Lepidico — Big swings and small roundabouts

Since our last note in December 2021, it has become clear that Lepidico has experienced, and is experiencing, ongoing delays, in particular in engineering works and the matter of assay turnaround times. These are not unique to Lepidico. As a result of the COVID-19 pandemic, one laboratory in Perth closed, while others have been working on either reduced hours or with a reduced workforce. As a consequence, the metallurgical testing industry’s capacity to process samples sent in for assay has reduced by approximately 30%.

In Lepidico’s definitive feasibility study on its integrated Karibib mining and concentrating and Abu Dhabi chemical plant – led by consultants Lycopodium – certain assumptions were made regarding the cost and operating performance of the major mechanical equipment within the chemical plant. One of these related to the cost and performance of the filters to be used in the plant. However, whereas cheaper filters with an adequate performance had been assumed for the purposes of Lycopodium’s DFS, subsequent more detailed work has established that so-called ‘plate & frame’ filters contribute to a notably superior performance of the plant and a better recovery of end-product chemicals. Substitution with plate and frame filters will have some impact on overall capital expenditure offset by improved efficiency. The water requirement in the plant has increased as a result, which will also necessitate an increase in crystalliser capacity. We have conservatively allowed an additional US$10m in capex for this refinement to the flowsheet versus Lycopodium’s US$96.2m DFS chemical plant capex estimate, which was conducted to an accuracy of ±15% in May 2020. At the same time, however, we note that the need for the associated design alterations is likely to delay the front-end engineering and design (FEED) workstream until mid-CY22.

In the meantime, Lepidico has commissioned a lithium hydroxide monohydrate trial at its demonstration plant, which will continue until early March. The results of the trial are important to the design and specification of the back end of the plant and, whereas previously the official results might have been expected to have been known later the same month, the requirement for prudence has caused management to plan around the possibility that the results will not be available until April-May.

An additional, likely refinement to Lepidico’s chemical plant design will be the installation of surge capacity at several stages within the flowsheet to allow for much greater plant operability and up-time. In particular, this will allow discrete maintenance to be performed on one section of the plant, while the remainder of the plant stays in production, rather than being required to shut the plant in order to perform maintenance on one specific section. In practice, this refinement will require the inclusion of storage tanks into the plant’s design. Once again however, we do not expect this to have a material effect on capex, although it will nevertheless represent a modest addition relative to the US$96.2m estimated in May 2020 (see our note, Valuation update post-feasibility study, published on 20 July 2020).

The prices of both lithium carbonate and lithium hydroxide have increased sharply since our last note on Lepidico, as the market has been squeezed upwards having previously been in the doldrums notably longer than almost all other metals, owing to its much greater exposure to the EV sector. Thus, whereas the prices of other base metals recovered from approximately March 2020 onwards, the price of lithium carbonate continued to decline until late October and barely recovered to finish close to its low for the year (rather than high, as for most other metals). As a consequence, exploration and mine development was severely curtailed in the period 2018–20, with the result that the long-term thesis in support of lithium remains, to all intents and purposes, unchanged (ie EV demand to account for nearly half of all cars sold by 2030, battery power to increase 13x relative to today and lithium demand to sextuple from 2019 to 2030), but after two years of ‘lost’ time and investment in the interim. As a degree of normality has returned to the world economy in 2021, therefore, there has been a period of restocking of lithium chemicals and concentrates – especially in China – superimposed onto a background of previously depleted inventories throughout the supply chain, causing lithium prices to bounce sharply. Moreover, this trend has accelerated into the New Year, as evidenced in the graph below of benchmark prices in North and South America.

Quarterly contract pricing increases (negotiated in the September to November period) have similarly been observed for 2022, and spot prices in China have recently exceeded US$50,000/t.

Our previous price assumption for lithium hydroxide (Lepidico’s principal product) had been based on an assumed long-term lithium carbonate price of US$12,000/t and a 25.8% price premium of the former over the latter, driven by the statistically significant relationship between that premium and the latter’s price since February 2016. However, as the following graph makes clear, this correlation now appears to be in the process of either breaking down or shifting to a ‘new paradigm’.

One justification for the apparent shift in the observed relationship between the lithium carbonate price and the lithium hydroxide price premium is that, historically, the bulk of lithium was produced from South American brines, which are typically processed into lithium carbonate. This could then be further processed into lithium hydroxide, albeit at a cost which was recouped in the form of the lithium hydroxide price premium. Hence, lithium hydroxide almost invariably traded at a premium to lithium carbonate to reflect the cost of conversion. At present, however, the majority of new lithium capacity is in the form of hard rock mining to produce spodumene concentrate and thence to lithium hydroxide without the need for a lithium carbonate intermediate product. Hence, in future, unlike the past, there will be no (or, at least, a reduced) expectation of a causal relationship between the price of lithium carbonate and the price of lithium hydroxide. That being the case, and in recognition of the current squeeze in the market, the continuation of the secular trend towards increased lithium demand and the two-year period of ‘lost’ investment between 2018 and 2020, we have now revised our short- and long-term forecasts for lithium carbonate and lithium hydroxide prices to those shown below.

While the near-term increase in our price forecasts for lithium hydroxide may appear large in percentage terms, they should be considered in the following context:

Note that, within this context, Lepidico, which had calculated its reserves previously based on a price of less than US$13,000/t, is expected to re-calculate them again mid-year at a yet to be determined (but likely higher) price.

In the light of the ‘big swings’ and ‘small roundabouts’ discussed previously, we have made the following adjustments to our financial model of Lepidico:

All other assumptions and forecasts remain unchanged.

Project

Lepidico’s DFS (see our note, Developing to the (L-)Max, published on 29 May 2020) calculated a project NPV8 for the integrated Karibib mining and chemical plant operation of US$221m, or A$310m (5.0c/share on a pre-funding basis and 3.9c/share on a post-FY22 equity funding basis) at the current foreign exchange rate of A$1.3936/US$.

In our report Gold stars and black holes, published in January 2019, we calculated a mean enterprise value for companies with projects at the DFS stage of development of 30.9% of project net present value (NPV), ranging up to 133.5%. This alone would imply a pre-funding valuation for Lepidico of 1.5c/share, ranging up to 6.7c/share.

Company

Our valuation of Lepidico varies from our value of the integrated Karibib mining and chemical plant project in that it takes into account Lepidico’s 80% interest in the Namibian mine (but 100% of the Abu Dhabi chemical plant), which will give rise to both a tax-paying position in Namibia and a minority interest in the profits generated from mining operations. It also assumes ongoing corporate costs in the order of A$3.1m per year.

In our last note on the company, we calculated a value for Lepidico’s shares of 5.43c plus 0.27c for the value of an envisaged loan to the minority shareholders in the upstream Namibian operation to give a total valuation for the company of 5.70c/share. In the wake of the changes discussed above, our (discounted) valuation of Lepidico’s future (maximum potential) dividend stream to shareholders has now increased by 18.0%, from 5.43c to 6.41c/share in FY21, rising to a peak of 8.98c/share on the cusp of the company’s first material dividend in FY26, as shown in the graph below:

To this valuation of 6.41c/share should then be added the value of Lepidico’s envisaged future loan to the minority shareholders in the Namibian mining and concentrating operation, which we estimate at 0.23c/share (fully diluted), to result in a total value for Lepidico’s shares of 6.64c/share (cf 5.70c/share previously), based solely on its Phase 1 project. A ‘bridge’ chart, showing the transition in valuation from 5.70c/share to 6.64/share by component is provided below.

To this valuation of 6.64c/share may then be added an (updated) potential risk-adjusted 0.73–1.77c/share (fully diluted) for a conceptual 20,000tpa LCE Phase 2 plant (see pages 4-6 of our note, Phase 2 coming into view, published on 18 June 2021, updated for a long-term lithium hydroxide price of US$18,000/t), to take the total aggregate conceptual valuation to 7.37–8.41 cents per share.

Two of the principal risks to which our valuation of Lepidico is exposed are: 1) the long-term price of lithium hydroxide; and 2) the price at which it raises future equity. The effects of variations in the long-term price of lithium hydroxide from the one currently assumed (US$18,000/t) are shown in the table below:

At the same time, our financial model assumes that Lepidico will raise US$41.8m/A$58.3m (gross) in FY22 at a share price of 3.4c to achieve a future (project) maximum net debt:equity ratio of 70:30 and a (company) maximum net debt:equity ratio of 54:46. Exhibit 7 demonstrates the sensitivity of our valuation to variations in this assumption, as follows:

Note that Lepidico may choose to source all (or a portion) of this future equity funding requirement from a strategic partner after debt funding has already been secured. In this eventuality, it is possible/likely that a higher price than that currently prevailing could be supported.

Lepidico has recommenced exploration drilling again within its 68km2 prospecting mining licence area, with a view to increasing its resource to a size that is sufficient to support a Phase 2 plant. Initial focus will be on Helikon 2-5 and other lithium pegmatites that have yet to be drill tested.

The current resource at Helikon 2-5 amounts to 2.2Mt at an average grade of 0.41% lithium oxide, distributed between the various Helikon deposits as follows:

At 0.41% lithium oxide, the average grade of Helikon 2-5 compares well with the average resource grade of Rubicon 1 and Helikon 1 combined of 0.43% and the average reserve grade of Rubicon 1 and Helikon 1 combined of 0.46%.

Management’s initial target is to increase the combined resource at Helikon 2-5 from 2.2Mt to 6.0Mt, which it believes would be sufficient to support a Phase 2 plant of approximately the same size as its Phase 1 plant of c 5,000tpa, which could be located in either Namibia, Europe or North America (note that this compares with the aggregate tonnage of 9.0Mt at Rubicon 1 and Helikon 1 currently dedicated to supporting the Phase 1 plant). Beyond this, management believes that a 10–12Mt resource inventory would support a c 10,000tpa Phase 2 plant. However, the ostensible goal of the programme is to delineate a resource of 25Mt, which management estimates could support a full 20,000tpa Phase 2 plant.