If you’re not already aware of the electric vehicle (EV) industry, you should be.  In the next decade, EVs will go from niche products to eventually overtaking gas-powered vehicles as the primary mode of transportation. In 2020, EV stocks have been one of the strongest-performing industries parts of the market. Year-to-date, the KraneShares Electric Vehicle and Mobility ETF (KARS) is up 58%, while the S&P 500 is up 13.6%.

However, in the short-term, many EV stocks have become overvalued by traditional valuation metrics. Some publicly traded  EV companies have A handful has similar market capitalizations that exceed those of legacy auto manufacturers, yet they are only selling a fraction of the cars that traditional automakers are selling.

Further, they have many difficult hurdles to overcome to justify their valuations, such as scaling production while maintaining quality, continually designing products that appeal to customers, and erosion of pricing power, as numerous EV companies enter the market over the next few years.

Lithium-Ion Batteries 

According to the IEA, 2.2 million EVs were sold in 2019, while 77.5 million cars were sold in total. The IEA estimates that by the year 2050, more than half of all passenger vehicles sold will be EVs.

An option for investors that want to profit from this massive growth in the EV industry, but are scared of these current high valuations, is to invest in companies that are part of the battery supply chain, since all EVs are dependent on lithium-ion batteries.

(Source: Elektrek)

Another reason to expect demand for lithium-ion batteries to increase over the next decade is that they are also used in portable electronics such as LCD displays, smartphones, tablets, laptops, and wearable devices. Overall, the global market for lithium-ion batteries was valued at $108.4 billion in 2019 and is expected to grow at a compound annual growth rate (CAGR) of 14.1% over the next seven years.

Tesla’s Lead

Tesla (TSLA) is the current leader when it comes to batteries. The company recently announced its first full battery cell factory in Berlin, which they claim will eventually produce 250 GWh, which is equivalent to the world’s current capacity.

At its “Battery Day” in September, Tesla unveiled the Tesla 4680 and laid out its plan to produce its own battery cells. One of Tesla’s biggest challenges in ramping up production is to produce batteries at scale for its vehicles. So far, it has relied on outside partners but is looking to move the process in-house. In past calls, CEO Elon Musk has talked about the company’s need for raw materials like lithium and nickel that are necessary inputs for its batteries.

Tesla has designed an in-house battery manufacturing, called Roadrunner, that is currently in a pilot program. However, it’s expected that its Gigafactories in Texas, Germany, and China will be starting battery production sometime next year.

Many expect that Tesla should be selling 1 million vehicles a year by 2023. This will require significant, continued investments to increase production. And, Tesla will also need batteries for its Powerwall, electric trucks, and possibly even other auto manufacturers.

(source: Bloomberg)

As the image above shows, as production increases, costs will further decline through increased efficiencies and greater scale. In EVs, batteries are the most expensive component, so it should lead to cheaper prices for Tesla’s cars which could create a positive feedback loop that leads to more innovation, more profits, and lower prices that gives it an insurmountable advantage over its competitors.

The POWR Ratings are also bullish on Tesla, as it has a Strong Buy Rating. It has an “A” across all categories including Trade Grade, Buy & Hold Grade, Peer Grade, and Industry Rank. Among Auto & Vehicle Manufacturers, it’s ranked #1 out of 34.

Three More Battery Stocks

I consider Tesla to be the premier battery stock. Energy storage is currently 7% of revenues. However, CEO Elon Musk has previously said that he expects the energy business to eventually be “roughly the same size” as Tesla’s automotive business.

This is consistent with the IEA’s projection that the total production of batteries will increase by seven-fold over the next decade. This type of growth will create opportunities for many companies. But, one of the biggest winners will be companies that are mining the raw materials – lithium and nickel – that are used to make batteries. These companies will prosper regardless of which EVs or batteries win the most market share.

Three companies mining lithium and nickel are Livent (LTHM), Albemarle (ALB), and Sociedad Química Y Minera (SQM).

Livent (LTHM)

LTHM is a spinoff from FMC (FMC).  Over the last decade, the Bloomberg Spin-Off Index is up 561%, while the S&P 500 has a gain of 209%.

While FMC was a conglomerate producing a variety of chemicals, LTHM is a pure lithium play which supplies battery-grade lithium, butyl lithium for polymer manufacturing, and lithium compounds. It derives the largest share of the revenue from lithium compared to its peers, so it would likely see the biggest gains when lithium prices increase.

LTHM’s business has been disrupted by the pandemic which caused a steep 32% drop in revenues in Q3. However, shares were bid up as the market is looking forward to the expected growth in lithium demand. Analysts expect LTHM’s EPS and revenue to grow 242.9% and 24%, respectively, next year. Moreover, its EPS is expected to grow at 6.2% per annum over the next five years.

LTHM’s strong fundamentals are reflected in its POWR Ratings. It has a “Buy” rating with an “A” for Trade Grade and Industry Rank, and “B” for Buy & Hold Grade. It is also ranked #15 out of 33 stocks in the Industrial – Metals group.

Albemarle (ALB)

ALB is the top global producer of lithium, accounting for 21% of global production. As more batteries are produced, the price of lithium will rise which means ALB’s earnings and assets will also appreciate in value.

ALB’s stock has gained more than 100% off its March lows, and it’s nearing its all-time high from 2017. Despite its gains, the stock remains reasonably attractive with a forward price to earnings ratio of 33 especially given the valuations of other EV-adjacent stocks.

ALB expects lithium demand to increase 25% every year for the next decade. The drop in lithium from 2017 to 2020 led many projects to be shut down, so supply won’t immediately bounce back even if prices start climbing.

The POWR Ratings rates ALB a Strong Buy. It has an “A” for Trade Grade, Buy & Hold Grade, and Peer Grade with a “B” for Industry Rank. Among the chemical sector, it’s ranked #6 out of 69.

Sociedad Quimica Y Minera (SQM)

SQM is the third-largest producer of lithium in the world and accounts for 13% of global production. The Chilean-based company also produces several other commodities that are inputs for the agricultural, chemical, and technology industries. including iodine and potassium nitrate. Lithium accounts for 26% of its revenue and the majority of revenue growth.

The coronavirus has resulted in serious disruptions to SQM’s business. This makes the stock an attractive candidate as it combines growth and value characteristics. The stock is quite cheap compared to its 2019 comps, while it also has growth characteristics given the secular boom in EVs and a commensurate increase in lithium demand.

The POWR Ratings ranks SQM as a Strong Buy. It has an “A” for Trade Grade, Buy & Hold Grade, and Peer Grade with a  “B” for Industry Rank. It’s ranked #8 out of 69 chemical stocks.

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TSLA shares were trading at $596.49 per share on Thursday afternoon, up $27.67 (+4.86%). Year-to-date, TSLA has gained 612.94%, versus a 15.66% rise in the benchmark S&P 500 index during the same period.

About the Author: Jaimini Desai

Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of the POWR Growth and POWR Stocks Under $10 newsletters. Learn more about Jaimini’s background, along with links to his most recent articles. More...

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