Lepidico — Everything moving all at once

Since our last note on the company (see Quantifying exploration’s dividends, published on 6 October 2022), Lepidico has:

This note updates our valuation for all of these developments. In addition, we have revised our short- and long-term lithium prices higher.

A full explanation of the methodologies and philosophies behind the changes in our lithium price forecasts is included in our report, Lithium’s adolescence, published on 1 February. The report includes a review of both long-run and short-term lithium prices. For long-run prices, we have surveyed available public data on new greenfield and brownfield projects to check timing, capital intensity and potential operating costs and also considered the supply challenge through to the end of the 2020s. Our short-run forecast is constructed on both an unrisked and risked basis, the latter allowing for a range of delays that could affect advertised project ramp-up schedules. The next 12–24 months are particularly uncertain given questions over the timing of supply additions, but the longer-term need for additional greenfield and brownfield expansion capacity is clear.

Our key conclusions include:

As a result, we have raised our short-term price forecasts to reflect recent price moves, and acknowledge near-term uncertainty. We project a potential supply/demand surplus on an unrisked basis in 2023, but a more balanced market once potential risks are incorporated (including technical risks, commissioning risks and other general delays). Short-term price momentum may dominate sentiment, but the longer-term need for additional capital spending is the core theme underlying lithium for the 2020s.

Lithium prices have been volatile over the past year, spiking to a peak of just over US$80,000/t (LCE spot basis) and averaging US$62,000/t in 2022. At the time of writing, spot prices for carbonate had eased slightly to approximately US$70,000/t. This compares to the average carbonate spot price in China of only c US$6,200/t in 2020. Lithium was the best performing commodity in 2022, outperforming all other industrial metals by a wide margin.

Forecasting average prices for 2023 is particularly uncertain given that prices are relatively high and the supply/demand outlook is particularly dependent on the ramp-up in projects. As a result, we have raised our 2023 price forecast from US$24,000/t to US$55,000/t and acknowledge, given the uncertainty in fundamentals in 2023, that this may require further adjustment as the year progresses.

Contract prices should generally follow the spot price, but with a certain lag. Based on the current market fundamentals, we conservatively model the average contract hydroxide price at US$55,000/t in 2023–24.

A cyclical forecast should only apply to a period where reasonable visibility of likely project commissioning is possible. We would place this as four to five years at present, around which time either demand destruction or the acceleration of marginal supply could come into play. We acknowledge that the late 2020s are particularly uncertain and, as such, apply long-run pricing only beyond 2031. It is possible that continued demand growth continues to place upward pressure on these equilibrium prices. We do not believe that lithium equities discount an extrapolation of current spot prices.

We assume a US$1,000/t price difference between carbonate and hydroxide, which is lower than the historical levels (driven by the traditional value chain for industrial applications), but could also be conservative given high carbonate demand in China owing to the growing use of lithium ferro-phosphate (LFP) batteries. At the moment, however, we understand that the spot carbonate price is on par with, if not at a premium to, the hydroxide price.

The mine plan summarised in Lepidico’s 22 November 2022 announcement was largely unchanged relative to its May 2020 DFS. However, in the intervening time, it is notable that approximately 1.6Mt (or three years’ worth of processing capacity) was upgraded from waste to ore reserves. While at a slightly lower overall grade (0.40% Li2O cf 0.46% Li2O), this upgrade also had the effect of reducing the waste:ore ratio of the overall project by a material 23.6%, from 3.77 to 2.88.

Subsequently, on 30 January 2023, Lepidico announced that it had upgraded substantially all of its resource at Helikon 4 (approximately a further three years’ worth of processing capacity) from the inferred category of resources into the indicated category at a higher grade (0.47% Li2O cf 0.38% Li2O). It also confirmed the availability of a further c one year’s worth of relatively high-grade material on surface at Rubicon (0.86% Li2O) and Helikon (0.64% Li2O) for processing once the project has commenced. A fortnight later, on 13 February, Lepidico announced that it had upgraded 62.6% of the upgraded resource tonnage at Helikon 4 that was in the indicated category (approximately 1.5yrs of processing capacity) into the probable category of reserves at an elevated grade of 0.51% Li2O (cf a 0.46% resource grade). It also announced that it had upgraded 100% of the upgraded resource tonnage of surface material at Rubicon that was in the indicated category (approximately 0.5yrs of processing capacity) similarly into the probable category of reserves at a grade of 0.89% Li2O (cf a prior project reserve grade of 0.40% Li2O).

In our last note on Lepidico, we posited an additional six years of life to Lepidico’s Phase 1 Plant project life (from 14 to 20 years) in anticipation of exploration results supporting additional resources and, ultimately, reserves, at Karibib. In the light of the upgrades demonstrated by Lepidico to both reserves and resources at Karibib to date, we have opted to retain the six additional years of production in our production model relative to that set out in its updated DFS. To this end, the Helikon 2-4 line of mineralisation will now be drill tested for both continuity along strike between the deposits and down dip to the south, with the objective of extending the Phase 1 operating life to well over 20 years. As well as targeting down-dip extensions to the mineralisation, the 2023 resource development drilling programme (that is scheduled to start imminently) will provide geotechnical data with the objective of both expanding the project’s indicated resources and increasing their conversion into probable reserves. The programme will also include infill and extensional drilling at Helikon 2-3, which together host an inferred mineral resource of 0.51Mt grading 0.52% Li2O. In addition, a new occurrence of lepidolite bearing pegmatites was identified in Q4 CY22 within EPL5439, with intermittent outcrop and historical workings extending over a 1.5km strike and site access is being arranged to drill this priority new target.

Apart from the lithium price, the principal changes set out in Lepidico’s updated and improved Phase 1 Plant project economics relate to its capital and operating cost estimates, which are summarised in Exhibits 4 and 5, below:

In general, while we had already inflated both our capex and opex estimates since the time of Lepidico’s original DFS in May 2020 by 62% and 15%, respectively, we were still approximately 15% too low in our capex estimates relative to Lepidico’s updated economics announcement of November 2022 and approximately 20% too low in our opex estimates (see below). While capital cost inflation is a reality in the mining industry in general at the current time, the materially improved project economics reported by Lepidico for the Phase 1 Plant project are a consequence of being in the right commodity (ie lithium) at the right point in its cycle. Moreover, the project is, to all intents and purposes, one of the first lithium projects to recalibrate its costs to current market conditions, in contrast to work conducted before 2022, which tended to recognise and capture disinflation, rather than inflation, within the industry.

In the light of these developments, we have updated our valuation of Lepidico to reflect both our updated lithium price forecasts, as well as the project’s updated capex and opex assumptions. For lithium hydroxide, a simple comparison of our revised price forecasts as they relate to Lepidico is as follows:

As stated previously, we have retained an additional six years of life in the project to reflect recent exploration success. In addition to the changes in operational and financial assumptions detailed above, we have made the following adjustments to our financial model:

Project valuation

Lepidico’s updated and improved economics announcement of 22 November calculated a project NPV8 for the integrated Karibib mining and chemical plant operation of US$530m, or A$749m (9.8 Australian cents per share) on a pre-funding basis at the current foreign exchange rate of A$1.4134/US$. By contrast, including six additional years of production, but also a 20% minority interest in the Karibib mining operation, we value the project at US$641.4m (8.4 US cents per share), or A$906.6m – 21.0% in excess of Lepidico’s updated estimate. A bridge chart of the evolution of the project’s valuation by component part since our equivalent valuation at the time of our last note (in October 2022) is as follows:

Company valuation

Our valuation of Lepidico’s equity varies from our value of the integrated Karibib mining and chemical plant project, among other things, on account of the following:

As a consequence, changes in the project valuation are typically dampened when compared to the company valuation.

In our last note on the company, we calculated a value for Lepidico’s shares of 5.67 Australian cents per share plus 0.38c 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 6.05c/share. In the wake of the changes discussed above, our discounted valuation of Lepidico’s future (maximum potential) dividend stream to shareholders has increased to 8.34c/share, rising to a peak of 12.20c/share (cf 9.26c/share previously) on the cusp of the company’s (assumed) first material dividend in FY27, as shown in the chart below:

To this valuation of 8.34c/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 now estimate at 0.28c/share (fully diluted), to result in a total value for Lepidico’s shares of 8.61c/share (cf 6.05c/share previously), based solely on its Phase 1 project. A bridge chart, showing the major components in the evolution of the valuation from 6.05c/share to 8.61/share is provided in Exhibit 9, below.

To this valuation of 8.61c/share may then be added a potential risk-adjusted 0.65–1.59c/share (fully diluted) for a conceptual 20,000tpa LCE Phase 2 Plant (see our note, Phase 2 coming into view, published on 18 June 2021), to take our total aggregate conceptual valuation of Lepidico to 9.26–10.20 cents per share (cf 6.71–7.66 cents per share previously).

In the wake of its updated economics, the two principal quantitative 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 the lithium hydroxide price sticking at a higher level, earlier than the long-term one currently assumed (US$23,500/t – see Exhibit 6) are as follows:

At the same time, our financial model assumes that Lepidico will raise a further A$37.0m (net) in FY23 at an unchanged share price of 2.8c (cf Lepidico’s prevailing share price of 1.5c at the time of writing). Exhibit 11 demonstrates the sensitivity of our valuation to variations in this equity price:

Readers should note that it is also possible 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 which case it is possible/likely that a higher equity price could be supported.