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With talks of an electric vehicle recession given the change in dynamics as the supply for electric vehicles outweighs the demand as global auto manufacturers increasingly invest in electric vehicle production capacity, this rapid growth in production capacity of electric vehicles and thus, batteries is a positive for battery recyclers like Li-Cycle (NYSE:LICY). The time has come for Li-Cycle as it looks to ride the tailwind of rising demand for localised battery materials as auto manufacturers scale up manufacturing capacity, with increasing number of spokes and hub coming online in the near term.
Investment thesis
Li-Cycle is well positioned in the lithium-ion battery market as the rapid rise in demand of electric vehicles has led to a large supply of and large increase in capacity for the production of lithium-ion batteries.
The company is an early mover in the lithium-ion battery space, and with increasing requirements to source battery materials locally, as well as a general trend of a shortage of battery materials needed for electric vehicle production worldwide, this bodes well for Li-Cycle as a leader in the space. As the company has a strong technological advantage and a patented business model, it will enable Li-Cycle to maintain its moat against peers. Furthermore, the company is constructing and ramping up operations of its 7 spokes and 1 hub in the near-term that will lead to exponential growth, in my view. I have written previous articles on Li-Cycle that can be found here.
After a slight hiccup, the North American spokes are back on track
As highlighted in my previous article on Li-Cycle, the previous quarter was the first one when the management first communicated to the market about taking optimization efforts in its North America spokes.
As a result in the recent third quarter of 2022, the company continues to take efforts to optimise the Arizona and Alabama spokes. Given that these spokes are regarded as the first of their kind as they are able to process entire battery packs without the need for dismantling, and because the Arizona spokes are the first of many of these types of spokes to be constructed, Li-Cycle decided to make improvements in the spoke to ensure that target throughputs are achieved before the other spokes start up.
These optimization projects are low capital cost optimizations made, and the company announced in its recent third quarter 2022 that they have successfully ramped to near target throughput using these optimization efforts and there has been higher recovery yields of black mass as a result of these efforts. These improvements and optimization efforts from the Arizona spoke are ultimately very important for the company as its Alabama and European spokes are regarded as carbon copies of this Arizona spoke. The company also mentioned that they continue to work with their key partner, Ultium, to develop the Ohio spoke to ensure that they take the optimal path of execution.
European expansion
Ultimately, I expect the European expansion to be following a similar strategy to that of its North America strategy. In Europe, given the robust demand for recycled battery materials, the capacity for the European spokes are likely to be easily absorbed due to Li-Cycle’s strategically position spoke locations that are close to manufacturers of electric vehicle manufacturers.
The Norway site is located near logistics networks, with availability to sustainable energy sources, which makes the Norway facility an attractive one for customers in Europe. The Germany site is located strategically, near battery and electric vehicle manufacturing sites and it also has access to renewable energy.
The Norway and Germany spokes are expect to follow a similar approach to the Arizona and Alabama spokes where there will be several stages to start up. The first to start up will be the Germany spoke, followed by the Norway spoke and the company expect that the two spokes will begin production by the second half of 2023. This presents a slight shift in timeline backwards due to more conservative timing expectations as the company looks to incorporate what they have learnt from the North America spokes into the European spokes.
Balance sheet strength sufficient for pipeline
While Li-Cycle is in a phase of rapid growth given the number of spokes it has to construct, as well as the Rochester Hub, liquidity and funding is key in the current environment. The company currently has $650 million in cash as of the third quarter of 2022. This was supplemented by the additional $250 million proceeds that were from LG and Glencore that helped to bolster the balance sheet. With this cash on hand on its balance sheet, I expect that Li-Cycle will have the necessary capital needed for its operating needs that is required for its project pipeline that is currently in development.
For the third quarter of 2022, the company spent $82 million in capital expenditures that was, most of it was used to spend on equipment needed for the construction of the Rochester Hub, as well as the needed expenditure for equipment and improvements to be made in the company’s North America and European spokes. The remainder of its needed capital expenditures will go towards funding the construction of the Rochester Hub.
Positive government policy to spur demand and lower costs
Li-Cycle continues to see favourable tailwinds from government policy that encourages and facilities the green transition that the company is part of. The Inflation Reduction Act remains to be one pivotal policy that will bring benefits to electric vehicle battery recyclers like Li-Cycle starting 2023.
As energy security in this new age of the green transition is a priority for the United States, this is what the Inflation Reduction Act is primarily for, as an accelerator to increasing the supply of battery materials domestically that will help to drive demand for electric vehicles. As a result, these programs in the Inflation Reduction Act aim to help reduce the costs of the building of facilities that make these key battery materials and to reduce the overall manufacturing costs for batteries.
In terms of the battery recycling industry in general, the Inflation Reduction Act has many benefits that applies to companies in the industry. This includes the $10 billion in advanced energy project tax credit that allocates up to 30% investment tax credit for the development of clean energy facilities in the United States, including facilities used for recycling. In addition, there are clean energy loans of up to $250 billion from the Department of Energy loan programs office, as well as 5-year production tax credits of up to $60 billion that are eligible for battery recyclers like Li-Cycle.
Ultimately, the United States, through the Inflation Reduction Act, looks to increase energy security by pushing for the building of electric vehicle batteries either in the United States or in countries that have free trade agreements with the United States. The requirement to qualify for the clean vehicle tax credit is that the electric vehicle needs to have at least 50% of its battery critical minerals come from either free trade agreement countries or the United States, and this requirement increases to 80% by 2027. This regulation is gradually increasing the demand for domestically sources critical battery grade materials as more of the electric vehicle’s key battery materials will then tend to come from domestic battery recyclers like Li-Cycle and this bodes well for the first mover players like Li-Cycle that is ready to benefit from this wave of demand. In addition, auto manufacturers are increasingly seeing the benefit of working with players like Li-Cycle in order to meet their production requirements for domestic battery content through recycled materials in order to meet clean vehicle tax credit conditions.
Valuation
The key for Li-Cycle will be to construct and ramp up its planned spokes and Rochester hub in the near-term and with that, we will see material revenue acceleration from now until 2025. Given that the 7 spokes and 1 hub planned are fully funded and expected to be profitable and cash generating once operational, my DCF will include financial forecasts until 2030. I apply a 40% discount in valuation multiple applied to the company compared to its peers in the recycling and waste industry as these are established and profitable players in the market so as to include some conservatism into my modelling.
As the peer group is trading at 12x EV/EBITDA, I assume that Li-Cycle terminal multiple will be 7x. I applied a slightly higher discount rate to Li-Cycle for the DCF given the higher rates environment. As a result, I use a WACC of 12% to discount Li-Cycle to derive the intrinsic present day value of Li-Cycle.
My target price for Li-Cycle is $11.30, implying an upside potential of 126% from current levels.
Risks
Execution risk
The biggest downside risk for Li-Cycle, in my view, is the ability to execute well. Given the huge variability involved in construction and ramping up production, there are risks that Li-Cycle may face further delays in the targeted timeline, as well as further problems in terms of achieving the throughput and yields that they target.
Competition
Li-Cycle remains to be attractive as a pure-play battery recycler, but there are many others in the industry, although at stages of production and commercialization behind Li-Cycle. For example, Albemarle (ALB), looks to study ways to recycle batteries in North America.
Commodity price risk
At the end of the day, Li-Cycle’s end products are largely benchmarked to the commodity prices of cobalt, nickel & lithium. If these metals experience a significant decline in prices, this could materially affect the profitability of the company.
Conclusion
I continue to think that Li-Cycle looks attractive fundamentally and 2023 could be the time for the company as this is the year when more spokes will come online and when the progress of the first hub will be near completion. For the North American spokes, these are progressing well with the target throughputs nearly met, while the European spokes looks set to benefit from the learnings of the North American spokes and will likely have a smoother ramping up experience. The company continues to benefit from tailwinds from government policy and support, while the current cash on hand in the balance sheet suggests sufficient funding for the current development pipeline. My target price for Li-Cycle is $11.30, implying an upside potential of 126% from current levels.
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