffeted steel producing states like Andhra Pradesh, we are seeing what could be termed as an infrastructure boom enabled by the government. Longer term, we see continued impetus on infrastructure spending, specifically transport infrastructure. We have seen the most recent union budget allocating close to $32bn US to the sector and new initiatives to wean the country off its reliance on diesel. Again, a focus on renewables also bodes well for the demand for iron ore. This remains a longer term play however, with ore imports still facing stiff competition and the steel industry being very much in its infancy.
So, buy now or wait it out?
For the purposes of this article, let’s limit ourselves to the big three, BHP, RIO and FMG. All three have seen incredible declines from peak to trough. -32% for BHP, -43% for FMG, -28% for RIO. We make the case that, given the above rationale, the market may have overdone it. But, even assuming a 90 USD/T base case, we would still extrapolate a return to investors of 25% for BHP at this price (inclusive of dividend yield and assuming continued payout ratios of 90%). This is within the context of the spin-off in the petroleum business, continued upward pressure in the other aspect of steel production, coking coal, and BHP’s recent move into potash which we estimate should give an internal rate of return of 15% over the next 5 years (this is above management guidance (12-14%) given where we see agricultural markets going, but that is an article in and of itself). So, BHP? Perhaps a good buy.
Let’s get to Rio which continued to sell off, perhaps not as aggressively as the other two but consistent nevertheless. We also found this to be a little overdone and the market seems to have misplaced or overlooked the fact that this particular business has some of the largest uranium mining operations in the world. Given our thesis around that particular commodity (which we wrote about last year), we think RIO presents as a solid buy at the current price of $96.89 AUD. This implies a dividend yield of 10.9%, however, let us strip out the recent price action in iron ore and in fact go with the lower bear case of 90 USD/T, assuming current payout ratios hold we would still expect a yield of 8%.
FMG, the pure play iron ore major, is another interesting story. Given the lower grades, it sits in the firing lines when it comes to any moves by Beijing to cut emissions. We do however contend that management has always had, and continues to have, good relations with the broader business community and has done a stellar job at managing its relations in that particular context. For those that have joined us in our line of thought around spot prices and the longer term potential, FMG offers a higher risk-reward play. At current prices, the implied dividend yield is a ridiculous 24%. Let us again use the lower for longer base case scenario of 90 USD/T. Assuming production stays consistent, we would still expect a grossed up dividend yield of approximately 11%.
So, basically, sell offs have been painful if you where an investor but all three present opportunities going forward in our view. BHP and RIO offer good value at current prices while FMG offers exceptional value if (and only if) you agree with our contention around the future of iron ore prices.
Disclaimer: BHP, FMG, RIO are currently not held in TAMIM portfolios.
This week brings us to the last in our series on the search for quality dividend yields with Cromwell Property Group (CMW.ASX) and Worley Ltd (WOR.ASX) rounding out our journey.
Cromwell Property Group (CMW.ASX)
Given the headwinds faced by Australian office demand, in many ways catalysed or at least accelerated by the pandemic, it may sound surprising that we would consider this particular business. However, given the current valuation, this may prove to be a surprisingly solid investment proposition. First though, a little context around the business.
Listed in 1998, Cromwell tells the story of a great Australian success. Currently operating in fifteen countries and managing a total of $11.8bn in AUM. The core strategy has been to avoid highly priced office assets in CBD markets, opting instead for more reasonably priced and higher yielding secondary markets. Many of you may be more familiar with the business for all the wrong reasons though, with FIRB (Foreign Investment Review Board) stepping in to block a takeover and the CEO Paul Weightman retiring (rather conveniently) after 22 years in the business. A situation not helped by headwinds resulting from Covid and a downgrade in distribution guidance. A rather unloved proposition by the market with the share price trading at 88c at the time writing (from a pre-covid high of $1.23).
So why does this make a reasonable proposition?
Author: Sid Ruttala
Firstly, the valuation. We feel that the risks associated with the fall in office space may be a touch overdone. While it is true that bargaining power is much more to the advantage of the renters, with an NTA per share sitting around the $1.00 AUD mark, even the worst case scenario associated with rental income cannot substantiate the current valuation (remember the 88c share price, for a market cap of about $2.3bn). It is the profile of the tenants that we feel the market is not properly considering, with 40% accounted for (in terms of income) by the government and a further 15% accounted for by Qantas, who are on a 15 year lease).
Secondly, we feel that the downside risks to office space are currently overdone. It is true that there is an increased tendency to go towards flexible work or at least office hours and part-time work but there still remains a space for the traditional office environment. One could, for example, argue that in the 1990s (during the initial stages of the dotcom era) office space would have faced substantially higher headwinds given the move towards part time work and higher structural unemployment. This time around we feel that the nature of the fall in demand and unemployment (i.e. Covid-related) is more transitory and the economy will see a faster recovery in employment (and thus demand for office space) than in the past. Something which we, again, feel the market is discounting in its valuation.
Thirdly, we arrive at the management and boardroom drama. The business has refreshed its board and management ranks over the course of the last financial year. Included among the fresh faces are a new CEO in Jonathan Callaghan (former head of Investa) and Gary Weiss (of great pedigree having served on the boards of Westfield and Premier).
With that, to the numbers. Statutory profit was up 73.5% to $308m, while underlying operating profit was down by 13.1% to $192.2m. Rather messy numbers on face value but one also has to strip out one-off items, including the sale of Northpoint. Adjusting for this, the business’ operating profit was up 140bps.
So, why does it make sense now?
Quite simply, the current price. Despite the potential for continued lockdowns across her major markets, with NTA at 1.00 AUD, this seems like a good investment proposition. This, along with a seeming turnaround as a result of the change in management and the opening up (though it may not feel like it in the short-run for many of you living in lockdowns) of the economies, makes for an interesting proposition when the dividend is also considered.
Red Flags & Risks: Put simply, debt on the balance sheet. With an average weighted maturity of 3.2 years and 42% gearing, this component remains the biggest risk on the balance sheet. We would ideally like to see management locking in longer duration, even at the risk of higher debt-servicing costs.
Dividend: 8% dividend yield. Expecting this to grow by 10% in 2023.
Worley Ltd (WOR.ASX)
Coming to the last stock of the series, we look at Worley Ltd. Another engineering and services business (we have previously spoken about CIMIC and SSM). Another unloved business that we feel that the market may be wrong about.
For those that are less familiar with the company, a little context. Simply, Worley provides engineering and professional services to the oil, gas, utilities, mining and infrastructure sectors. Most Australian investors (if you have had previous experience with the company) would see it as driven primarily by hydrocarbons given that 75% of the businesses revenues used to come from that segment. Indeed, we feel that this may be the reason why, like much of the energy sector in general, the market continues to discount the business. However, WOR’s rather smart acquisitions, including Jacobs ESR, recently have seen this reliance come down significantly. Hydrocarbons now accounting for 52% and chemicals (previously accounting for 6%) increasing to 23%.
In addition, the business has global scale. Operating in over fifty countries gives WOR a scale that is difficult to replicate. Moreover, given that most of the contracts are of a cost-plus nature, the risk from project delays and cost overruns (which are the most significant risks to the sector) remain minimised.
So, why does this make a reasonable proposition?
Again, returning to our commodities thesis, we stand firm that we are at the infancy stages of a multi-decade secular bull cycle in commodities. However, for the more conservative investor that wants to take advantage as well as gain exposure to thematics such as the transition to green energy, we feel businesses like Worley may be a more reasonable option (as opposed to paying egregious valuations for end producers). For the more impatient, one metric that is of particular importance is that the backlog in work is $14.5bn AUD as of March 2021 (a notable increase from $13.5bn at the end of December). In other words, we know the business has significant and sustainable cash flows from its traditional footprint over the short-to-medium term. This is important while WOR focuses and uses it to advance its longer-term ambitions, including sustainability and green energy in particular. One other metric that might be of interest is the fact that the global market for sustainable design is approximately $4.5tn USD, of which WOR’s addressable market share is 10-20% (or $900bn USD). For decarbonisation, this is around $1.5tn USD with an addressable market share of 3-5%. To put this in a little more context, the current revenues for Worley are $10bn AUD.
With that, numbers! EBITDA was down 25% to $649m, operating cash flow down 24% to $533m AUD. These may seem like rather lacklustre numbers but context is key here. We feel that this is a one off (importantly, revenues remained rather stable) with Covid related impacts the main driver and, accounting for the work backlogs, we should see this return to historic levels (assuming normalisation) within FY 2022. Moreover, the business has been deleveraging with Net Debt/EBITDA coming down to 1.9x.
Red Flags & Risks: Covid continues to be the biggest threat to the business with the situation in China and the Delta Variant creating broad risks.
Dividend: 4.7%, expecting double digit growth over the next 24 months.
Disclaimer: CMW is currently held in TAMIM’s Listed Property portfolio.
This week brings us to the second to last in our series on the search for quality dividend yield, looking at Bapcor (BAP.ASX) and G8 Education (GEM.ASX).
For one thing, the auto parts market in Australia and New Zealand remains a highly fragmented industry with BAP being a leader in consolidating across the space. Its size not only gives it economies of scale but significant buying power and the ability to allocate inventory in a manner hard to replicate by smaller scale competitors. Moreover, the take up of electrical vehicles remains in its infancy across BAP’s major markets (i.e. new car sales with no internal combustion engine currently make up less than 1% of the market) and effectively represents a rounding error within existing Australian fleets (which is what is relevant at least in the short term). This aspect gives the business enough lead time to transition towards EVs and spare parts within that market in addition to its ICE footprint. One disclaimer here is that EVs typically have fewer moving spare parts; we expect volumes to be an issue over the longer run though certain niches and non-specific categories to be consistent (e.g. windscreen wipers or lighting).
Author: Sid Ruttala
Moreover, the segment in which Bapcor operates is in our view quite defensive given that, unlike new car sales, the market for spare parts tends to be more resilient and less driven by consumer discretionary income on the downside. While on the upside stagnant wage growth perversely produces a tailwind given the likelihood of consumers sticking to their existing vehicles and buying second hand in preference for new purchases. On the upside, Covid created a catalyst for the business in two ways, one transitory and the other likely to stay into the medium term. The first is the continued government stimulus measures which saw consumers opt towards upgrading existing cars and the second being the more longer term likelihood of domestic travel in preference for international as the world continues to battle with the Delta variant (i.e. elevated domestic travel). Indeed, this is reflected by the average age of on-road vehicles. There are currently more than 14m vehicles in circulation with an average age of greater than 5 years.
With that context let’s get to the numbers! Revenue was up 20% to $1.763bn, EBITDA up 20.8% to $280m and NPAT up 46.5% to $130m AUD. Arriving at the juicy and all important part, the metric that we feel most relevant given the capital intensive nature of the business, the requirement for inventory. ROIC came in at 11.6% (up 2.31%). Leverage also continues to be managed conservatively, standing at 0.7x debt to earnings (flat).
Red Flags & Risks: Continued lockdown measures and related unemployment numbers provide substantial risks by decreasing the distance driven. The risk of online sales for non-essential parts could also act as a long-term headwind for the business though management has been investing into its omnichannel strategy. At a PE of 22x the business is also pricey.
Dividend Yield: 2.6%
This is, however, a dividend growth story and we expect them to grow in the high single digits.
G8 Education (GEM.ASX)
This is a business that continues to be deeply unloved by the market, never quite recovering from the Covid-related sell-off as uncertainty continues to persist within the broader childcare segment. Before delving further, a brief summary of the business. G8 Education is a childcare provider that currently operates around 500 facilities across the nation. Its model was primarily acquisition driven thus far, buying smaller privately owned operators within the space at a multiple of 4x earnings and issuing debt/equity at lower multiples than acquisition. A smart strategy for the time and allowed it to grow EPS in the high single/low double digits through its initial growth phase. On the flip side, this has also meant that management operated it along the lines of a listed private equity type model, stripping out costs in preference for high payouts and service quality.
As can be imagined, Covid and the related lockdowns turned out to be significant headwinds for the business. The firm cancelled dividends through last year. With that in mind, it may be surprising that we would consider GEM, but here is the flipside. G8 operates in an industry that should see significant tailwinds from a policy and demographic perspective with a growing population of 0-5 year olds and government support for the sector. Currently, around 60% of childcare costs are subsidized at the federal level which continues to increase thanks in no small part to Australia’s short election cycles. And, with an aging demographic, we feel that this is one area where there is broad policy and economic consensus as childcare will be increasingly crucial in boosting productivity and participation rates amongst the half of the population taking on primary care responsibilities.
Given the above tailwind, we believe that the business has hit critical scale to focus more on organic growth as opposed to its historic strategy (many of you may be familiar with ABC Childcare and that particular debacle in the GFC). Here is where we feel that management can add the most value, especially within the context of competition from the not-for-profit sector and the highly fragmented nature of the industry. There is scope for improvement in improving quality of delivery and balanced cost outs especially through the implementation of smart-rosters, reduction of direct consumables (which make up about 10% of the cost base) as well as better negotiation of lease agreements. We will continue to watch those metrics. From a dividend perspective, given the fiscal incentives provided by the government during lockdowns we feel that it was a good move to suspend on an interim basis but expect reinstatement through 2022.
Now, let’s get to the numbers (which will be in comparison to 2019, as opposed to 2020).
Revenue was down 2% to $421m, EBITDA down 6.1% to $102m, NPAT up 83.1% to $25m AUD. Honestly, quite messy numbers but the metrics seem to be stabilising across the business given the significant 244m loss in 2019. Moreover, with management raising equity capital in 2020 and retiring all its existing Net Debt, we feel that the worst of the turbulence is now behind them. Liquidity remains strong with undrawn facilities amounting to $400m.
So, why does it make sense?
Quite simply, the current price. Despite the potential for oversupply in the market, we feel that the sell-off is overdone. Especially when considering a likely stabilisation in the business and, as the population continues to get vaccinated, we should hopefully see lockdowns ease heading into next year. We also see dividends coming back in CY22 and, assuming previous payout ratios, with the reduction in leverage it gives investors the potential to lock in an approximate 4% yield with the potential for longer-term growth given the tailwinds in the sector.
Red Flags & Risks: Given the centrality of subsidies to the sector, the business remains uniquely exposed to any changes in government policy. Continued lockdowns and oversupply also remain key threats in the short-to-medium run.
Dividend: 4.1% (expected) dividend yield, assuming continued recovery into next year.
Disclaimer: BAP & GEM are currently held in TAMIM portfolios.
This week we will be talking about one of our three pillars and a key theme in our Global Mobility portfolio; the pillar centred around electrification of vehicles and a stock we believe is well-positioned to capitalise on the significant increase in lithium demand.
Author: Adam Wolf
This year we have seen a lot of action in the lithium space, with the price of the alkali metal doubling and stocks like SYA and VUL seeing 1000%+ gains. We also saw the likes of BMM and CHR surge 250% after listing on the ASX. The company in question today is Albemarle Corp, listed in the US and trading at a $30bn market cap. Unlike a lot of the lithium stocks you come across, Albemarle is involved in multiple projects that are already producing lithium. They are the largest producer of lithium in the world.
Albemarle Corporation (ALB.NYSE)
Albemarle is a global specialty chemicals company based in the US. The company operates through three segments: Lithium, Bromine Specialties and Catalysts. The Lithium segment develops lithium-based materials for a wide range of industries including the manufacturing of the lithium ion batteries used in electric vehicles. ALB’s Bromine Specialties segment is focused on bromine and bromine-based business, which includes products used in fire safety solutions and other specialty chemicals applications, while their Catalysts segments are used in the downstream oil process to refine oil. ALB controls the strongest vertical position in the lithium industry; they have the technical expertise for both processing lithium and specialty product manufacturing.
Source: ALB company filings
Source: ALB company filings
Lithium is the primary component of lithium-ion batteries (LIB), which are rapidly gaining traction due to their wide applicability in energy storage solutions, in particular solar and wind energy projects, and the strong demand in the electric vehicle (EV) sector.
Lithium is very difficult to process and requires significant capex on necessary infrastructure to produce and manufacture it into specialty products. Data from Benchmark’s Lithium Forecast shows a projected annual lithium supply deficit of up to 225,000 tonnes in North America and 500,000 tonnes in Europe by 2030. To incentivise the right amount of investment in new mines there is going to have to be a sustained period of elevated prices. Bringing deposits into production is a time consuming process and can take years to undertake all the feasibility studies and actually construct a mine. Lithium deposits can either be produced from brine or spodumene rock production. Brine production is far cheaper and significantly more environmentally friendly.
Source: ALB company filings
Our outlook for robust lithium demand is primarily predicated upon increased demand for electric vehicle batteries. Albemarle produces lithium from both salt brine deposits in Chile and the US and hard rock joint venture mines in Australia.
Battery Innovation Center
Recently ALB completed their Battery Innovation Center in North Carolina, the centre will enable ALB to research new materials and processes and incorporate them into battery cells for performance testing. With this new resource, ALB will be well equipped to optimize their lithium materials for a drop-in solution that helps them deliver high-performing cost-effective batteries for customers in the rapidly growing electric vehicle market. ALB isn’t like any other lithium company that produces the concentrate and sells it through off take agreements; they are a fully integrated company from the production of the metal to manufacturing of the battery and are innovating their end solution.
Bromine
Albemarle is also one of the world’s largest producers of bromine. Bromine is used as a flame retardant that provides properties in order to keep our electronics safe. Bromine will be a winner from the transition to 5G, a thematic that we also have exposure to in the Global Mobility portfolio. The shift to 5G relies on printed circuit boards to transmit signals, all the materials involved will need fire retardants like bromine to keep consumers safe.
Why Albemarle?
Many people would look at ALB and conclude they are an overvalued stock. But! We believe their technical expertise and the runway for lithium more than justifies the premium. Unlike in other mineral industries, ALB has been able to establish a dominant position in the lithium market due to their technical expertise in processing, allowing them to achieve significant economies of scale across their operations. ALB has a lithium footprint spanning the globe covering key markets. They have multiple joint venture interests in producing lithium projects; both in South American brine projects as well as interests in rock projects in Australia and China, which is a low cost jurisdiction. They also have production plants in Germany, giving them a fully integrated supply chain and access to the car makers in the heavily environmentally mandated EU jurisdiction.
Source: ALB company filings
ALB is on track to produce 125k tonnes of lithium hydroxide this year and has interests in a number of advanced projects in Australia, America and China which will head into production over the next few years as part of ALB’s stage 3 and 4 plan. They are aiming to be producing 450k tonnes of lithium hydroxide per annum. To put in perspective how big that is, Vulcan Energy are currently conducting a DFS on their brine projects in Germany to produce just 40k tonnes per year.
Source: ALB company filings
There are many companies one could invest in to gain exposure to lithium but how many of those companies can say that they have grown their dividend for 27 consecutive years and are delivering over $800m of EBITDA at a margin of 26%? ALB is the clear leader in lithium production and processing, they have low cost brine projects in South America and they have the balance sheet to pursue their lithium strategy and are innovating the lithium ion battery. There are no other lithium focused companies that have the technical expertise and access to the cash and credit necessary to scale their operations. ALB recently sold their fine chemistry business for $570m USD and this will enable them to focus on their core lithium strategy, pursue more M&A opportunities, acquire more interests in lithium projects and invest further in their development processes.
We see ALB as a company that has significant leverage to the lithium upside but at the same time has other profitable businesses in their Catalyst and Bromine divisions. This enables them to return cash to shareholders while also funding their lithium operations without diluting shareholders like many pre-production lithium companies are doing. As mentioned, it takes years to bring a lithium project into production and a lot can go wrong in that time. ALB is already one of the largest producers of lithium and has high quality, proven and large scale projects. They are achieving significant cost benefits as a result of their technical expertise and vertical integration. ALB offers full exposure to the lithium product cycle from the ground all the way to the battery in your electric vehicle.
Source: ALB company filings
Using ALB’s estimates of future production, their lithium segment could be contributing well over $1.5bn of EBITDA to the business. It is worth noting that this is assuming their margins don’t increase as a result of lithium price appreciation.
ALB is a profitable company that ticks all the boxes for the investment focus of our Global Mobility fund. They will benefit from the increased production of EVs through their lithium operations, this increased production is effectively being mandated by governments around the world via green initiatives and targets, tax breaks and rebates. Regardless of your personal opinion on electric cars, it’s happening. While not quite the opportunity afforded by lithium, ALB will also be a winner from the rollout of 5G and IoT through their Bromine division. Rather than buying companies in the exploration stage, we are looking to buy and hold established players in the industry that have the skillset and the funding to capitalise on the rise of EV production. We see ALB dominating the lithium production and processing market while also expanding their scale through near-production projects and potentially via M&A activity.
Disclaimer: ALB is held as a long position in TAMIM’s Global Mobility portfolio. The TAMIM Global Mobility strategy seeks to to capitalise on the ongoing $7 trillion autonomous and electric vehicle revolution.
Given the headwinds faced by Australian office demand, in many ways catalysed or at least accelerated by the pandemic, it may sound surprising that we would consider this particular business. However, given the current valuation, this may prove to be a surprisingly solid investment proposition. First though, a little context around the business.
Coming to the last stock of the series, we look at Worley Ltd. Another engineering and services business (we have previously spoken about CIMIC and SSM). Another unloved business that we feel that the market may be wrong about.
This is a business that continues to be deeply unloved by the market, never quite recovering from the Covid-related sell-off as uncertainty continues to persist within the broader childcare segment. Before delving further, a brief summary of the business. G8 Education is a childcare provider that currently operates around 500 facilities across the nation. Its model was primarily acquisition driven thus far, buying smaller privately owned operators within the space at a multiple of 4x earnings and issuing debt/equity at lower multiples than acquisition. A smart strategy for the time and allowed it to grow EPS in the high single/low double digits through its initial growth phase. On the flip side, this has also meant that management operated it along the lines of a listed private equity type model, stripping out costs in preference for high payouts and service quality.
Albemarle is a global specialty chemicals company based in the US. The company operates through three segments: Lithium, Bromine Specialties and Catalysts. The Lithium segment develops lithium-based materials for a wide range of industries including the manufacturing of the lithium ion batteries used in electric vehicles. ALB’s Bromine Specialties segment is focused on bromine and bromine-based business, which includes products used in fire safety solutions and other specialty chemicals applications, while their Catalysts segments are used in the downstream oil process to refine oil. ALB controls the strongest vertical position in the lithium industry; they have the technical expertise for both processing lithium and specialty product manufacturing.
Source: ALB company filings
