Morgan Stanley's bearish take on Pilbara Minerals (in six charts)

Here we go again, another Sell-rated lithium note from an industry heavyweight. Morgan Stanley initiated coverage of Pilbara Minerals (ASX: PLS) on Wednesday with an Underweight rating and a $3.15 target price. The stock was down 4.1% to $3.54 the day the note was released.

“We see Pilbara Minerals’ expansion to 1Mtpa and margin capture strategies well appreciated by the market, with spot prices creating profitability headwinds for tolling arrangements and for the pricing of future uncontracted spodumene tonnes,” said analysts including Rahul Anand, Matthew Costa and Gary Zhang.

Morgan Stanley forecasts Chinese lithium prices – which are currently down approximately 57% year-to-date to US$28,760 a tonne – to fall to US$25,000 a tonne in the second half of 2023.

The decline in lithium carbonate prices drew criticism for the company’s plan to capture downstream margins via tolling arrangements earlier this year. 

“We note that as mining supply rises and lithium carbonate prices retreat, the addressable margin under the current compensation structure (US$5,000 a tonne for tolling and US$5,000 a tonne for conversion) is unlikely to remain unprofitable.

This structure is forecast to become unprofitable at current spot lithium prices and either tolling costs have to be negotiated lower or likely to cease. The analysts also flagged risks to the other incremental margin opportunities such as the BMX platform and conversion via the POSCO joint venture.

A bearish thesis in 6 charts

1. “Pilbara Minerals’ share price has traditionally followed the lithium carbonate spot price with the market receiving production expansions positively. This helped the company perform strongly in FY22 despite many operational issues. This thematic has now turned negative with Chinese lithium carbonate prices moving sharply lower,” the note said.

Source: Morgan Stanley

2. Pilbara Minerals has the second lowest volume growth (on a percentage basis) for names under Morgan Stanley coverage.

Source: Morgan Stanley

3. The company also has the lowest downstream exposure among the stocks under coverage, with approximately 99% of FY24 revenue coming from spodumene. 

Source: Morgan Stanley

4. As well as increasing uncontracted volumes in future years, which run the risk of falling below contracted prices in a well supplied market. 

Source: Morgan Stanley

5. The capital intensity for mine expansions like P680 and P1000 were also relatively expensive compared to peers like Liontown (ASX: LTR), Core Lithium (ASX: CXO) and Mineral Resources (ASX: MIN). 

Source: Morgan Stanley

6. At the same time, free cash flow yields for FY24-26 was relatively weak compared to the same peers as above.

Source: Morgan Stanley

Morgan Stanley’s preferred lithium pick: Allkem

“With the Li sector currently facing demand and overstocking concerns, we focus on volume growth and valuation as our stock picking methodology,” says Morgan Stanley. 

Allkem was the preferred pick with an Overweight rating and a $13.30 target price and offering investors the “most growth potential” at a lower implied price. 

Elsewhere, Mineral Resources was Equal-weight rated with a $77.00 target price. And IGO was Underweight with a $10.20 target price.