Should You Invest In Li-Cycle?

2) The company has a sound process, business model, and financials. Li-Cycle’s process is agnostic to battery chemistry, and it’s patented, which increases the barriers to entry for potential rivals. What’s more, the firm’s spoke-and-hub model is highly scalable, and reduces collection and transportation costs. That’s because the firm locates spokes in areas near where batteries are going to end up. Multiple spokes then send black mass to one strategically located, centralized hub.

Li-Cycle has a proven business model with plenty of commercial contracts in place. For example, it has over 100 suppliers of end-of-life batteries and battery manufacturing scrap with some big names like LG Chem and Mercedes-Benz. On the output side of things, all of the black mass produced at Li-Cycle’s existing spokes are fully contracted, and so are all of the key battery materials to be produced at its very first hub when it comes online in 2023.

Finally, the firm has a healthy balance sheet with over $500 million of cash (net of debt). That’s enough to fully fund its plan to have seven spokes and one hub in operation by the end of 2023. That funding is important considering the firm is currently unprofitable and burns through cash every quarter.

3) Li-Cycle’s shares could see strong demand. Li-Cycle is the only publicly listed, pure-play battery recycling company. That means its stock offers the most direct way for investors to gain exposure to the fast-growing battery recycling sector, and could see increased demand as a result. What’s more, because Li-Cycle hits on several mega trends, its shares could see demand from funds focused on those themes – think: EVs, battery tech, recycling, lithium, ESG (environmental, social, and governance), and so on. Finally, Li-Cycle was added to the Russell 2000 Index in June in a move that’ll add yet another source of demand for the firm’s stock, as funds passively tracking the index become forced to buy and hold it.

4) It’s a potential acquisition target. If Li-Cycle’s market value happens to shrink, it could tempt some other firm to acquire it. This could provide a floor to its share price, increasing an investor’s potential risk-to-reward. Some potential acquirers include other battery recycling firms wanting to get their hands on Li-Cycle’s intellectual property, battery manufacturers who want to close their economic loops, or EV makers looking to secure key battery materials and at a lower cost.

OK, but why shouldn’t you invest in Li-Cycle?

1) It’s very risky. First, there’s operational risk. The firm doesn’t have an operational hub – its first one is still under construction and is expected to come online in 2023. Until then, there’s risk surrounding the firm’s ability to finish building the hub on time and on budget. And while it’s piloted a small-scale version of a hub, its ability to successfully operate a fully sized one is still unproven. The firm’s revenue-making potential depends on this: a fully operational hub means it can stop selling black mass at a discount and instead convert the mass to battery-grade materials that fetch a premium price.

There’s also customer concentration risk. Li-Cycle heavily depends on Traxys – a firm that offers trading solutions to the metals sector. Traxys has agreed to buy 100% of Li-Cycle’s production of black mass until the hub is up and running, and has also agreed to buy 100% of the end products from the hub. Summary: the bulk of Li-Cycle’s revenue today and even after its first hub comes online comes from a single customer. The firm is trying to diversify away this risk, mind you, as evident by its recent deals with mining giant Glencore.

And finally, there’s commodity price risk. Li-Cycle’s revenue ultimately comes down to how much metal it recovers and the prices of those metals at the time it sells them considering it does not have a hedging program in place. So if the prices of its key metals – nickel, cobalt, and lithium – fall, the firm’s future revenue will take a hit.

 

Nickel, cobalt, and lithium prices are currently elevated. Source: Company presentation

 

2) This market’s going to be competitive. Li-Cycle is facing rising competition from several upstarts. Ascend Elements, a relatively new venture-capital-backed firm, recycles EV batteries and uses the extracted materials to manufacture new battery cathodes. It claims to have a 98% recovery rate. Another firm, Hydrovolt, recently began operations of Europe’s largest EV battery recycling plant. The firm, which uses a technology that’s similar to Li-Cycle’s and also has a 95% recovery rate, wants to be big in Europe.

Another firm that claims to have a 95% recovery rate is Redwood Materials. Not only is the firm run by a former Tesla co-founder and chief technology officer, it’s also really well-funded: it raised $700 million from high-profile investors at a $3.7 billion valuation last year. The firm plans on using the proceeds to expand in North America and Europe. It’s worth noting that Redwood uses a combination of pyrometallurgy and hydrometallurgy, meaning its process is probably more energy intensive and polluting – things that could give it a slight disadvantage.

 

3) Li-Cycle’s valuation is steep. Li-Cycle is unprofitable. It has an enterprise value of $720 million and analysts expect it’ll make $38 million in revenue this year, giving Li-Cycle an EV/sales ratio of 19x. That’s very steep: the same valuation ratio for the Nasdaq is just 3x. But Li-Cycle’s revenue is expected to grow fast, with the firm saying it’ll start churning out operating profits soon – especially after its hub is operational in 2023. Looking at the firm’s own forecasts from its SPAC presentation (shown below), it expects to make $339 million in EBITDA (earnings before interest, taxes, and non-cash expenses such as depreciation and amortization) in 2024.

 

Li-Cycle’s own projections in February 2021 (take these with a pinch of salt). Source: Company presentation

 

Company-provided forecasts on SPAC presentations are always super optimistic, so let’s say Li-Cycle makes only $100 million in EBITDA that year. That would imply a 7.2x valuation multiple using EV to forecasted 2024 EBITDA. That looks a lot more reasonable. For example, materials company Umicore, which generates over 50% of its revenue from metal recycling, trades at an 8.2x valuation multiple using EV to forecasted 2024 EBITDA.

But this 7.2x multiple for Li-Cycle looks reasonable only if you believe it’ll execute and actually generate $100 million in EBITDA in 2024. As I already mentioned, there are operational and commodity price risks that could all derail this train. And if we value the firm on its more near-term (and tangible) expected revenue, it’s very expensive.

 

So, what’s the bottom line here?

Li-Cycle is a high-risk, high-potential-reward stock. And the current market environment is unforgiving for unprofitable firms that have a lot of promise but that ultimately don’t end up delivering. That’s why I think it’s probably best to keep Li-Cycle on your watchlist and revisit it once its first hub is operational next year – a milestone that would significantly de-risk its growth story. At that point in time, it’s also worth seeing whether nickel, cobalt, and lithium prices held onto their recent gains.

Investment conclusion. 
It’s probably best to keep Li-Cycle on your watchlist and revisit it once its first hub is operational next year – a milestone that would significantly de-risk its growth story.

 

KEY INSIGHT
If you do insist on investing in the stock right away, my two tips to you would be;

Do some of your own research first and invest only a small amount, considering it’s a high-risk stock.
Or better still join my closed circle to get and know other alternatives that will be more profitable with lesser risks. 

 

JEFF BROWN 

FOUNDER & CHIEF INVESTMENT ANALYST