SQM – A High-Yield Dividend Stock On The Rise?

Sociedad Quimica y Minera de Chile (NYSE: SQM)

Wait what?

Never heard of the company?

Perhaps not surprising. They are not your usual dividend kings, aristocrats or champions that you often hear dividend investors talk about…

Yet SQM could be the dream stock you might want to consider holding in your portfolio.

First, It pays a great dividend, and offers serious growth potential in a growth sector.

Nevertheless, there are risk involved, so let’s take a look at why SQM and why NOT SQM.

The EV story – The biggest growth market ever?

What’s the hottest growth stock in town?

Everywhere we go… it’s TESLA this, TESLA that…

Elon Musk this, Elon Musk that…

Well, Electric vehicles (EVs) are taking the world by storm as governments around the world seek to push their climate change policies. In the UK, sales of new ICE cars will be banned from 2030. At this time of writing, the EU is in the process of legislating for a ban on new ICE vehicles from 2035. And in the United States, many states have already legislated for bans on new ICE vehicle sales by 2035. In China, sales of EVs rose to almost 6 million in 2022 – up 83% from 2021.

New cars sold around the world have averaged around 70 million a year since 2010. In 2022, the market share of EVs sold rose to 13% from 8.3% a year earlier. The growth potential is still phenomenal, and, barring an eye-popping, multi-governmental policy U-turn, carved in stone. Within the next decade, the EV market could be around 8 times larger than it is today.

This growth is inevitable…

So, shouldn’t you invest in EV manufacturers who will clean up the market?

Well… the truth is, any upside is virtually written into the share prices of EV manufacturers. Then again, the market is so competitive that manufacturers are being forced to slash prices of new vehicles to retain or gain market share.

As a consequence, margins are eroding and share prices are collapsing. Tesla ─ the gorilla in the EV world ─ has seen its shares slide from near $400 in November 2021 to around $180 at the time of writing, having been as low as $122.40 in early January 2023. And yet, still trading at a PE ratio of 50 – almost double the S&P 500 Index average PE ratio.

So… if not for EV manufacturers, where do we look?

Looking Beyond The Primary Focus

Smart and savvy investors look beyond the most obvious beneficiaries of new innovation.

Like when Rolls Royce announces a new aero engine and a truckload of orders for it. The run-of-the-mill investor buys Rolls Royce shares – and by the time they do, the shares have already moved 20% or 30% or 50% higher, and more.

The smart investor looks beyond the manufacturer and looks at the engine. Where do its components come from? The smart investor then buys shares in the companies that manufacture the essential components.

On the other hand, there is another group of investors that looks even further down the chain, at the tertiary layer, asking what raw materials are needed by the manufacturer who produces those essential engine components.

The Lithium Miners

The projected growth for the EV market should be around 800% over the next decade or so.

The share prices of car manufacturers have already moved. Plus, there’s going to be a lot of competition. And they will have to take on board the costs of changing production from ICE to EV, as well as end-product price erosion and the effect on margins.

So let’s go down the food chain.

EVs need car batteries. So, should you buy into the companies that produce these? It may be a similar story to the car manufacturers. Massive growth is coming but with limited potential to profit. The four biggest automotive battery manufacturers – CATL, LG Energy Solution, BYD, and Panasonic – have a grip on a 70% global market share.

Take a look at the share price of Contemporary Amprex Technology Co. as an example, and it has followed a similar pattern to Tesla, though not with quite the same volatility: increased by around 300% between 2019 and 2021, and is now down around 41% from its peak. Though still trading at a PE ratio of 37.

And what do batteries need? Lithium. The tertiary layer. The miners.

SQM – The gorilla in the lithium market

SQM is the world’s largest lithium producer with a nearly 20% market share. It has offices in 20 countries and sells to more than 100.

It doesn’t only produce lithium, either. Its products are diversified, including potassium and specialty plant nutrients, sulfates, etc. for use in many industries.

Its primary lithium business is based in Chili, and it also mines in Australia. SQM had forecast sales volumes of 140,000 MT in 2022. Actual sales hit a record 157,000 in the year.

A PE ratio of 6 in a market guaranteed to boom!

Tesla is down more than 50% from its all-time high and is trading on a PE ratio of 50.

CATL is trading more than 40% below its peak, on a PE ratio of 37.

SQM hasn’t been immune from the fallout. Like Tesla, its shares have risen strongly from around $16 in March 2020 to a peak of over $113 in May 2022. Now at around $70 at the time of writing, they are 35% below their all-time high.

And trading on a PE ratio of only 5.5.

While operating in a market sector with an almost guaranteed growth potential of 800%.

Producing something on which the whole sector relies.

In very rough terms, what this means is that if the company makes the same profit that it made last year every year for the next six years and distributes this profit as dividends, then shareholders will have recouped their investment in six years.

How Much Dividends Are We Talking About?

This is a dividend channel…

So… just how much dividend is SQM paying?

Well, as a stock in a high-growth sector, with a large share of the global market, SQM has a dividend yield of more than 8%.

Compare this to:

  • 1.68% dividend yield on the S&P 500 Index
  • 0% on Tesla
  • 0.16% on CATL

Then consider that the forward dividend yield (based on today’s share price and forecast dividends) is 10.1%.

Can the dividend be sustained?

After stellar growth this year, SQM expects more of the same

SQM reported its Q4 2022 earnings on March 7, and they were impressive:

  • Revenues increased from $2.9 billion in 2021 to $10.7 billion in 2022
  • Net income for the year was $3.9 billion, up from $585.5 million in 2021
  • EPS totaled $13.68 for the year versus $2.05 for the 2021

The company expects more to come. When delivering guidance, it is extremely bullish on prospects in the lithium market. It believes the market will reach 1.5 million MT by 2025. The company has set aside $3.4 billion of investment to boost its production capacity to 210,000 MT in 2023 – expecting at least 20% growth this year as EV sales growth solidifies around the world (as well as the increasing need for renewable energy storage systems).

Investment is not without risk

It wouldn’t be correct to discuss the investment potential of SQM without casting an eye over the risks.

One of the primary risks is the volatility of lithium prices. As with all mining of minerals, there is a base cost of getting lithium out of the ground. If lithium prices fall, then margins are reduced. If they fall below the cost of mining, then profits turn to losses.

There are various ways to mitigate this. These include investing in new technology to improve mining efficiency and signing sales agreements at pre-set prices – both of which SQM are doing.

At present, lithium prices are declining as supply is currently outpacing demand (fresh supplies have come from China, Australia, and Chile). The price now stands at a 13-month low of around $52,500 per MT, a correction of around 40% from the all-time high recorded in November 2022.

Another risk is if recycling potential explodes. At present, according to the IEA, only around 1% of lithium batteries are recycled.

Then, of course, there are political risks. The main locations of lithium mining operations are in Australia, China, and Chile. Should governments in these countries increase regulation of lithium mining, then this could negatively impact share prices of lithium miners. However, it is worth noting that SQM has contributed around $5 billion to the Chilean Treasury, as well as making contributions to local governments and neighboring communities (smart politicking?).

The bottom line

SQM operates in a high-growth market. There is no doubt that sales of EVs will grow around the world. Governmental climate change policies ensure this. Unless you believe that there will be a massive U-turn against EVs, then you’ll realize that the growth potential for lithium demand is huge.

However, as with all investments, there are risks that you’ll need to understand. It’s almost without doubt that technology will catch up with the lack of lithium battery recycling ability. When this does, it could hammer lithium demand.

Earnings from its lithium operations represent 79% of total SQM earnings. That’s a good chunk, but also offers some support should lithium prices move lower or demand fall.

With a forward dividend yield above 9%, a payout ratio of 54%, and a miserly PE ratio of below 6, SQM shares does look like a very attractive income and growth investment in an exciting market sector.

To close, this is not a recommendation to buy. Please do your own due diligence before placing your hard-earned money into any investment. If you love stability, then the Kings and Aristocrats might just be the place to be. But if you like some drama, and prefer a little bit of growth while collecting a 10% yield… then a small percentage of allocation might be worth the bet.

Loved this? Spread the word