Today’s stock is in the ultra-glamourous lead-acid battery recycling market. If you want to be a part of what could be the next great industrial revolution, this month’s Cabot Small-Cap Confidential candidate should be right up your alley.
Aqua Metals (AQMS)—CSC
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THE BIG IDEA
Do you know what happens to your car battery after it dies and you exchange it for a new one?
The answer might surprise you. Especially since your little battery is part of a $22 billion global recycling market. And this market is about to be completely revolutionized by an emerging technology that offers the rare benefits of being simultaneously cleaner, more efficient and more profitable (for select companies in the supply chain) than the status quo.
First, a little background. Lead-acid batteries (LABs) were invented in 1859. Today, lead is still the essential ingredient in 95% of the world’s rechargeable batteries. It’s just too good at holding a charge to be replaced.
The commodity is traded on the London Mercantile Exchange (LME). You can buy a metric ton of lead for around $2,275 right now. This is what the 10-year historical price chart looks like.
Incredibly, a lot of the lead used in batteries over the last 150-plus years is still in use today. That’s because lead has chemical properties that allow it to be recycled over and over. The recycling process can literally go on indefinitely.
Lead is the most recycled metal on the planet. And almost 100% of used LABs are recycled. After they run out of energy, they are melted down through a process called smelting and born again. Around 65% (and rising) of the lead in LABs comes from recycled batteries. The rest comes from lead mines, or as a secondary product from zinc mining. But in-ground lead supplies are running out. And as battery demand for vehicles, datacenters and alternative energies grows, an efficient lead recycling industry is becoming increasingly important. This is especially true given that the current recycling process and supply chain for used LABs is horribly inefficient, terribly polluting and incredibly unhealthy for workers.
The smelting process is the biggest issue. First, they break batteries into bits to separate them into three parts: lead, plastic and sulphuric acid. Then the smelters heat the lead up to around 1,400°F. This metallurgical reduction process melts down the lead and causes it to react with various reducing agents to get rid of oxygen, sulfur and other impurities. What’s left is waste slag and lead. Another process is required to get the pure lead that can be poured into ingots, which become the raw material used to make new LABs, and other forms of raw lead.
The smelting process is toxic, dirty and energy intensive. Dust is created throughout the entire process. Workers in smelting plants are constantly at risk of lead poisoning, since no level of lead exposure is good for humans. And to make matters worse, smelting is only economically efficient when done on a large scale (over 200 metric tons a day).
People that live around smelting plants are at risk too. So much so that the U.S. forced the closure of the last lead smelting plant in the U.S. back in 2013. That was the Herculaneum, Missouri lead smelting plant owned by the Doe Run Company. It couldn’t face the costs of upgrading its technology, yet again, to meet increasingly stringent EPA standards.
The writing was on the wall prior to the plant’s closure though. It’s not like LABs are being recycled near where they are dropped off by the end consumer. Most are traveling the world to get recycled. The system would seem inefficient if we were talking about light weight plastic bottles and aluminum cans! But we’re talking about lead batteries that usually weigh 40 pounds or more.
And where do they go to get recycled? Mexico, the Philippines, China, Russia; places that don’t have nearly the same environmental restrictions as the U.S. I hate to think what smelting is doing to the roughly two million local people exposed to the smelting process in those countries where it’s still permitted. Many of these places are trying to improve the process, but it’s inherently bad.
The good news is that this industry is about to change in a big way. A group of people out in the Nevada desert have invented a new way to recycle LABs. And they just fired up their first recycling plant.
From the perspective of a used LAB, this new process sounds more like a trip to the spa then the blast furnace. That’s probably an apt comparison for workers too, who no longer need to wear heavy and cumbersome respiratory equipment to protect them from lead poisoning.
The used LABs are still broken up into pieces to separate out the lead, plastic and acid. But then the lead goes through a water-based process that creates no emissions, poisonous dust or toxic waste. That’s not only better for the lead, which comes out 99.99% pure, but for the workers too.
And, this process can take place right here in the U.S. or in remote regions of the world. That means lead from used LABs spend a lot less time on trucks, boats and trains waiting to get recycled. And a lot more time spent where it can be more useful—under car’s hoods or powering a datacenter.
Major industry players have been vying for ownership stakes in the only industrial small cap that has invented the technology and equipment to fundamentally change the global lead industry. This company’s technology is poised to do for lead what the Bessemer process did for steel, and the Pilkington float glass method did for glass. Those two technologies resulted in the first inexpensive process to mass produce steel in the 1850s, and created a better way to manufacture glass in the 1950s.
If you want to be a part of what could be the next great industrial revolution, this month’s Cabot Small-Cap Confidential candidate should be right up your alley.
THE COMPANY/PRODUCT
Aqua Metals (AQMS) is a $358 million market cap company trying to disrupt the $22 billion global lead recycling industry. The company was formed in 2014, went public in mid-2015, and has already opened its first used lead-acid battery (LAB) recycling facility in McCarran, Nevada. The business is based around a modular, patent-pending process called AquaRefining, which is cleaner, cheaper and requires less capital than conventional lead smelting. Aqua Metals is mainly focused on vehicle LABs now, but is also eyeing other markets that use LABs, including internet and cloud datacenters and energy grid scale storage. The company is based in Alameda, California.
You might think a 150-year old technology is due to be upgraded. But LABs still dominate the battery market. They’re even growing in popularity as stop-start vehicle batteries evolve and as electric bikes (now over 15% of LAB production), cell tower, data center, clean energy storage (think wind and solar) and industrial back-up markets turn to LABs for power. Over the last five years, lead output is up 20%. And that’s with nearly 100% of all LABs heading to the recycling plant.
AquaRefining is a truly revolutionary process (see accompanying flow chart) that came about because the inventors figured out how to design a proprietary, non-toxic water-based solvent (which is reused indefinitely) to dissolve lead compounds. And they cracked the riddle to design a fully automated electro-chemical process and electrolyzer to convert the dissolved lead compounds into pure, primary grade lead. These are the two core processes that form the backbone of Aqua Metals’ patent-pending process.
Unlike smelting, which requires huge amounts of energy to heat the lead, AquaRefining is a water-based process done at room temperature. There is no dust, no gas and no lead-filled slag and dross byproduct as there is from smelting. Only the lead compounds are converted back into lead, and high value lead compounds are recovered directly at the source and turned into ingots. Permitting is relatively easy since the process is not subject to the National Emissions Standards for Hazardous Air Pollutants (NESHAP) that apply to conventional smelter-based recycling facilities.
It is designed to be a modular recycling system (see image above from a Batteries International article). The equipment can be manufactured in standard-sized modules on a conventional production line. AquaRefining recycling facilities can easily be configured to match the desired capacity—whether it’s 10 metric tons per day or 1,000 metric tons—by varying the number of modules. This variable capacity is dramatically different from conventional smelting facilities which are only economical at around 200 metric tons per day.
This modular design could also mean that the LAB industry can stop shipping spent batteries around the globe to be recycled in a relatively limited number of facilities. AquaRefining modules can be set up in regional centers closer to where batteries are collected, and where lead ingots are turned back into new batteries. This has the potential to further reduce the environmental impact of the lead recycling supply chain, not to mention reduce the time it takes to turn a spent LAB into a new one. The ability to build much smaller recycling centers can also greatly reduce the financial risk of building a massive lead smelting facility.
Strategic Partnerships Lend Credibility, Cash and Clout
Johnson Controls (JCI) is a diversified technology and industrial company with a global business and a market cap of nearly $40 billion. Its solutions make buildings safer, infrastructure more reliable and energy more efficient. It also happens to be the world’s largest automotive battery manufacturer, producing one-third of the industry’s output. That’s over 150 million batteries every year. It makes lead-acid batteries, lithium-ion batteries and hybrid automobile batteries.
On February 7, 2017 Johnson Controls stepped up to the plate and made a deal with Aqua Metals. The deal stipulates that Aqua Metals will supply its proprietary AquaRefining technology and equipment to both new and retrofitted used LAB smelting facilities operated by Johnson Controls in North America, Europe and China. This is a licensing deal, and Aqua Metals will generate revenue dependent on the capacity of the equipment it supplies. It is non-exclusive (that’s good), but there is a first-mover advantage window granted to Johnson.
The two companies also struck a five-year tolling and lead production deal. Aqua Metals will accept used LABs from Johnson and recycle and return the lead to JCI for a fee (this is called “tolling”). JCI’s initial supply will represent a good chunk of production capacity at the McCarran, NV plant.
The lead purchase agreement stipulates that Johnson Controls will buy up to 100% of Aqua Metals’ monthly production of recycled lead for automotive applications from McCarran. Production for non-auto applications (i.e., back-up power for internet and cloud, grid scale storage, etc.) is not included in the deal. As part to of the deal, Johnson Controls acquired a 5% stake in Aqua Metals (939,000 shares at $11.33 each) for $10.6 million.
This is a huge deal, for a number of reasons. One, it helps to validate Aqua Metals’ technology. Second, it allows Aqua Metals to expand production (through licensing) far faster than it otherwise could. This is especially relevant in China, where it would be difficult for Aqua Metals to operate on its own. Third, it provides enough used batteries to nearly fill capacity at the McCarran plant, when added on top of the deals Aqua Metals already had (more on this in a minute). And that supply should help Aqua Metals obtain the financing needed to expand production. And lastly, it means Aqua Metals is a partner, not just a competitor, with the largest automotive battery manufacturer in the world. That’s not a bad card to have in your back pocket.
Interstate Battery is the number one replacement brand battery in North America and the country’s largest battery recycler. Its nationwide distribution network of over 200,000 dealers brought in almost 25 million automotive batteries in 2015. That was more than the 17 million auto batteries the company sold! Interstate also sells batteries for heavy equipment, lawn and garden equipment, security systems and data center cloud infrastructure.
In May of 2016, Interstate Battery teamed up with Aqua Metals, agreeing to supply over one million used automotive and other LABs as feedstock for AquaRefining on a cost-plus basis. The deal is for an initial 18-month term. Interstate also made a strategic investment of $10 million into Aqua Metals, consisting of stock (700,000 shares at $7.12), two cash warrants to purchase stock over the next three years, and a $5 million note.
Building Out 800 Metric Tons of LAB Recycling Capacity
In May 2015, Aqua Metals purchased 11.7 acres of undeveloped land near Reno, Nevada for $1 million. Three months later, the company broke ground and began constructing what it now refers to as TRIC, a 136,750 ft2 LAB recycling facility located in the Tahoe Regional Industrial Center (hence the acronym “TRIC”). As expected, this facility is not subject to NESHAP.
Construction of the recycling facility (see the two pictures taken during the construction process) took 12 months, commissioning took a few more, and the first 99.99% pure AquaRefined lead was produced in October 2016. Before the end of 2016, Aqua Metals made a few incremental upgrades to bump up full capacity—with four shifts—to 120 metrics tons of lead per day. Production can be expanded to 160 metric tons if the company invests another $12 million to bring the total number of AquaRefining modules up to 32, which it is planning to do. All in, this facility will end up costing around $54 million. It will serve as the blueprint for future plants, and Aqua Metals has plans to build five additional plants relatively soon.
Just to recap, $54 million in capital builds one plant with 32 AquaRefining modules cranking out 160 metric tons per day (roughly five metric tons per module), when four shifts are working full time. At current lead prices, this plant can generate $100 million to $120 million in revenue per year. Five plants, each recycling 160 metric tons annually, would generate $500 million to $600 million in revenue per year (revenue from partnerships like the one with Johnson Controls are above and beyond this), and would require a total of 160 AquaRefining modules. The company plans to raise around $150 million to $250 million more in debt financing to construct four more plants. We prefer that plan over a dilutive secondary stock offering. Aqua Metal’s near-term growth plan relative to the global lead market is shown in the table above.
Right now, Aqua Metals’ TRIC facility has a capacity of 120 metric tons per day with four shifts running. In mid-February, when we received the latest update, the company had started a second shift and was recruiting for a third shift. Management was clear to mention it wasn’t close to producing 120 metric tons a day yet, and that plans to expand capacity to 160 metric tons are dependent on a clearer path to build the second plant. In the company’s annual report, management said it is planning on ending 2017 with 120 metric tons of production. Management also said it was going to be very tight-lipped about how much it is producing since the global lead industry is very secretive. That was news to me! But we’ll be able to figure it out somewhat accurately based on reported revenue.
The Business Model
Aqua Metals designs and manufactures LAB recycling modules. It also builds, owns and operates one LAB recycling facility in Nevada, and has plans to build, own and operate more. Additionally, it licenses its technology and installs AquaRefining modules at third-party LAB recycling facilities. The only current licensee is Johnson Controls, but other partnerships are likely to be forged in the future.
For directly-owned recycling facilities, Aqua Metal’s business plan is to select locations close to regional supplies of used LABs that it receives through strategic partnerships (currently with Interstate Batteries, Battery Systems and Johnson Controls). Aqua Metals pays for the used LABs it receives, and gets paid for the recycled raw materials (primarily lead ingots) that it sells.
A key component of the business plan is to educate participants in the current supply chain (including regulators) about the advantages of AquaRefining technology compared to smelting. These benefits include greater supply chain efficiency, lower adverse environmental and human health impacts, and lower total cost for recycling each ton of lead.
I suspect this business model will evolve over time since licensing potential could be far greater than revenue from company-owned facilities. And this technology could be adapted to work for other industries.
The Bottom Line
Aqua Metals is emerging from a developmental-stage company into a revenue generating one. In 2016, it posted a net loss of $13.6 million ($0.89). Share count currently sits at around 19.2 million. It ended the most recent quarter with $26.6 million in cash, helped in part by a secondary offering of 2.3 million shares on November 21, 2016 at $10 per share. After the close of Q4, cash increased to $34.2 million due to the Johnson Controls deal. The company has $9.2 million in long-term debt, due to Green Bank, backed by the USDA (this loan helped fund construction of the facility in McCarran, Nevada).
The company believes it has the capital to fund its business plans for the next 12 months, including ramping the Tahoe Regional Industrial Center up to 120 tons per day. However, it needs to raise capital to build additional company-owned facilities, and probably to increase TRIC capacity to 160 tons. Management has said it will do this by raising debt. It should also have just begun generating revenue in the current quarter. It’s reasonable to expect around $1 million in revenue this quarter, and roughly $5 million in Q2. In 2017, consensus estimates point toward $40 million in revenue. In 2018, it seems reasonable to expect around $120 million in revenue from TRIC and Johnson Controls. The company is expected to deliver an EPS loss of $0.35 this year, and a gain of $0.65 in 2018. But that’s all quite speculative—I suspect this is going to be a story that evolves somewhat differently than expected (hopefully in a good way).
RISK
LAB supply: Aqua Metals requires a constant supply of spent LABs to use for raw material feedstock. Limits in supply could lead to instability in its business, as could lead price volatility. That said, the company’s ability to forge partnerships with major players has helped to reduce risk of being “boxed out” of the market.
Possible dilution: This is an early stage company and strategic partnerships have been forged, partially funded by issuing warrants. Secondary stock offerings are also possible in the future if debt financing isn’t practical. The stock is likely to be volatile at times, so averaging in and maintaining a long-term perspective is critical.
Patents: Starting in 2013 Aqua Metals began filing a wide variety of patents covering its AquaRefining process, its water-based solvent and electrolyzer, aspects of electrode management, aspects of continuous lead plating, etc. Applications have been filed in the U.S. and in accordance with the Patent Cooperation Treaty (PCT), which governs international patents. To date, no patents have been granted. While the process does take a while, we would like to see some level of patent protection in the near future.
Plant operations could be variable: This is a new process and Aqua Metals’ hasn’t been operating for years like smelters have. Issues with the process could arise that require redesigns, and that could lead to production reductions and/or plant closures while equipment is retrofitted. In the early days, it seems as though this isn’t an issue, but proving the technology out over the next year is critical.
COMPETITION
Aqua Metals’ primary competitors are companies that operate existing plants for smelting LABs, many of which are battery manufacturers (who collectively control roughly 50% of used LAB supply). In the future, it could also compete with any companies that develop alternative LAB recycling processes. However, at the moment, the only commercially-viable alternative is smelting. Isamelt, a variation on the smelting process that uses a thermal lance to provide heat, and Flubor, an electro-refining process that’s an alternative to smelting for lead ore, were developed years ago. But neither process has been adopted commercially, suggesting they are not commercially viable. Aqua Metals competes with companies making money in certain stages of the reverse supply chain for LABs (i.e. the recycling process). These could include auto repair shops, auto dealers and auto parts stores. And Aqua Metals could face competition from companies that wish to keep it out of the recycling supply chain by restricting access to used LABs.
THE STOCK
Trading Volume: Aqua Metals has a market cap of $358 million and trades an average of 360,000 shares daily. That means roughly $6.6 million worth of stock trades each day. Our subscriber group shouldn’t move this stock. Trading volume prior to the Johnson Controls deal was lower than it is now, suggesting interest in the stock is rising.
Historical Price: The company went public on July 31, 2015 at 5. The stock was relatively unchanged until after it reported Q4 results in March 2016, when it rallied to 6, then 8. Shares then rallied as high as 13 upon news of the Interstate Battery strategic alliance (announced May 19, 2016). Things cooled down and the stock moved back to 9 in August 2016, ultimately staying there until Q3 results were released in early November. After that, the stock spiked as high as 14. It retreated to 11 in early February 2017, then the deal with Johnson Controls drove shares up to 18, and a spike above 22 occurred in March. Since March 15, the stock has mostly traded in the 17.5 to 20.5 range.
Valuation and Projected Price Target: This company is just emerging into a revenue-generating business from a developmental-stage one, so most valuation metrics aren’t very useful. It’s impossible to find good peers for comparison. The analysts that have done extensive financial modeling on the business have mostly come out with price targets in the 28 to 35 range, which suggests roughly 50% to 100% upside potential right now. But even these price targets are admittedly rough given that we won’t know the true pace of growth and market potential for several quarters, if not years. For simplicity sake, I’m going to back into a valuation using the price-to-forward sales ratio, and assume $120 million in sales in 2018. That implies TRIC running at full capacity (at 120 metric tons/day), plus some revenue from partnerships. For the stock to go up by 50% over the next year, we need it to trade up to around 28, which works out to a price-to-sales ratio of 4.7 a year from now. I think that’s a very reasonable starting point. We can review other valuation metrics as things evolve.
Buy Range (next two months): Since the stock broke out in early February, it has traded mostly in the 16 to 20 range. Until we get another business update or another major development occurs, that’s my preferred buy range. The low end of the range means picking up shares near the 50-day moving average (which is typically a good buy point), while the high end of the range means buying roughly 10% below the all-time high. I advise averaging in, with larger purchases in the 16 to 18 range, and smaller purchases in the 18 to 20 range.
The Next Event: I expect the company to release quarterly results around mid-May.
Aqua Metals (AQMS) Financials
Aqua Metals (AQMS 17.96) |
UPDATES ON CURRENT RECOMMENDATIONS
Due to the nature of the stocks recommended, it is to your advantage not to share these recommendations.
Strong Buy means the stock should be bought immediately and is expected to move sharply higher in the very near future.
Buy means accumulate shares at or around the current price.
Hold means just that; hold what you have. Don’t buy, or sell, shares.
Sell means the original reasons for buying the stock no longer apply, and I recommend exiting the position.
Sell a Half means it’s time to take partial profits. Sell half (or whatever portion feels right to you) to lock in a gain, and hold on to the rest until another ratings change is issued.
There will be no update on current positions in this month’s Issue since I have been traveling. Weekly Updates on the entire Cabot Small-Cap Confidential portfolio will resume next Friday as usual.
Please email me at tyler@cabotwealth.com with any questions or comments about any of our stocks, or anything else on your mind.
Next Cabot Small-Cap Confidential issue is scheduled for May 5, 2017
Cabot Small-Cap Confidential is published by the Cabot Wealth Network, an independent publisher of investment advice. Neither the corporation nor its employees are compensated in any way by the companies whose stocks we recommend. Sources of information are believed to be reliable, but they are in no way guaranteed to be complete or without error. Recommendations, opinions or suggestions are given with the understanding that subscribers acting on information assume all risks involved. Copyright © 2017 - COPYING AND/OR ELECTRONIC TRANSMISSION OF THIS NEWSLETTER IS A VIOLATION OF THE U.S. COPYRIGHT LAW. For the protection of our subscribers, if copyright laws are violated by any subscriber, the subscription will be terminated.
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