Small Caps | Sep 11 2018
Lithium producer Orocobre is in the spotlight after the Argentine government imposed "temporary" levies on exports, but brokers consider any sell-off overdone.
-At spot rates, inflation and currency devaluation have cancelled each other out
-Duty will affect the Olaroz and Borax Argentina businesses of Orocobre
-Buy ratings maintained for Orocobre because of the quality of the asset
By Eva Brocklehurst
The inflation bogey has returned to Argentina with a vengeance and the government has imposed temporary levies on exports to reduce its fiscal deficit. A temporary special export duty will be immediately applied to all exports of finished products. As Argentina is a current hot spot for several lithium producers, brokers evaluate the potential impact, if any, on both pricing and supply.
At current rates of the Argentine peso to the US dollar the duty implied is 7.7%, levied at a rate of three pesos for every US dollar. It will be applied until December 31, 2020. The rate is on the basis that exported lithium carbonate is classified as a non-primary product, attracting a lower duty than primary products, which are being levied four pesos per US dollar.
Canaccord Genuity notes Argentine futures imply a -27% devaluation to the exchange rate by August 2019, which would mean the duty reduces to 5.46%. Hence, while the current economy in Argentina is creating a lot of uncertainty, the impact of the duty is minimal and any sell-off on that basis is considered to be overdone.
A bigger concern is increasing country risk, Ord Minnett suggests, as this latest policy is unexpected given Argentina's pro-business government. The peso is yet to stabilise and this indicates markets are not convinced the measures will resolve the fiscal deficit. Until capital flows back to the country there is a risk that further measures will be introduced, although these may not necessarily affect lithium producers.
Operating in Argentina has always had its risks, Macquarie asserts, and this is a prime example. Regardless, the broker envisages value in the sector and highlights that Albemarle has indicated it is on the look-out for acquisitions.
It is possible the tax and the turmoil in Argentina could make investment in a number of lithium projects in the country less likely yet, perversely, Citi suggests this would be a positive for the global lithium market. The broker has wondered whether producer discipline can subdue the supply wave coming through, despite the demand emanating from electric vehicles.
Orocobre
Assuming the tax is only in place for two years, Citi calculates an impact on Orocobre ((ORE)) of around -2.5% of net present value and does not assume any cost benefit from devaluation of the Argentine peso. At current spot rates, inflation and currency devaluation are calculated to somewhat cancel each other out.
Orocobre is the only lithium junior currently operating in Argentina and most affected by this duty. The company has acknowledged the duty will affect both Olaroz and the Borax Argentina businesses. Deutsche Bank points out that around 45% of the costs for Olaroz are denominated in peso so there is a cost benefit in that regard.
Credit Suisse acknowledges the benefit of currency depreciation exceeding inflation but believes it is more likely to be temporary and modest versus the formal tax. On an historical basis inflation has run modestly ahead of currency depreciation, and as such would eliminate any currency advantage. Still the broker likes the high-quality Olaroz asset, the company's established market position and operating knowledge.
In sum, Canaccord Genuity adjusts its project valuation by -2.6%. If the measure is applied over the life of the mine it would reduce net present value by -15%. Canaccord Genuity, not one of the eight brokers monitored daily on the FNArena database, has a Buy rating as well, and a target of $7.30.
Ord Minnett assumes higher royalties into perpetuity and, if the duty is indeed removed the end of 2020 this would add to $0.70 to valuation. The broker maintains a Buy rating for Orocobre because of the quality of the asset and the balance sheet and lowers the target to $6 from $8, lifting the nominal discount to -12.5% from -10% to account for the increased risk.
Macquarie also models the tax as permanent and incorporates large falls in earnings for the forecast years. Still, the broker has upgraded the stock to Outperform from Neutral and envisages another $0.60 in value, if the company can offset the taxes through FX or if they are temporary.
There are seven Buy ratings and one Sell (Morgan Stanley, yet to comment on the Argentine tax) on FNArena's database for Orocobre. The consensus target is $5.81, suggesting 59.2% upside to the last share price.
Galaxy Resources ((GXY)) is not expected to be affected, as its Sal de Vida operation is not likely to start production until 2021. Hence, while the current economy in Argentina is creating a lot of uncertainty the impact of a duty is considered minimal. Any sell-off on the basis of the duty is considered to be overdone.
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