Food & Batteries

An out-of-favour critical minerals name offering a highly asymmetric return of ~90%+.

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Value Situations is NOT investment advice and the author is not an investment advisor.

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Readers of this newsletter will be aware that I regard companies with exposure to real assets and materials as attractive potential investments in the current inflationary environment. Yes, the latest CPI reading indicated inflation slowed to +3% YoY in June but what’s surprisingly overlooked by commentators is this still constitutes rising inflation, not disinflation.

To put some numbers to my point, looking at the data the latest CPI print follows YoY CPI growth of +3% in the previous year to June 2023, which itself followed CPI growth of +9.1% the previous year to June 2022. In simple terms, prices today are almost +16% higher than they were three year ago, before the effects of COVID on supply chains and the Russian invasion of Ukraine changed the inflation regime. Going back further, the data indicates today’s prices are almost +23% higher than five years ago during the pre-COVID era, while today’s ~3% CPI rate is ~2x the average rate of inflation in the US over the five year period from 2015 - 2019, prior to the recent regime shift.

Data aside, on a more anecdotal basis the “real economy” experience also appears to confirm a inflationary backdrop, as consumers experience affordability issues across groceries and a range of other key categories:

Source: The Kobeissi Letter / X.

On this basis, my view is that we remain firmly in an inflationary environment despite what recent headlines might tell us, and with the prospect of interest rate cuts coming later this year, I think it is very reasonable to assume inflationary conditions (comfortably above 2%+) will persist as looser capital will inevitably flow into assets again.

In my view, such an outlook necessitates exposure to real assets, commodities and other inflation-linked/resilient businesses. As paid-tier subscribers to this newsletter will know, I hold a number of names in my Model Portfolio that fit within this framework, such as OCI and BG. Subscribers might also recall that I recently wrote about the slowing adoption of EVs globally as it relates to an auto parts name I hold in the Portfolio, which has lead me to my latest value idea.

While reading up on current EV market trends, I was interested to note a major development has been the rise of lithium-iron-phosphate (LFP) battery technology. LFP batteries now account for ~40% of batteries used in EVs sold in 2023, up from less than 10% in 2018:

Source: IEA World Energy Outlook Special Report, April 2024.

A major driver behind the increased use of LFP batteries is that they are cheaper to produce than the nickel-manganese-cobalt (NMC) batteries, which have been the dominate battery type used to date. Due to their cost advantage LFP batteries are increasingly regarded as a key element in making EVs more affordable relative to ICE cars and hybrids, particularly in the US and Europe as competition from lower cost Chinese manufacturers intensifies (notably, a key driver of Chinese manufacturers’ cost advantage over US and European peers has been their deployment of cheaper LFP battery chemistry, with two thirds of EVs sold in China in 2023 containing LFP batteries).

In addition to their cost advantage, LFP batteries also benefit from a longer battery life and do not have the same environmental and ethical issues associated with mining for cobalt and nickel used in NMC batteries. Despite LFP batteries’ advantages over NMC technology, NMC batteries have dominated the EV market to date as they have a greater energy density, meaning they offer greater driving range and so do not need to be recharged as frequently as LFP batteries, assuming battery pack sizes are equal (to increase an LFP battery’s range to match an NMC battery would require a larger battery pack, which would in turn increase an EV’s weight and size).

Until recently, the lack of EV charging infrastructure had made driving range a key selling point for EVs competing against ICE vehicles, thus making NMC the preferred battery technology. However as EV sales have slowed in recent months, vehicle economics has started to displace range as perhaps the key consideration among manufacturers as well as consumers. Tesla was among the first to realise the benefits of LFP technology and switched to LFP batteries in 2021. A range of major auto players have since followed and embraced LFP technology, including Ford, Hyundai, Volkwagen, Mercedes and Stellantis:

Source: First Phosphate Investor Presentation, July 2024.

So as the four-fold increase in LFP’s market share indicates, it is clear that the shift to this technology is a major structural trend in the auto industry, and one underpinned by a clear economic incentive.

An interesting implication arising from the increased adoption of LFP batteries is that growing demand for this technology will put the EV industry in direct competition with the agricultural sector for phosphate supplies. Recall that phosphate is one of the three major fertiliser types (along with potash and nitrogen), and is essential to the global food supply, being a critical nutrient for staple crops such as corn, wheat, rice and soybeans. Given the rapid adoption of LFP batteries in EV manufacturing, it now seems that phosphate has become a critical mineral for the EV transition as well as for the global food supply. Indeed, phosphate rock is already classed as a critical mineral in the EU and earlier this year a bill was proposed in the US Senate to include phosphate (along with potash) on the US government’s list of critical minerals.

Readers will know already that food and energy security are major investment themes of mine, and recent EV battery market trends have again piqued my interest in this regard. And so in this issue of the newsletter I present a “Quick Sit” idea that I believe offers a way to play this “food vs. batteries” critical mineral thesis. Similar to OCI and BG, this latest idea is a strategically important business with an irreplaceable asset base but most interestingly, it is out-of-favour among investors despite being both cheap and uniquely positioned to benefit from long-term food and energy trends.

The stock is…