Returning to Corvette / Shaakichiuwaanaan: Second Visit Presents Second Opportunity

The Koala physically and intellectually revisits Patriot Battery Metals

The koala has been invested in Patriot Battery Metals since December 2021. It’s been an amazing adventure this past 2.75 years. Doubled down at the end of March 2022. First physically visited the Corvette site in June 2022. Was amazed by the potential of what I saw. So much so I bought even more stock after the site visit.

And now over 2 years later, the koala returns from the now renamed as Shaakichiuwaanaan project pondering what to make of this going forward.

If you’d said the stock would not have even doubled from that June 2022 site visit after delivering incremental discoveries in the district, attracting a world class management team, and a robust resource and maiden Scoping Study, the koala would have been shocked. And yet here we are.

I have no desire to re-open the discourse around the Scoping Study. It a snapshot of one possible pathway forward for this district that shows incredibly robust economics at $1500/t for 6% spodumene. And at the koala’s long term price view of $2,000/t the plan looks even more robust and phenomenal. If you agree with the Koala about that long term price assumption, you see the road back to C$18/sh and beyond over the course of the rest of this decade as this becomes a North American Pilbara Minerals.

You also then probably already own the stock, so most of this will not be new to you.

The question the koala wanted to answer for itself, as it still holds ~80% of its max share/economic exposure from back in February 2023, is what do we make of the pathway forward if lithium needs to spend a little more time in the penalty box than usual at the bottom of this cycle. Put another way in the spirit of the “Lithium is the New Iron Ore” metaphor the koala coined in 2022, if we are still in 1H 2015 and not the 2H 2015 rock bottom, what’s the pathway?

The conclusion the koala has come to is threefold. First on the asset, second on the lithium market itself, and third is on the industry dynamics / soft issues at play here. The combination of these conclusions is the koala feels underweight quality lithium assets here and also Patriot itself specifically today (even if Patriot is already the dominant position in its portfolio).

First, there is a very viable pathway to push Shaakichiuwaanaan forward through the development trough of the Lassonde Curve even if lithium/spodumene prices remain where they are today. In doing so, Patriot will be positioned to capitalize on the next lithium cycle and be in a position to implement Phase 2 of perhaps first Phase 1b. Because of this, there is no reason to wait to gain exposure to this project even if you think it takes another 12-24 months for lithium prices to rebound.

Second, as weird as it is to speak of a commodity besides copper being 50-100% higher than spot in the “long term”. We need to take this moment in the cycle to discuss through the supply chain economics, particularly if we are to have a lithium ion battery one not at the mercy of China. The conclusion the Koala has come to is without a $25-30,000+ LCE price, we simply will not see that western supply chain build out. And without that, in this “past peak globalization” world, there simply won’t be the electrification super trend. That will only be solved through higher prices.

Third, we need to talk about the hesitancy of strategic capital to pursue the upstream supply chain in the west and how that inaction is effectively shaking a champagne bottle before reluctantly opening it.

Let’s start with Patriot’s pathway forward: if you find yourself in hell, keep walking…

Simply put, the PEA lays out a plan to mine ~2 million tonnes per annum out of the underground mine for close to 20 years (total stope mined is ~36.8 million tonnes, another ~3 million tonnes of development). This is part of a broader combined mine plan including an open pit and 5 million tonnes per annum processed.

So why does this…if you’ll indulge the koala’s lazy back of the envelope formatting, as a worst case scenario intrigue the koala?

Because even at these sorts of lithium prices we’ve seen today, you probably still would build the Nova zone underground mine! You just swap out the open pit capex for underground capex, just do “Phase I” which is a 2.5MM tpa processing plant and get on with it. That stage 1 “net capex” of C$640MM will probably be pretty similar.

But when you then consider Vega zone is ~30m height x 300 wide and 300 long and open in multiple directions, doesn’t take a mathematician once you know specific gravity of pegmatite is 2.7 to see there is already ~8 MM tonnes of incremental high grade resource at Vega and it is likely to grow with more resource.

Put another way, even if you are bearish lithium long term and think 6% spodumene trades below $1,000/t USD, there is probably still a viable mining operation at Shaakichiuwaanaan for many decades to come.

Just to indulge in bridge from this “spot shall stay spot” scenario to somewhere in between that and the $1500 6% spod ($1375/t for 5.5) used as the PEA base case, Ken in the site visit presentation spent a lot of time focusing on this slide and the revenue factor used on the open pit being <US$900/t for 5.5% spodumene at an RF of 0.65. To put it into more macro terms, this base case open pit is profitable at a headline 6% spodumene price of $1,000/t or better. Below that, there will be some marginal years as the pit gets deeper. But alas, that’s why the Nova zone and Vega zones are so critical to the flexibility in the pathway forward no matter where we in the lithium cycle.

Ideally, you don’t have to chase the high grade immediately and preserve the flexibility it provides to the overall project economics through multiple lithium price cycles, but that doesn’t change the fact you have the ability to do so if it gets you through the worst part of the Lassonde curve now.

TLDR – this is not going on the shelf to wait for “the next cycle”, the true sign of a world class / Tier 1 district scale project. The management team has the optionality with this resource endowment to keep moving forward even at these current lithium prices.

There is no point talking about the upside optionality because frankly if you agree with the koala on that, you probably already own the shares. But are wondering what is the pathway forward if this lithium cycle bottom takes longer than your current bonus cycle to sort out.

Can nitpick a few facts here but core point is there is an economic project within this resource even at these lithium prices and that means PMET will be in a position to have the OPTION to brownfield expand if there ever again is another lithium upcycle, and bring the PEA economics back onto the playing field.

And if you are looking at Patriot Battery Metals with a fresh set of eyes today, that is really the outstanding question that needed to be answered.

Which brings us to the second set of conclusions from the eucalyptus tree: what price does capital need to build a western supply chain such that the electrification revolution will not be dependent on China? Kind of a big question in the pursuit of happiness and energy independence.

We could very extensive here but instead the Koala is just going to show you a slide from Albemarle’s 2Q 2024 presentation. Simply put, excluding Greenbushes (which is represented by that after-tax “equity income” which is grossed up on a pre-tax basis and included in Adjusted EBITDA) the rest of the Albemarle lithium business does not generate positive EBITDA. This is a company that has a portion of the Salar de Atacama.

In fact, it looks like even at $20/kg LCE (so call it $20,000+ / t hydroxide pricing) the rest of the business ex-Greenbushes is barely breakeven on an EBITDA basis. Like think EBITDA margins less than 10%, which is pretty wild for a business that has the Salar de Atacama in there. The koala thought salars/brines were supposed to be amazing.

It what world does a business like this find the balance sheet capacity and internally generated capital to redeploy into growth to satisfy a 15-25% lithium demand growth CAGR without an LCE price >$25/kg?

Now, if you really get into the weeds and think about how Albemarle buys spodumene at spot and sells hydroxide 6-9 months later without hedging price risk, maybe this is a touch too extreme. But how do you hedge that price risk embedded in your working capital and in your sales & purchase contracts? It requires capital.

It’s very silly but basically, go look around at the western lithium names. Who has the balance sheet capacity and free cash flow generation to invest in supply growth to meet projected demand growth at these prices?

You can also see in the recent Arcadium Investor Day presentation with their intention to effectively double LCE production and EBITDA is predicated on spodumene prices returning to $1400/t for 6% and hydroxide/carbonate prices being over $20,000 compared to the current spot prices of $10,000/t.

In what world is there $1.5 billion of growth capex available for Arcadium at these current lithium prices?

This isn’t copper where the capital markets and strategics will invest billions in anticipation of higher prices. You can see that in the fact Albemarle did not continue its strategic MOU with Patriot to explore a downstream hydroxide facility to partner with Shaakichiuwaanaan. Where today at these lithium prices does Albemarle have line of sight to the $1.5 – 2.0 billion of capital probably required to build a greenfield 50kt LCE lithium hydroxide facility in North America?

And then consider needing a 15% IRR on that sort of investment and let’s be kind and say pre-tax IRR, that’s $225-300 million per year or $4,500-$6,000/t lithium hydroxide profit margin.

8 tonnes of 5.5-6% spodumene at ~$1,000/t is $8,000/t feedstock

Let’s use the $3,000/t “refining cost” from a great Sigma Lithium slide

Then layer on said profit margin of $6,000/t, you basically get to the current broker consensus of $18,000/t except $1,000/t spodumene isn’t realistic at those levels. So truthfully the real number is well north of $20,000/t.

And of course any shareholder is going to ask why build greenfield refining capacity at 6.6x EBITDA ($1.5 Billion versus $225MM) if the shares are not already valued at a much higher EBITDA multiple. Cost of capital analysis is fun…

Layer on the fact there just aren’t that many quality deposits that will survive full cycle, you will likely see the long term price higher than what it is modeled to be. The koala’s $25,000-30,000/t hydroxide and $2,000/t 6% spodumene views don’t sound crazy anymore.

The conclusion is for the western supply chain to develop, you need materially higher lithium prices than you see today. The status quo is not sustainable.

You may say to the koala that a western supply chain doesn’t matter because China and free trade, but quite candidly no matter how low your view of politicians and policymakers are, surely you don’t believe electrification in pursuit of Net Zero will be pursued such that the west is at the mercy of China being a willing refiner. If you believe that, then nothing else matters and you should stop reading here.

I will stress though as outlined here, there is a path forward for Patriot where it sends material to Asia to be refined provided spodumene is ~$1,000/t or better. As you can see looking at the high grade math outlined above at ~$850-900 for 6% spodumene, and be conservative and hit it for some incremental shipping cost.

But if you agree with the koala on that foundational premise, then while we have already shown a pathway forward at CURRENT prices for Patriot to push forward through the Lassonde Curve, we can also now see in the suffering of its more advanced peers, there is a level of pain and difficulty such that these current prices are not sustainable.

So perhaps we should not be so quick to brush off the $1500/t 6% spodumene economics that form the base case of the Scoping Study. Which gives us clear line of sight to Patriot going back to being a unicorn in US dollars.

$1 billion USD, 150 MM shares, 1.35 USDCAD, we are easily back to C$9.00/share and frankly that seems conservative. But the current share price is <C$4.00/share so let’s not dream the real dream, at least out loud!

And that brings us to the third question, the strategic capital deficit.

Pilbara is acquiring Latin. Albemarle has to do some “self-care” to its balance sheet to put it diplomatically. SQM has a 20% Chinese shareholder. Covalent isn’t ramped yet. Mineral Resources has its own issues right now at these lithium and iron ore prices considering its balance sheet.

Which leaves from an outside looking in perspective only one obvious acquiror – Rio Tinto. A company that has made >$100 million in exploration commitments in James Bay. No need to read too much into that sort of interest at all.

But here in lies an opportunity to apply some lessons from the Koala’s career after witnessing TRQ, and the recent Vicuna/BHP processes play out. The M&A mechanism in these major companies is complicated.

Case in point, Latin is getting a ~75% premium from Pilbara. How does Jakob and management say to the Rio Tinto board it’s going to take a multi-hundred percent premium to current price to acquire Patriot today?

Because Ken Brinsden, CEO/MD of Patriot, who brought Pilgangoora to the promised land as MD of Pilbara Minerals, has 1 million options at C$7.00 and 1 million options at C$9.20. They expire August 2026. Just a hunch here, he didn’t move from Chairman to CEO/MD and move to Montreal to sell Patriot for below his option strike price.

And as someone who has been in this investment for almost 3 years now, that’s a good thing. It’s rare to have an asset of this quality in independent hands. And Ken has been very prudent at making sure the cash / liquidity requirements do not become a concern (that May 2024 raise looks genius today).

While the koala cannot give all its creative ideas away for fun, there are quite a few levers the Koala has in mind that would not be equity that could push the liquidity runway beyond YE 2025 well into 2026.

You get a recovery in lithium macro anytime in the next 18 months, after the market has learned in this downcycle which assets have true “full cycle viability”, the share price should recover nicely as the market goes from processing the “spot is forever reality” towards “oh the PEA base case is actually quite sensible”.

You get back to C$9-10/share, we can have a conversation about appropriate premiums on an M&A side of things. The Latin 75% premium on C$10 would get you back to the all time high for Patriot’s share price but let’s not get carried away here, spodumene isn’t even back above $1,000/t yet.

But equally interesting, in case you thought this was coming to a close, there is phenomenal argument to “go the distance” here and the koala believes there is access to a lot of attractive capital.

Consider how the iron ore industry went from annual contracts to a free floating spot market at BHP’s insistence. Basically after enough customers reneged on contracts when steel prices went down, BHP decided no point continuing to sell effectively a call option on steel prices to steel mills in China.

Whereas in the US steel market, the annual auto sheet negotiation happens every autumn. Because Ford and GM want to know what their steel will cost so they can set the pricing on their cars. Consumers do not want the price of a car to change every month/quarter because the price of steel did.

So Cleveland Cliffs and US Steel agree on a price with the major automakers. Then, since price is fixed, they go to work on securing their margin. Both companies are vertically integrated upstream in iron ore, so the other big raw material input is coking coal. Hence why AMR, METC, ARCH all do domestic fixed price contracts with the US blast furnaces.

Nuclear utilities do floor / ceiling based contracts with Cameco and other uranium producers.

Is it not crazy to think there could be a similar pricing mechanism for lithium units in the west?

Imagine the credit market availability to finance the build of a Tier 1 / world class lithium mine in Quebec if there was a floor / ceiling offtake for Phase 1 production for the initial 3-5 years at $1200-1800/t 6% spodumene equivalent?

There are many moving parts here once the lithium market bounces off the bottom. But what really matters is there is a way forward if this bottom continues for a prolonged period of time. And that there are multiple levers to pull if/when the lithium market turns if Rio Tinto or another major mining/chemical company does not make a bid for Patriot Battery Metals so Ken and the team have to build the mine independently and create Pilbara Minerals the sequel.

For reasons to discuss another time, the koala is thinking a lot about September/October 2019 including its time in Santiago where it met with SQM. The buyside meeting attendees were irate with their investment plans and finally IR put it best (from memory) “who in here believe the lithium market will grow at a 20-25% CAGR next several years? Because we do and we are investing accordingly”. I’ve thought about that meeting a lot these past couple months.

Because now even if you believe in the demand CAGR, how do find the financial capacity to invest accordingly given these current spot prices in the lithium space? The cure for low prices, as ridiculously cliché as it is, but also profoundly simple if you are not a pod monkey with limited duration, is low prices.

Whether you buy the Koala’s high level thinking around the pathway back to a $20,000+ hydroxide price and a spodumene price of $1500+, all that really matters at this share price and this spot price complex, there is a viable pathway forward that provides optionality to the next cycle, whenever that may be.

Because of these very high grade zones of material tonnage, there clearly is. Ken kept using the words optionality and flexibility when presenting to the site visit attendees the night before the visit, and it really rings true. You can see both this high grade smaller scale pathway outlined here and at the same time stand on CV5 looking west and east with mineralization as far as you can see then fly over CV13 back towards CV5 and realizing that 3 kilometer gap seems pretty quant compared to the already established mineralized trend and be wondering “why can’t this be Greenbushes in North America / Atlantic Basin?”

There is a pathway forward at basically any lithium price.

Hindsight 20/20, the Koala has ridden quite a wave in this name in the past 12 months. But as a fundamental investor in natural resources focused on quality, if we set aside the rearview mirror and look forward, looks to this marsupial like investors are getting a second chance at the opportunity the Koala got in 1H 2022.