[This Week's Industry Insight] L&F Partners with Tesla, Will It Escape Undervaluation?

Tesla Signs 3.8 Trillion KRW Anode Material Supply Contract
Proves Technological Competitiveness... Successfully Diversifies Customers

Editor's NoteDear individual investors dreaming of successful investments. How well do you know the stocks you invest in with your own money? In the unrefined and chaotic online environment filled with all kinds of information, Asia Economy aims to be your hands and feet, eyes and ears, delivering accurate information about companies. Each week, we focus on companies that ranked high in stock views provided by the financial information provider FnGuide, delivering everything from basic information to analyses of related companies such as partners, customers, and investors. We will explain companies' financial status, performance, and future value in an easy-to-understand manner. We meet you every week under the name "This Week's Watchlist," highlighting stocks of interest. This week, we analyzed L&F, a secondary battery (battery) material company gaining attention after signing a supply contract with Tesla, the world's largest electric vehicle company.

3.83 trillion KRW. This is the scale of the high-nickel cathode material supply contract L&F signed with Tesla on the 28th of last month. This figure is comparable to L&F's annual sales last year. As L&F emerged as a key partner of Tesla, the world's number one electric vehicle manufacturer, it attracted significant attention from investors last week. With favorable reviews pouring in from the securities industry, the stock price soared rapidly. The stock price, which had been gradually rising due to expectations of the Tesla supply contract and increased by 40% this year, jumped about 50% after the contract announcement. Although investors worry that the price has risen too much, the securities industry considers these concerns unfounded. The stock price is still undervalued compared to the company's valuation and even relative to competitors.

According to the Korea Exchange on the 8th, L&F's stock price steadily rose from 185,400 KRW (closing price) on January 2, the first trading day of the year, surpassing the 250,000 KRW mark by mid-February. Rumors of an imminent supply contract with Tesla led to the stock price reflecting the positive news in advance and continuously rising. On the day the contract announcement was made on the 28th of last month, the intraday stock price surged to 271,500 KRW and closed at 262,000 KRW. Although profit-taking sales caused a slight decline afterward, the stock price still firmly holds the high 250,000 KRW range.

Supply Contract Equivalent to Last Year’s Annual Sales

L&F signed a contract to supply approximately 2.91 billion USD (about 3.83 trillion KRW) worth of high-nickel cathode materials to Tesla over two years starting January next year. This amount is close to L&F's provisional annual sales of 3.88 trillion KRW last year. However, the contract amount may vary depending on exchange rates and fluctuations in raw material prices such as lithium. Kim Hyun-soo, a researcher at Hana Securities, analyzed, "This contract involves about 77,000 tons of high-nickel cathode materials (an average of about 40,000 tons per year), which can be used in 783,000 electric vehicles," adding, "L&F will supply Tesla with high-nickel cathode materials sufficient for about 400,000 electric vehicles annually over two years." Regarding the impact of this contract, Jeon Chang-hyun, a researcher at Daishin Securities, evaluated, "It can be summarized as entering as a core partner in Tesla's battery internalization plan and a major cathode material vendor, with expectations for follow-up orders and customer diversification."

Founded in 2000, L&F is a company that produces cathode materials, a core component of batteries. The higher the nickel content in cathode materials, the larger the battery capacity and the lower the price. In 2007, L&F succeeded in mass-producing 'NCM (Nickel-Cobalt-Manganese)' cathode materials with about 50% nickel content for the first time in the world. Later, in 2020, it developed NCMA cathode materials with 90% nickel content. Last year, it developed and succeeded in mass-producing NCMA cathode materials with 92% nickel content. An L&F official explained, "We have continuously invested in technology development to increase the nickel content in cathode materials, aiming to mass-produce NCMA cathode materials with 95% nickel content by 2024," adding, "Based on the technology accumulated over 18 years, we were highly evaluated for quality and price competitiveness, enabling us to sign a large-scale supply contract with Tesla."

The implicit meaning of this large-scale supply contract with Tesla is that L&F's technological prowess has been proven in the global market. Kang Dong-jin, a researcher at Hyundai Motor Securities, evaluated, "This contract once again proves L&F's NCMA high-nickel cathode material technology." Jeon Chang-hyun of Daishin Securities analyzed, "Not only the competitiveness of leading high-nickel cathode materials with nickel content in the mid-90% range but also the stable supply history through existing battery maker LG Energy Solution were positively evaluated."

PER of 17.1 Times, Significantly Undervalued Compared to Competitors

Since succeeding in developing and mass-producing cathode materials, L&F's performance has been on a rapid growth trajectory. In 2019, sales were 313.3 billion KRW, but it recorded an operating loss of 7.7 billion KRW. It turned profitable immediately from 2020. Sales, which were 356.1 billion KRW in 2020, surged to 970.8 billion KRW in 2021 and 3.88 trillion KRW in 2022. Operating profit also grew from 1.5 billion KRW to 44.3 billion KRW and then to 266.2 billion KRW during the same period.

The securities industry judges that L&F's stock price is still undervalued and has high valuation appeal. Jeon Chang-hyun of Daishin Securities emphasized, "Despite the stock price rising after the announcement, the valuation attractiveness compared to peer companies remains high, so there is sufficient room for further price increases." Jung Jae-heon, a researcher at DB Financial Investment, also pointed out, "Despite the recent overall stock price rally in the secondary battery sector, L&F's expected 2024 price-to-earnings ratio (PER) is about 17.1 times, significantly undervalued compared to competitors," adding, "Being a major cathode material supplier to Tesla, the world's number one electric vehicle company, will be a sufficient premium (stock price boost) factor."

Overcoming LG Energy Solution Concentration

Expectations that the concentration risk of a specific customer, which had been a drag on L&F's stock price, will be resolved are also expected to boost the stock price. Kim Jeong-hwan, a researcher at Korea Investment & Securities, noted, "Currently, LG Energy Solution accounts for about 80% of L&F's sales in electric vehicle cathode materials, so performance volatility is high depending on sales volume changes and market share within the customer," adding, "This has been a reason why L&F has been undervalued compared to other cathode material companies."

The possibility of securing additional customers beyond the concentration risk is another reason for optimism about L&F's future. Kang Dong-jin of Hyundai Motor Securities said, "L&F stated that about 30% of orders will be direct OEM contracts by 2025. Considering the production capacity guidance of about 400,000 tons in 2026, more than 100,000 tons must be directly contracted as OEM, so there is potential for additional supply contracts with Tesla or other OEMs beyond Tesla," adding, "With additional orders, stable mass production, and technology verification, the gap between stock price and valuation will narrow." Park Jin-soo of Shin Young Securities also said, "The diversification of mid- to long-term supply customers is positive," explaining, "Since the delivery schedule in this supply contract announcement extends to 2025 and considering previous guidance, additional supply contracts for Tesla's direct delivery volume in 2025 can be expected."

According to Daishin Securities, Tesla is expected to continue expanding production capacity at its Texas plant, focusing on North American factories to actively respond to the U.S. Inflation Reduction Act (IRA). The expected annual electric vehicle production at Tesla's Texas plant is projected to increase to 300,000 units this year, 600,000 units in 2024, and 1 million units in 2025. It is estimated that about 30% of the electric vehicles produced at the Texas plant in 2024-2025 will be equipped with in-house produced batteries. Jeon Chang-hyun of Daishin Securities said, "The scale of in-house battery production in Texas is also expected to expand from about 40 GWh in 2025 to 100 GWh in the future," adding, "With this contract, L&F secured a supply reference for Tesla in 2024-2025 and can expect more follow-up orders after 2026." Jung Jae-heon of DB Financial Investment also noted, "Tesla is currently rapidly expanding battery production capacity at its Nevada plant (targeting 100 GWh) and plans to secure 1,000 GWh of battery production capacity in the long term, so L&F's direct supply volume to Tesla is likely to increase sharply in the future."

Accordingly, as performance growth is expected, target prices are also being raised. Korea Investment & Securities raised the target price from 330,000 KRW to 380,000 KRW, Daol Investment & Securities from 300,000 KRW to 380,000 KRW, and Daishin Securities from 262,000 KRW to 390,000 KRW.

Fierce Market Competition... Raw Material Supply War

One of the threats to L&F is fierce market competition. Cathode material manufacturers have traditionally signed contracts with single customers, but this trend is changing. Posco Chemical, which mainly supplied LG Energy Solution, recently signed a 10-year supply contract worth 40 trillion KRW with Samsung SDI. Earlier, EcoPro BM and L&F each signed large-scale cathode material supply contracts with SK Innovation (now battery subsidiary SK On). As the existing practice of not supplying competitors' customers among partners is breaking down, competition in the cathode material industry is intensifying. An industry insider said, "The competition among cathode material companies to expand major customers' project orders is expected to be both an opportunity and a threat."

The raw material supply war is also expected to intensify. Batteries commonly used in electric vehicles consist of cathode materials, anode materials, separators, and electrolytes. Among these, cathode materials are a very important factor determining battery performance. Cathode materials are made from a combination of metals such as lithium, nickel, cobalt, manganese, and aluminum, with lithium having the largest proportion. According to the Korea International Trade Association, 89% of total lithium demand is for batteries. Demand is expected to increase 42-fold in 2024 compared to 2020. Accordingly, smooth lithium supply will be a key factor for the future of the battery industry, and stable raw material supply will determine the competitiveness of battery material companies.

Especially, supply chain instability has been greater than ever due to the war between Russia and Ukraine, which has disrupted raw material transactions since March last year. The industry is closely monitoring key variables in nickel supply and is fighting hard to secure raw materials.

The scale of supply contracts may also vary depending on raw material prices. An L&F official explained, "The sales price was recently applied based on the delivery price, and it may increase or decrease depending on future lithium price fluctuations," adding, "The contract amount was calculated based on an exchange rate of 1,317.4 KRW per USD, and the total contract amount may vary depending on raw material prices and exchange rate fluctuations."

Meanwhile, L&F has started a battery material recycling business with Doosan Enerbility to secure lithium. L&F provides waste powder generated during cathode material production, Doosan Enerbility extracts lithium carbonate, and L&F receives it to reprocess into lithium for electric vehicles and use it in product manufacturing. L&F is also pursuing establishing a joint venture with the U.S. battery recycling company Redwood Materials in South Carolina.