Blog / Albemarle: A Cautionary Note

Albemarle: A Cautionary Note

Albemarle (ALB), this Dividend Champion, has increased its dividend for 25 consecutive years.  The company is a specialty chemicals company, and as such, the world’s largest producer of lithium from which it generates approximately half of its total profits.  Longer term, the lithium business is quite exciting as a result of the rapidly-growing adoption of electric vehicles and other lithium battery uses. 

Shorter term, lithium supply has caught up with demand putting pressure on prices.  This supply/demand headwind is likely to last for the next couple of years.  As a result, Albemarle has elected to temporarily delay the buildout of what MorningStar referred to as capital-intensive lithium hydroxide production assets in Australia in favor of expanding their capacity in lower capital cost options in regions such as China.

According to their most recent earnings transcript, Albemarle’s management suggests that these actions will save $1.5 billion of capital expenditures over the next 5 years.  But more to the point of this cautionary note, management suggests that this will allow them to become free cash flow positive in 2021.  Since Albemarle is a Dividend Champion, I thought it was important to point out that the company has been free cash flow negative since 2017 and is expected to remain so through 2020.

This negative free cash flow for Albemarle represents the one metric referenced above, that Albemarle does not look especially attractive on.  Whenever I am evaluating dividend growth stocks, I always look to operating cash flow and free cash flow in order to provide me confidence that the dividend is well covered and hopefully safe and sustainable.  For most of the company’s history where Albemarle has increased their dividend achieving Dividend Champion status, the company’s free cash flow has more than adequately covered their dividend.  However, that has obviously changed since 2017.

Summary

The following FAST Graphs analyze out loud video will elaborate on and summarize Albemarle’s current valuation based on numerous metrics and calculations.

Conclusions

As I attempted to demonstrate in the above video, I do believe that Albemarle is a very attractively-valued dividend growth stock.  Management has raised their full year 2019 earnings outlook and guidance while reaffirming their revenue guidance.  They also expressed confidence that lithium demand and rational pricing would resume in 2021 and remain a strong driver of growth for the long run.

Although I tend to agree with management’s assessment, I do believe it’s only prudent to exercise a certain amount of caution.  Lithium pricing will be a major factor as to whether the company can successfully grow going forward.  However, according to Zacks, the company is facing challenges in their catalysts unit and are also exposed to headwinds from potentially unfavorable currency translations.  Zacks also believes that higher raw material costs across its Bromine and catalysts units are other concerns.  Personally, I remain confident that all these issues can be successfully managed by Albemarle’s excellent management team.

This leads me to my final comments that stimulated this cautionary note.  Albemarle’s capital expenditures more than doubled in 2017 because of lithium expansion projects which resulted in a negative cash flow referenced above.  Higher spending has hurt Albemarle’s free cash flow in recent years and is expected to continue through fiscal year 2020.

This poses important questions that prospective or current investors should be asking.  How will management deal with negative free cash flows relative to continuing their commitments to shareholders in the form of dividends and share buybacks?

The company does have adequate cash on the balance sheet, although it has dwindled significantly in recent years.  At this point, Albemarle’s dividend does appear to be safe – at least for the time being.  Albemarle has historically announced dividend increases in February when reporting their year-end results.  Consequently, investors should pay very close attention to the next couple of financial reports with a special focus on cash flows and dividends.  I am not trying to be an alarmist here; I just feel it’s prudent to recognize Albemarle’s current and expected near term future free cash flow situation.  But with that said, I do believe that most of the risk is already priced into the stock.  Caveat emptor.

Disclosure:  No position.

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