Investor Essentials Daily

While there are many tailwinds for this battery ETF, certain hidden downsides may scare off investors

April 9, 2021

As grid power storage and electric vehicles are becoming more prevalent in our society, individuals are trying to figure out ways to get exposed to battery investments.

Today, we will take a deeper dive into a lithium and battery ETF that has become popular given these larger trends in the industry, along with highlighting some of the potential issues with this investment.

In addition to examining the ETF, we’re including a deeper look into the ETF’s largest current holding, providing you with the current Uniform Accounting Performance and Valuation Tearsheet for that company.

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In the aftermath of the Texas power crisis last month, one news story failed to gain traction among the reporting on the political scandals and costs of the disaster.

This was how battery storage systems helped some utilities fare better than most other solutions in dealing with the low temperatures and massive grid failures.

Responding specifically to this widespread failure, Tesla (TSLA) is building grid power storage solutions through its Gambit initiative across the state of Texas.

As grid power storage and electric vehicles are becoming more prevalent in our society, individuals are trying to figure out ways to get exposed to battery investments.

One of the methods investors have been using to gain exposure to this space is through ETFs.

Specifically, LIT is a lithium and battery ETF that has recently become popular given these larger trends in the industry.

That being said, there are some issues with the composition of this ETF that investors should be aware of before buying. First, LIT does not give investors total exposure to batteries, electric vehicles, or many of the other drivers which investors are excited about in the space.

The composition of the ETF resides mostly with lithium names or battery manufacturers themselves.

The most popular lithium batteries at the moment are not solely made of lithium. Lithium batteries require cobalt, nickel, graphite, and copper for various components. Without all of these elements and compounds they would simply be useless blocks of lithium.

Additionally, lithium batteries are not the only game in town. Looking at grid-based storage solutions, there are more esoteric solutions such as Zebra batteries and PbSb liquid metal batteries. An ETF focused strictly on lithium fails to capture the entire breadth of the space.

That is why we worked with one of our institutional partners to potentially design an all-encompassing battery ETF in 2017.

We aimed to capture companies that would be winners in the space, as they were exposed to many of the other key metals and compounds that go into a battery.

Sadly, nothing came out of this project as we entered a battery winter in 2017 where the entire space came under significant pressure. Despite this, the research we conducted gave us an invaluable window into the entire battery space.

Despite its shortfalls, LIT is the most popular ETF to gain exposure to the industry. As a result, it may be helpful to gain a better understanding of the holdings this ETF includes through a Uniform Accounting perspective.

To show this, we’ve conducted an audit of LIT’s top equity holdings, based on its most recent 13-F, focusing on its non-financial company holdings.

We’re showing a summarized and abbreviated analysis of how we work with institutional investors to analyze their portfolios.

For the most part, LIT’s research appears to line up with Uniform Accounting.

Uniform Accounting metrics highlight the company’s equity investments are much higher quality, and have higher potential, than the market and as-reported metrics imply.

See for yourself below.

Using as-reported accounting, investors might think LIT incorporates companies with low returns in its ETF. In reality, looking through the accounting noise, investors can see LIT’s returns are much higher than the as-reported metrics highlight.

On an as-reported basis, these companies are poor performers with returns below the cost-of-capital, the average as-reported ROA being around 4%.

However, once we make Uniform Accounting (UAFRS) adjustments to accurately calculate earning power, we can see that the returns of the companies in this ETF are much more robust.

The average company in the ETF displays an average Uniform return on assets (ROA) of 9%. While this is below the U.S. corporate average of 12%, it is above the returns as-reported numbers are depicting.

Once the distortions from as-reported accounting are removed, we can realize that Wuxi Lead Intelligent Equipment (SZSE:300450) doesn’t have an ROA of 6%, but returns of 28%.

Similarly, Contemporary Amperex Technology’s (SZSE:300750) ROA is really 20%, not 4%.

Sunwoda Electronic (SZSE:300207) is another great example of as-reported metrics mis-representing the company’s profitability. Sunwoda Electronic’s ROA isn’t 3%, it’s actually 13%.

The list goes on from there, for names ranging from Ganfeng Lithium (SZSE:002460) and EnerSys (ENS), to Yunnan Energy (SZSE:002812).

To find companies that can deliver alpha beyond the market, just finding companies where as-reported metrics misrepresent a company’s real profitability is insufficient.

To really generate alpha, any investor also needs to identify where the market is significantly undervaluing the company’s potential.

Let’s take a look at the discrepancies between market and analysts expectations for EPS going forward.

This chart shows three interesting data points:

  1. The 2-year Uniform EPS growth represents what Uniform earnings growth is forecast to be over the next two years. The EPS number used is the value of when we take consensus Wall Street estimates and we convert them to the Uniform Accounting framework.
  2. The market expected Uniform EPS growth is what the market thinks Uniform earnings growth is going to be for the next two years. Here, we show by how much the company needs to grow Uniform earnings in the next 2 years to justify the current stock price of the company. If you’ve been reading our daily analyses and reports for a while, you’ll be familiar with the term embedded expectations. This is the market’s embedded expectations for Uniform earnings growth.
  3. The Uniform EPS growth spread is the spread between how much the company’s Uniform earnings could grow if the Uniform earnings estimates are right, and what the market expects Uniform earnings growth to be.

The average company in the U.S. is forecast to have 5% annual Uniform Accounting earnings growth over the next 2 years. LIT’s companies are forecast by analysts to grow by 68%.

The market is pricing these companies to grow earnings by 36% a year on average. While these companies are growing faster than the market, they are still intrinsically undervalued, as the market is mispricing their growth by 32%.

These are the kinds of companies that are likely to see their stocks rally when the market realizes growth potential. This may be the market pricing some of these companies for massive declines in profitability in distressed credit situations. Without Uniform numbers, investors cannot see the creditworthiness of these names.

One example of a company in the LIT ETF that has growth potential that the market is mispricing is Tesla (TSLA). Tesla’s analyst forecasts have 300% Uniform earnings growth built in, but the market is pricing the company to have earnings grow by 95% earnings each year for the next two years.

Another company with similar dislocations is Yunnan Energy (SZSE:002812). Market expectations call for 54% growth in earnings. However, the company is actually forecast for Uniform EPS to grow by 140%.

Yet another is LG Chem (KOSE:A051910). Market expectations call for 36% growth in earnings. However, the company is actually forecast for Uniform EPS to grow by 122%.

Although we do recognize some concerns with the exposure to various segments within the space for the LIT ETF, Uniform Accounting metrics do highlight the strength of investing within LIT to see the potential of fast growing companies exposed to strong market trends.

SUMMARY and Albemarle Corporation Tearsheet

As LIT’s largest individual stock holding, we’re highlighting Albemarle Corporation’s tearsheet today.

As the Uniform Accounting tearsheet for Albemarle Corporation (ALB:USA) highlights, Albemarle’s Uniform P/E trades at 55.7x, which is above the corporate average valuation of 25.2x and its own historical valuation of 38.6x.

High P/Es require high EPS growth to sustain them. In the case of Albemarle, the company has recently shown a 28% Uniform EPS shrinkage.

Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.

We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Albemarle’s Wall Street analyst-driven forecasts are 11% EPS shrinkage in 2021 and 77% EPS growth in 2022.

Based on current stock market valuations, we can back into the required earnings growth rate that would justify $150.74 per share. These are often referred to as market embedded expectations.

The company can have Uniform earnings grow by 21% each year over the next three years and still justify current price levels. What Wall Street analysts expect for Albemarle’s earnings growth is above what the current stock market valuation requires in 2021, but below that requirement in 2022.

Furthermore, the company’s earning power is below the corporate averages. Also, cash flows and cash on hand exceeds its total obligations—including debt maturities, capex maintenance, and dividends. Together, this signals a low dividend risk and moderate credit risk.

To conclude, Albemarle’s Uniform earnings growth is well below its peer averages, while their valuations are traded well above its average peers.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research