Should You Invest In Li-Cycle?

Should You Invest In Li-Cycle?
Reda Farran, CFA

over 1 year ago9 mins

  • Li-Cycle has a sound process, business model, and financials, and the firm benefits from a huge growth opportunity. Its shares could see strong demand for several reasons, including the firm being a potential acquisition target.

  • But Li-Cycle is also a very risky stock with a steep valuation. What's more, it’s facing rising competition from several other battery recycling firms.

  • 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.

Li-Cycle has a sound process, business model, and financials, and the firm benefits from a huge growth opportunity. Its shares could see strong demand for several reasons, including the firm being a potential acquisition target.

But Li-Cycle is also a very risky stock with a steep valuation. What's more, it’s facing rising competition from several other battery recycling firms.

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.

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The electric vehicle (EV) boom has increased the demand for batteries, and the importance of figuring out how to stretch the limited supply of the key metals that go into them. One way is to recycle lithium batteries and extract the valuable materials for reuse in new batteries. That’s the business model of battery recycling startup Li-Cycle, which I’ve analyzed to see whether you should invest in its stock.

What is Li-Cycle exactly?

Founded in 2016, Li-Cycle (ticker: LICY) is a Canadian company that debuted on the US stock market last August after merging with a SPAC (special purpose acquisition company). The transaction gave Li-Cycle a substantial war chest of $580 million to fund its goal of closing the circular economic loop for the expanding battery manufacturing supply chain. It does this by recovering key materials from batteries and reintroducing them into the supply chain.

There are two ways to recycle lithium batteries today. The most common, because it’s cheaper and simpler, is known as pyrometallurgy: applying heat to extract the precious metals. The process is energy intensive, releases harmful pollutants, and is not entirely efficient, with a recovery rate of only about 50%. Li-Cycle uses a more environmentally friendly method based on hydrometallurgy, which involves shredding the batteries before extracting end products like lithium, nickel, and cobalt in a water-based solution. The firm claims a recovery rate of 95% using this method.

Li-Cycle’s hydrometallurgy process compared to pyrometallurgy. Source: Company presentation
Li-Cycle’s hydrometallurgy process compared to pyrometallurgy. Source: Company presentation

Li-Cycle divides the process into two separate facilities: spokes and hubs. End-of-life batteries – regardless of shape, size, and chemistry – and manufacturing scrap from battery producers are first shipped to spokes, where the material is shredded, screened, and filtered. Spokes recover plastics, copper, and aluminum that can be recycled into other products. But spokes’ most valuable output is “black mass” – a powdery mix of battery materials containing key metals like lithium, nickel, and cobalt. Black mass can be sold to third parties or shipped to Li-Cycle’s hubs, where it’s used to produce battery-grade materials like lithium carbonate, nickel sulfate, and cobalt sulfate, as well as some other metals.

Li-Cycle’s spoke and hub model. Source: Company presentation
Li-Cycle’s spoke and hub model. Source: Company presentation

Why should you invest in Li-Cycle?

1) This is a huge growth opportunity. According to PitchBook, the battery recycling market is expected to grow to $27.3 billion in 2030, from just $2 billion in 2021, for a stunning compound annual growth rate of 33.8%. And that’s mainly being driven by the EV boom. See, battery recycling not only offers a safe, scalable, and sustainable solution to dealing with end-of-life EV batteries, but also expands the domestic supply of the key metals needed to power the future of transport and energy. This is especially important for North American and European countries, which have barely any lithium, nickel, and cobalt deposits.

The key battery materials supply chain is largely controlled outside of North America and Europe. Source: Company presentation
The key battery materials supply chain is largely controlled outside of North America and Europe. Source: Company presentation

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 deal 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
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
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.

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.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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