Small Caps | Oct 30 2017
After a weak September quarter, lithium producer Orocobre is surmounting some of the problems which occurred and brokers are becoming more comfortable with the outlook.
-Brine concentration improving, inventory increasing and production rates rising
-Increased production should mean cash costs fall
-Next six months considered a critical catalyst for financing expansion plans
By Eva Brocklehurst
Lithium producer Orocobre ((ORE)) had signalled the September quarter was always going to be soft, with poor weather conditions slowing the evaporation rates at its brine ponds and continued work occurring to re-balance pond conditions. Meanwhile, weaker volumes and increased soda ash prices lifted cash costs over the quarter.
Management has signalled that since the end of the September quarter, brine concentration has improved and there is increasing inventory and rising production rates. Costs are expected to come down as higher-grade brine is fed to the plant.
Olaroz (Argentina) missed Deutsche Bank's estimates by -15% because of lower brine grades and the five days of plant maintenance that was brought forward into the quarter. Sales of 2,072t were -19% lower quarter on quarter but realised pricing was up 5%. Deutsche Bank calculates the lithium carbonate price out of China, which rose 12% quarter on quarter, is flowing through to realised pricing.
Production came in below Citi's forecasts and costs were higher than expected, albeit offset by an improvement in realised prices. Recovery in harvested inventories is expected to improve the production profile going forward and, in conjunction with the carbon dioxide recovery, will enable a better product mix.
Overall, this results in a 25% increase to Citi's earnings estimates over the medium term. As the cash margin profile is better, and the balance sheet is being de-leveraged, the broker no longer considers the stock high risk and upgrades to Buy from Neutral.
Realised prices of US$11,190/t were largely in line with estimates, supported by the ongoing strength in the market. Citi expects realised prices to improve to US$13,750/t in FY19 as the proportion of battery grade product improves to offset the moderating of product prices. Increased production should also mean cash costs fall.
Although disappointed with the quarter, Macquarie notes October has been strong to date and management is now confident enough to maintain guidance. Costs will continue to fall into FY19 as the carbon dioxide circuit is installed. Macquarie also upgrades, to Neutral from Underperform, but considers the stock fully valued until higher production levels can be achieved and sustained, and there is clarity on the phase 2 of the hydroxide plant.
Hydroxide Plant
A response from the Japanese government is due in regard to the construction of the lithium hydroxide plant and the company anticipates the plant will commence construction in June 2018, although it still requires joint-venture approval, financing and permits.
Morgan Stanley continues to be Underweight. Production, annualised, was significantly below the broker's forecasts for the first half.
While the company has pointed out that an audit by experts on the ponds is complete, and there are no design faults that would prevent overall production of 17,500tpa, the purification plant has only been tested to sustained production levels of 73-83% of nameplate and remains to be fully tested at nameplate for extended periods of time.
Subsequent to phase I at Olaroz reaching steady-state production – and Deutsche Bank notes there is now no design fault that prevents it from running at nameplate – the construction of phase 2 could commence in the first half of 2018.
The cost of the pond system is US$75m and total capital expenditure is US$160m, lower than phase I because of the duplication of design and no purification circuit, as the company will pursue this option of building a hydroxide plant in Japan.
Morgans adjusts its production profile, reiterating the stock as its preferred investment in the lithium sector and retaining an Add rating. The company has repaid a further US$14m in debt and reports it has US$46.6m in available cash, emphasising that expansion and development will be matched to cash flow.
Canaccord Genuity suggests guidance could be within reach. The broker expects the next six months will be the real test, but is becoming more comfortable with the stock and reiterates a Buy rating. The broker, not one of the eight monitored daily on the FNArena database, has a $6.00 target.
Canaccord Genuity believes the stock offers the most upside potential in the sector, despite the recent rally in the share price. Should the company achieve targeted production levels in the next six months, as guided, this could be the catalyst for financing of the capacity expansion to 35,000tpa and a final investment decision for the Japanese hydroxide project.
The database shows four Buy ratings, one Hold (Macquarie) and one Sell (Morgan Stanley). The consensus target is $4.91, suggesting 6.6% upside to the last share price. This compares with $4.59 ahead of the update. Targets range from $3.60 (Morgan Stanley) to $5.70 (UBS).
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