Lithium demand is forecast to soar over the next decade as more people snap up electric and hybrid vehicles requiring special batteries. Vanadium is the hot commodity for energy storage batteries, but it is lithium that’s key to the transport sector. There’s two UK-listed stocks that offer a play on lithium: Bacanora Minerals (BCN:AIM) looks very interesting but its sector peer Rare Earth Minerals (REM:AIM) looks overvalued and should be avoided.

A bout of mining takeovers has raised the profile of the lithium sector with chemicals producer Rockwood (ROC:NYSE) investing in a rival business before itself receiving a takeover offer from specialist metals group Albemarle (ALB:NYSE) in mid July for $6.2 billion.

Structural change

The commodity is undergoing a structural change in demand thanks to developments in the electric vehicle market. Rechargeable lithium-ion batteries are seen to be the key driver for the commodity price.

HD Capital reckons the lithium space is reminiscent of uranium in 2004/5 where few people knew much about the commodity and where the market was dominated by only a few producers. As uranium demand increased, more miners started to get involved in the space - and a few years later you saw a rapid increase in the value of uranium mining equities.

As we revealed in the 25 September issue of Shares, Bacanora is one of this year’s best-performing IPOs (initial public offering), up more than 100% since joining the market on 25 July to 67.5p. That’s a great performance, but somewhat misleading as only the few individuals who took part in the IPO placing will have seen these generous capital gains.

Already listed in Canada, Bacanora priced the issue of new shares to join AIM at 33p on 25 June. It planned to join the UK market soon afterwards yet there was a slight delay which meant it took another month to complete the transaction. In that interim period, rumours emerged that Tesla Motors (TSLA:NDQ) would build a $5 billion lithium-ion battery factory in Nevada which raised the profile of the commodity and sent investors clambering for shares in Bacanora on the Toronto market.

Also fueling its share price was read-across from the Albemarle/Rockwood takeover. Because the AIM placing had already been locked in at 33p, it meant Bacanora’s share price would automatically open significantly higher on its first day of dealings, to reflect the subsequent appreciation in the Canada-listed stock. Indeed, the shares opened at 63p, immediately giving the AIM backers a 91% paper profit.

The stock subsequently shot up to 87.5p on the following day, just as we predicted (see Shares, Small Caps, 10 Jul) and has since come straight back down. The business is now valued at £52.8 million. We had a feeling the shares would initially spike due to hype around the stock emanating from Bacanora shareholder Rare Earth Minerals. The latter’s chairman, David Lenigas, had spent a lot of time talking up the stock ahead of its AIM listing so there was an army of UK investors eager to get in immediately.

At the time of the listing, Rare Earth Minerals owned 9.93% of Bacanora; that figure now stands at 12% and we are not surprised it has raised its stake. Rare Earth Minerals has two joint ventures with Bacanora; one is 30% ownership of the El Sauz/Fleur concession; the other is 30% stake in the Buenavista, Megalit and San Gabriel land. Both these assets lie on Bacanora’s Sonora licence area which could eventually become a lithium mine. Bacanora chairman Colin Orr-Ewing says its 100%-owned La Ventana concession is the priority to be developed, adding that this is also easier to mine as it doesn’t have the overburden matter that lies across the joint venture sections (and which will have to be removed, pushing up costs for the Rare Earth Minerals section).

This is important to understand. The section of the land containing Rare Earth Minerals’ joint venture is many years away from being developed. Rare Earth Minerals is clearly aware of this situation, hence why it has been buying more Bacanora shares on the market as that’s the firm that should generate lithium-related revenue first, potentially in late 2017 says Orr-Ewing.

Rare Earth Minerals is currently valued at £78.3 million. For that you get the Bacanora equity stake, worth £6.1 million at current market prices, and a 3.02% stake in Western Lithium USA (WLC:TSX) worth £1.6 million. That means the market is valuing its remaining exploration assets at £70.6 million, which is split between a 38.4% economic interest at the project level for the Bacanora joint venture tenements, 100%-owned prospects in Greenland and a 30% stake in a rare earth exploration project in Australia. That seems very rich given the early-stage nature of all these assets.

One of the problems is that lithium is a fairly niche industry so mining analysts are still trying to understand how to properly value these assets, particularly those at the exploration stage. We also expect retail investors are simply buying Rare Earth Minerals on the hype around lithium rather than any proper analysis.

Theoretically, Rare Earth Minerals is a short selling opportunity on valuation grounds but none of the big spread betting companies contacted by Shares were able to offer a market to short the stock, saying you could only go ‘long’ with a spread bet due to its small size.

Lithium is very much in vogue at present but this could rapidly fade if there’s technological developments which use alternative raw materials. Orr-Ewing at Bacanora seems very aware of this situation, implying that the company’s job is to advance the lithium project but ultimately hope it will be bought by someone in the near future.

Solid business

We prefer Bacanora because it looks like there could be a solid business underpinning its investment case, should the lithium be successful or not. It has a borate project in Mexico, a commodity that absorbs water and is used in fibreglass, pyrex and cleaning products; it is also used as a micronutrient in crop protection and as a wood preservative. There’s resilient demand, meaning this could be a nice long-term earner for Bacanora.

Its Magdalena borate mine could start initial production at the end of next year, says Orr-Ewing. He reveals Mexican glass firm Vitro (VITROA:BMV) could be a potential customer and has asked for samples to test in its plant. Samples from the lithium asset have already confirmed recovery of 99.5% battery-grade LCE (lithium carbonate equivalent).

The big catalyst for Bacanora’s share price comes towards the end of 2014 when two pre-feasibility studies are published on both the lithium and borate projects. There’s already a preliminary economic assessment on the borate asset but the company has subsequently changed its product plans, hence why the numbers are likely to be very different. Bacanora has now decided to produce boric acid, a higher value product which sells for a premium.

(Lithium salt flats)

Bacanora Minerals (BCN:AIM) 65.0p

Growth: MEDIUM

The twin streams of lithium and borate should give Bacanora a strong platform from which to build a revenue-generating mining business.

Risk: HIGH

Commodity prices, economic returns and development funding are the big uncertainties. But these are partially offset by large assets and favourable progress with studies and sample tests to date.

Quality: MEDIUM

Early indications look good for the lithium quality and ability to produce boric acid, yet economic quality is unknown until pre-feasibility studies come later in the year.

[buy_or_sell b]

Rare Earth Minerals (REM:AIM) 1.44p

Growth: MEDIUM

The company seems eager to get its foot in many doors which gives welcome asset diversification but exploration requires focus, so having too much can be a negative.

Risk: HIGH

Its only 100%-owned asset is in Greenland where mining developments can be dogged by red tape. Other interests are via stakes in other companies or projects: a minority position can mean little or no control over speed of work or strategic decisions. Association with chairman David Lenigas can be a negative as he’s been involved in many failed small caps.

Quality: LOW

It clearly benefits from any good news from Bacanora, given the equity stake, but Rare Earth’s own projects are just too early stage to get an idea of quality.

[buy_or_sell s]