UBS’ favourite lithium stocks (and a cautionary note for the bulls)

After a 440% gain in 2021, the changes  of another high-flying year for lithium were low. But that is exactly what happened. Unprecedented supply chain challenges, the lockdowns in China, and huge growth in the demand for electric vehicles are all giving lithium a seemingly endless runway for growth.

That must explain why UBS’ Lachlan Shaw continues to be positive on the commodity and its respective ASX entities.

“We remain structurally bullish on lithium, thanks to unprecedented secular growth and ongoing supply challenges. China's EV sales recovery post CNY / winter / COVID-19 reopening is the #1 catalyst we are watching,” Shaw wrote in a note to clients dated Monday 20 February.

In this piece, we’ll look at the key signals UBS is watching in the medium to long-term. Plus, we’ll share the broker’s four BUY-rated lithium plays in the space.

“Fever pitch” signals

1. China's reopening: In January, Chinese auto sales were down 45% y/y while EV sales were down a much more tepid 6% y/y. The massive slowdown is a reflection of the lockdowns and how it weighed on sentiment. Even EV giant Tesla has had to slash prices in its largest but most challenging market in order to generate some more short-term demand.

2. Chinese-based lithium prices: Wuxi futures have been falling on this same thematic as well as a generally bearish news flow. Even spot lithium prices have been in a downward trend in Chinese Yuan terms since October last year.

3. Bearish news: Reporting from China’s national news agency suggests the world’s largest battery maker is offering steep discounts on its products to automakers. The news follows a report of a failed spodumene auction and lithium inventories reaching two-year highs. 

4. Then, there’s the bullish news: In its latest earnings report, US-based battery manufacturer Albemarle said "early indications are that both cathode and battery inventory are decreasing, which is a good sign for the lithium market". 

5. Manufacturers are investing: LGES is investing US$75 million into Piedmont Lithium (ASX: PLL) in return for 200kt of spodumene over the next four years from late 2023. This follows GM's US$650m investment into LAC (NYSE: LAC). Analysts expect more equipment manufacturer investment into lithium supply.

6. Supply delays continue and pricing uncertainty remains: Apparently, some Chinese buyers have sought to renegotiate term contracts. This further emphasises the importance of Chinese demand recovery in coming weeks and months.

Is the lithium price being reflected in the stock valuations? 

Goldman Sachs has long had bearish views on the lithium price and most of the ASX lithium plays. Morgan Stanley and Credit Suisse both have underweight ratings on Allkem and Pilbara Minerals. UBS’ tracking suggests that most companies are also trading well above the spot commodity’s price.

And without further ado, UBS’ favoured plays:

• Allkem (ASX: AKE) - BUY rated with a price target of $19.10/share, implying 66% upside from recent levels.

• Liontown Resources (ASX: LTR) - BUY rated with a price target of $1.90/share, implying 43% upside from recent levels.

• IGO (ASX: IGO) - BUY rated with a price target of $18.20/share, implying 37% upside from recent levels.

• Lynas (ASX: LYC) - BUY rated with a price target of $10.30/share, implying 24% upside from recent levels.

• Pilbara Minerals (ASX: PLS) and Iluka Resources (ASX: ILU) are both NEUTRAL rated.