Top brokers explain why not all ASX lithium shares are created equal

When lithium prices eventually retrace, the explorers are likely to be hit harder than the producers.

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Key points

  • ASX lithium shares in focus amid strong share price growth 
  • Established lithium producers tipped over explorers 
  • Look for large companies in tier-one locations 

ASX lithium shares have certainly gotten their fair share of attention over the past year.

And for good reason.

Lithium prices have been soaring amid rapid growth in electric vehicles. Lithium is a core ingredient in the batteries that get them from A to B. And with current supplies struggling to keep up with demand, the price of the lightweight, conductive metal has soared some 500% over the past 12 months.

And that’s seen the prices of both established ASX lithium shares as well as junior lithium explorers skyrocket.

ASX lithium shares booming

Here’s what we mean.

Below are the share price gains for a range of ASX lithium shares over the past 12 months:

For some context, the All Ordinaries Index (ASX: XAO) is up 4% over the same period.

But with many investors now looking to get in on this outperformance, we look at why these brokers warn that not all ASX lithium shares are created equal.

Explorers could face big pullbacks

Ben Cleary is the CEO of the Tribeca Global Natural Resources Fund.

According to Cleary (quoted by the Australian Financial Review):

The surge in prices has lifted all boats in the lithium sector, and in terms of exploration assets, you’ve only got to say that you think there’s lithium and you’re getting material re-rates. So of course, when lithium prices do eventually pull back, there are going to be some fairly big pullbacks in some of these exploration assets.

The incumbents are generating a lot of cash flow for retail investors, so you’d expect to see pretty significant shareholder returns, and dividends and buybacks, which you’re not going to get with exploration companies.

The existing producers still look pretty cheap on current spot prices, but the key question is where do long-term prices land?

Cleary favours the established ASX lithium shares already producing product. Mineral Resources and Allkem are the biggest lithium stock holdings in the Tribeca Global Natural Resources Fund.

What prices are they really receiving?

Another issue to consider when running your slide rule over ASX lithium shares is the prices they’re actually receiving for their product.

Often producers may be selling at prices determined in prior months, rather than the soaring spot price.

“We think the ability of a producer to realise prices closer to a rising spot is a key factor in picking relative outperformance in the sector,” UBS analyst Lachlan Shaw said (quoted by the AFR). “This means realised prices lag spot pricing when spot is rising, with the difference accentuated when the spot market is moving quickly.”

David Franklyn, portfolio manager of Argonaut’s Natural Resources Fund added, “The raw material suppliers are in a very strong position to negotiate, particularly if they can grow production over time because the people they have offtake agreements with are scrambling for resources and are more likely to deal.”

What to look for in ASX lithium shares

According to Franklyn (from the AFR):

We look out for large companies that are in tier-one locations, have a large resource base, are in production and also have the ability to further grow production. The guys who maximise the benefit of those higher prices are the ones that are in production today and don’t have everything locked away in long-term contracts because you need to be able to sell near spot.

In the medium term, there will have to be a point when supply will catch up to demand and prices will clearly soften. The question is when that happens because there are many moving parts, but the way to try and mitigate risk is to go with the bigger, more established producers.

The Argonaut Natural Resources Fund’s biggest ASX lithium share holdings include Pilbara Minerals, Mineral Resources and Liontown Resources.

The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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