Sigma Lithium: New Phase 3 Could Bring Inventory Demand (NASDAQ: SGML)
Sigma Lithium Corporation (NASDAQ: SGML) recently announced a new valuation of its Grota do Cirilo project, which stands at more than $5 billion. The market capitalization stands at nearly $2-2.6 billion and the management reports almost no debt. According to my own discounted cash flow (“DCF”) model, without taking taking into account phase 3 of the project, the implied valuation should be close to 40 to 41 dollars per share, or 4 billion dollars. In my opinion, as Sigma Lithium conducts more exploratory work and measures its proven lithium reserves a little more, many market players will likely look into the project. Finally, with the first earnings appearing around 2022 and 2023, I expect demand for the stock to increase soon.
Sigma Lithium manages the Grota do Cirilo project in Brazil, a vertically integrated operation that plans to produce high-purity 5.5-6% battery-grade lithium concentrate.
Considering the increase in demand from the lithium-ion battery supply chain for electric vehicles and the size of Sigma’s lithium mineralization, many media have made optimistic comments on the company’s flagship project.
If we go a little further in the figures of Sigma Lithium, the project seems rather profitable. With the price of battery-grade lithium concentrate at $6.75, the company’s EBITDA margin at a price of $2.24 per ton would be 82%, which is quite impressive.
A recent project appraisal estimate, including both project phases and 13 years of life, results in free cash flow of $455 million in 2023 and $595 million in 2024. net present value would be $5.1 billion.
Sigma Lithium’s market capitalization is between $2 billion and $2.6 billion, so I think there is significant upside potential in the market capitalization. Keep in mind that Sigma brings in almost no debt and $105 million in cash. With 100.7 million shares outstanding, the NPV at an 8% discount is $5.1 billion, or nearly $51 per share. These figures interested me so much that I decided to launch my own financial model.
My conservative assumptions lead to a fair price of $40-$41 per share
The company plans to sign deals to sell concentrate at $2.8k in 2023 and even $3.6k in 2024. I tried to be as conservative as possible so I used a constant price of $1737.
I invite investors to read the feasibility study, which includes substantial information on the company’s production forecast. The price of lithium concentrate has increased significantly since the reports were published. However, there is a lot of valuable information for the evaluation of mineral deposits. In the latest feasibility studies, the company was talking about more than 1.6 million dry tons of ore per year for a mine life of 12 years.
The Feasibility Study mining plan assumes the development of an open pit and the construction of a processing plant to process 1,680,000 dry tonnes of ore per year for a 12-year life and eight months. Source: GROTA DO CIRILO LITHIUM PROJECT
In my previous assumptions I have also included 270 kt of concentrate in 2023 and 2024 which relates to phase 1. From 2025 phase 2 I believe the company will be able to deliver 531 kt of concentrate. Using an ultraconservative price of $1790 per ton, revenues would grow from $483 million in 2023 to $779 million in 2034. If we also assume an EBITDA margin of around 82%, the company’s NOPAT would be most likely close to $517 million.
If we add back D&A, and deduct changes in working capital, free cash flow would be between $210 million in 2023 and nearly $633 million from 2025 to 2033. With an 8% discount, the present value would be $4.05 billion, and with a 10% discount, the net present value would be $3.6 billion. Finally, with an 8% discount, the implied enterprise value would be close to $4 billion. I added cash worth $105 million and subtracted debt to get the equity valuation. The implied fair value would be close to $40 to $41 per share.
I believe I am considerably more conservative than the company. In a recent technical reportwith information from phase 1 and phase 2, Sigma Lithium obtained a net present value of nearly $5 billion.
Finally, note that management expects to have three phases. I have only included planned production for Phases 1 and 2. In future feasibility studies, the company may provide more detailed information about its plans for Phase 3, which may increase expectations for future sales growth. . As a result, the stock price would likely rise as earnings forecasts rise.
In this regard, let’s say that in a separate technical report, the company noted a 50% increase in total mineral reserves due to the new phase 3. I don’t think the current market price includes this new information:
Sigma Lithium reports that it has filed a technical report titled Grota do Cirilo Lithium Project Araçuaí and Itinga Regions, Minas Gerais, Brazil, Phase 3 Mineral Resource Estimate in support of its June 22, 2022 press release, announcing the increase approximately 50% of the total National Instrument 43-101 (“NI 43-101”) Mineral Resource Estimate at its 100% owned Grota do Cirilo project. Source: SECOND
Prejudicial conditions and several risks would lead to a valuation of $17.3 per share
In this scenario, I would describe what I consider to be a detrimental outcome. First, Sigma Lithium may not find the total amount of minerals expected. Keep in mind that many of the free cash flow projections used indicated and unmeasured reserves. This means that geologists may not have correctly assessed the amount of lithium. Therefore, future production may be lower than forecast. The company discussed these risks in a recent report:
The Company’s business strategy is largely dependent on the development of the Project into a commercially viable mining operation. The commercial viability of a mineral deposit depends on many factors, including: the particular attributes of the deposit, such as size, quality and proximity to infrastructure; commodity prices, which are highly volatile. Source: Management discussion and analysis
The company may also have problems with supply chain issues. Lack of machinery to drill, explore or produce minerals could delay production, leading to less revenue growth. As a result, the implied NPV of the project would be lower than expected and the fair price would decrease.
Let me also point out that the company’s flagship project is in Brazil, where voters will probably elect a new president in a few months. The new administration may change relevant laws that may affect the Sigma Lithium project. If the company has to invest more in environmental research or change its mining plans, future production could be lower. As a result, I think the market price could go down.
Finally, I think the company may need additional funding for future capital expenditures. At this moment, the balance sheet reports cash equal to CAD 123 million. However, I believe the future capital expenditure required could be more than $187 million. Without sufficient funding or due to a higher cost of equity, the net present value would be lower than expected.
I tried to evaluate a more penalizing scenario with a production of 250 kt of concentrate in 2023 and 2024, and 500 kt from 2025 to 2034. I also assumed that the price of concentrate would drop from $2200 per ton in 2023 to $950 per ton in 2034. Additionally, with an EBITDA margin down about 75% and 65%, I achieved non-operating profit after tax of almost $135 million in 2034.
If we add D&A back to NOPAT and subtract changes in working capital and capital expenditures, free cash flow would be between $214 million and $238 million. With a 15% discount, the implied valuation would be close to $1.7 billion. Finally, equity per share would be close to $17.3 per share.
I think a lot of analysts haven’t had enough time to look at Sigma Lithium. Stocks look quite undervalued. Even with the recent valuation of $5 billion given by the company, or my net present worth of $4 billion, Sigma’s market cap seems too low at $2-2.6 billion. In my view, as more investors look at feasibility reports that may include Phase 3, more investors might grab stocks. Also, if the company measures its reserves a bit more and generates more market awareness, the stock price will likely trend north. Finally, in my view, as the company begins to report its first earnings in 2023 or 2024, demand for the stock will likely increase.