Is Pilbara Minerals a bargain at $3?

It was a sea of red for lithium stocks on Tuesday after the most active lithium carbonate futures on the Guangzhou Futures Exchange tumbled 7% to 93,000 yuan a tonne. Shares in lithium darling Pilbara Minerals (ASX: PLS) finished the session down 8.5% to levels not seen since August 2022 and now down around 40% from its August peak.

Taking a bullish or bearish view on lithium often sparks a heated debate. Instead of getting caught in the crossfire –  this piece will seek to provide some of the latest data points of interest to help readers stay more informed.

Lithium Markets at a Glance

I would pull up a lithium chart but just imagine a line that goes from the top left to the bottom right-hand side of the screen. Prices have been in a downward spiral for several months, which might reiterate the old adage – "The trend is your friend."

Commodity price reporting agency Fastmarkets provided some interesting insights from various industry players earlier this week. Here are some of the key quotes and takeaways:

• “We, along with many major lithium producers, are no longer offering spot lithium salts because spot demand is muted and spot prices are too low. We are only delivering regular long-term orders,” a Chinese lithium producer source said.

• “Some traders are offering lithium carbonate at competitively low prices, but they will recoup the loss from the spot sales with their positions in the futures market. For the majority of major producers, they won’t sell at similar price levels due to no margins.”

• “Lithium inventory levels across the supply chain seem to be still pretty high, especially for lithium hydroxide in China," an international consumer source said.

• “We haven’t done any spot deals recently and have been just delivering our long-term orders. We approached some consumers and offered spot units but they didn’t buy [because] are wary of their inventory levels at the year-end," an international lithium producer said.

When do prices bottom?

"Lithium prices continue to grind lower in the face of weakening demand sentiment and the robust supply outlook," UBS analysts said in a note last Friday. You can read the full coverage of the note here.

"In our 2024 outlook, we highlighted the near-term supply-demand imbalance near-term with supply in 2024 expected to grow 40% vs. demand 25% albeit without fully factoring any supply response to lower lithium prices."

The analysts warn that spodumene prices could get as low as US$800 a tonne based on feedback from their China lithium analyst and the continued uncertainty on near-term demand.

"It is hard to be all-out negative on a market that even on conservative estimates is expected to grow 2- 3x by the end of 2030," the analysts said. However, they stressed that the lower price environment will place additional scrutiny on new greenfield projects while the incumbents will rethink brownfield investments.

The note downgraded Pilbara Minerals to a SELL (from Neutral) with a $3.05 target price.

Revisiting an old note

Macquarie has been a perennial lithium bull and it maintained upbeat target prices and ratings for most of the large-cap names this year.

On 26 October, it retained an OUTPERFORM rating on Pilbara Minerals with a $7.10 target price. However, the modelling is based on spodumene price assumptions of US$4,335 a tonne in FY24 and between US$5,400 and US$4,125 in FY25-28. The Shanghai Metals Market price for spodumene concentrate is currently US$1,670 a tonne.

Of course, lithium miners typically have long-term contracts in place, where prices can differ materially from the opaque futures prices we see. But to say that miners are selling spodumene at US$4,335 a tonne right now is a little bit of a far stretch.

Macquarie's FY24 assumptions land at a net profit figure of $2.2 billion but only $791 million in free cash flow after accounting for (these are again assumptions but relatively well-documented ones):

• Interest, tax and D&A of $671 million

• Capex of $926 million vs company guidance of $875-975 million

• POSCO joint venture $108 million

The question here is: What do free cash flows look like if you halved those spodumene price assumptions? Could free cash flows be negative under the current spot price scenario and if so, does that justify today's valuation?

Pilbara Minerals produces spodumene at unit operating costs of around A$600-700 a tonne. When spodumene prices were fetching for more than US$6,000 – That's a lot of operating leverage.

But when prices spiral down to less than US$2,000 a tonne, coupled with chunky capex costs and tax (PLS said it will pay the remaining FY23 income tax of $773m in the first half of FY24) – Your leverage suddenly disappears.

Food for thought: Dips and rips

Every time Pilbara Minerals pukes towards the downside, it tends to squeeze towards the upside the next day. I note some of the dips and rips in the below chart:

Pilbara Minerals daily chart (Source: TradingView)

The same happened on Wednesday, when the stock opened 4% lower (after Tuesday's 8.5% selloff) but traded 2.6% higher at noon.

The stock's ~20% short interest doesn't make it any easier to follow and analyse. Is it genuine buying that's causing the reversal? Or is it profit taking from shorters?