Porter’s “Dig Baby Dig” Pitch for a “Blood in the Streets” Opportunity

by Travis Johnson, Stock Gumshoe | September 25, 2024 1:01 am

Recently Porter Stansberry[1] posted a pitch titled “Dig, Baby, Dig” that serves as a bit of a tease for a recommendation that is apparently a combined issue of Porter’s own Big Secret on Wall Street and the Distressed Investing service run by Martin Fridson… and it caught the attention of a few readers, so I’m finally taking a little look today.

As with most of those Big Secret issues, the initial storytelling and intro part of the piece is freely available for anyone, so you can check that out here[2]… but the specific recommendation and the more detailed investment analysis are just for paid subscribers, so it’s not really a “hard sell” like some promos, but it’s certainly a tease to encourage folks to sign up for The Big Secret on Wall Street ($1,425/yr).

But as is often the case, the first part of the story includes some clues about the recommendation… so we can check those out, call on the Mighty, Mighty Thinkolator for some answers, and at least get you started on your research for a much lower price (how does free sound? Too cheap? OK, in lieu of a tip jar you can always sign up for our bargain-priced premium service[3]).

The story begins with a poem that sums it up pretty nicely, written by Martin Fridson:

The price of lithium[4] has declined
Quite sharply, therefore we found
A stock/bond hybrid well designed
To profit from the rebound.

So that’s the big story — lithium was the hottest commodity in the world in 2021, when we were all ga-ga over the latest electric cars and believed the promises that all cars would be electric before 2030. Now, with lithium production ramping up over the past decade to begin to meet that expected EV demand, and with the cost of mining rising as the end-user demand for electric cars has emerged much more slowly than expected… lithium prices have been crashing, almost back down to the lows in early COVID.

I pulled this chart and explanation from the TradingEconomics site[5] — this is maybe the craziest commodity price surge and collapse you’ll ever see, much more dramatic even than the surges in uranium[6] or cobalt[7] that have caught the eyes of investors in decades past… even just this year lithium has fallen by almost 30%, which would be a lot for most commodities, but since the late 2022 peak the price of lithium carbonate delivered to China[8] has fallen by 90%… almost entirely erasing the crazy 1,400% move from the COVID lows in mid-2020 to that November 2022 high.

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So that’s the play, find a way to bet on lithium now that it has given up most of the speculative fervor. And, as Fridson says in that poem, they’re looking for relative safety in a “stock/bond hybrid” … here’s how they hint at it further on…

“Not even natural gas[10] – known as the ‘widow maker’ commodity for its extreme price volatility – has shown the wild oscillations seen in the price of lithium.

“But with volatility comes opportunity, at least for those investors willing to go against the herd. As veteran commodities investor Rick Rule[11] says, ‘In commodities, you’re either a contrarian or a victim.’ With lithium currently trading near its lowest level of the last 10 years, we’ve found the ultimate opportunity.

“It’s a special type of security: it’s neither a stock nor a bond, but a hybrid of the two. In this issue, we will recommend an investment opportunity that:

• is in a world-class company that has nearly $2 billion in cash and net debt that is super-low 2.1x operating profit
• provides a dividend yield of 8.5% (versus 1.8% yield of the company’s common stock)
• pays dividends[12] between now and March 1, 2027, that work out to roughly $9 per share, or 21.1% of the current market price of $42.89 per share”

So… hoodat? Thinkolator sez that Fridson and Stansberry are recommending the Albemarle 7.25% Mandatory Convertible Preferred Series A, which has been chopped into pieces to trade as a preferred stock (ticker ALB/PA). These publicly traded preferred shares went were created by a public offering just six months ago, in March of 2024, at $50 per share… and thanks to that “mandatory conversion” they have pretty closely followed Albemarle’s share price, dropping about 24% (ALB is down about 29% during that same time period). So you can now buy these preferred shares in the low $40s, it was almost exactly $42 when I pulled my data… what does that mean?

Well, it means the current yield is indeed pretty close to that 8.5% that Fridson notes… the 7.25% coupon on those preferred shares is based on the $50 per share of the initial raise, so that means the annual dividend is $3.625, payable in quarterly installments of 90.625 cents per share. $3.625 is an 8.6% yield if you pay $42 per share.

There are a lot of different kinds of preferred shares out there, but the key things to note about this one are that the dividends are cumulative, which means they intend to pay them in full even if they have to skip a quarter for some reason (like common stock dividends, the preferred dividends do have to be approved by the board each quarter); that they can opt, under some circumstances, to pay in stock instead of in cash, which is probably a release valve in case they get in serious trouble; and that the stock does not have a cash maturity like a bond would, so you never get that initial $50 back, but instead it automatically converts into common stock at maturity. Which is why it’s a hybrid stock/bond investment — it’s got a high yield[13], but in the end it’s going to turn into common stock, which means the eventual outcome depends on where the price of Albemarle common stock is in 2-1/2 years.

What are the possible outcomes for these Albemarle preferreds? Well, probably the most likely outcome, since this is the biggest independent lithium producer in the world, and has been through thick and thin before and is expected, at least by analysts, to remain profitable through this lithium pricing trough and into 2027, is that Albemarle survives and keeps paying the preferred dividends in cash, and the preferreds convert to become common shares on March 1, 2027.

The range of conversion rates is already set, so we know that each preferred share will become something between 0.3809 and 0.4570 shares of Common Stock (the lower number if the price of ALB common stock is above $130 in the weeks leading up to the conversion, the higher number if it is below $109, which is roughly where the common shares were trading when these preferreds were created, and somewhere in between if it’s between those two prices). ALB is at about $88, so if the conversion were today they’d use the higher number, 0.457 shares, and your $42 worth of ALB/PA would become $40 worth of ALB. That’s not great, of course, but they won’t convert this week — they’ll convert in 2-1/2 years, during which the preferred shares will very likely track the ALB share price pretty closely, and during those 2-1/2 years you should receive about ten quarterly dividends on those preferreds, totaling about $9 (as teased).

Analysts obviously don’t know what will happen to the price of lithium in the next year or two, any more than you or I do, but they are probably predicting at least a bit of a rebound, because they’re penciling in a bit of a recovery for Albemarle on the revenue and earnings front — ALB earned a windfall of $22 per share in adjusted earnings in 2023 ($13 in GAAP earnings), because of that surge in lithium prices, but their adjusted earnings are expected to be 35 cents in 2024, rising to $3.61 in 2025 and $6.76 in 2026. If that’s exactly how it goes, which it won’t be, then that means in the months while they prepare for the conversion of these convertible shares, in  early 2027, the trailing earnings per share number would be $6.76. Albemarle has been all over the map for the past 20 years when it comes to their earnings multiple, but if we imagine that investors will pay, say, 15X earnings for a commodity producer with good earnings growth at that time, then ALB shares might be at $101.

That would mean a 15%+ gain for ALB shareholders starting at today’s $88 price, or a little over 20% if we assume that ALB continues to also pay its 41 cent quarterly common dividend. Not bad for two and a half years, but nothing spectacular. In that same scenario, ALB Preferred shareholders who buy at $42 today would end up with $46 worth of common shares in that conversion (0.457 multiplied by the $101 share price for the common stock), and they would collect $9.30 along the way in their preferred dividends, for a total gain of about 31%. A little better. That’s kind of the sweet spot for the preferreds outperforming the common stock.

If Albemarle soars, as it might if lithium goes higher again, you’ll get most of that exposure, since your preferred shares will track that price — but not quite all of it. You’ll get a little less exposure if the stock really goes bonkers, so if it goes back to $300 again, the conversion rate would drop to that 0.3809 common shares per preferred and your $42 would go to $114 for (only) a 172% gain (not counting the dividends), while shareholders who own Albemarle common shares would enjoy almost a 250% gain.

And if Albemarle continues to struggle, dropping down to, say, their 2020 lows of $56/share, then an ALB common shareholder would face a 35% loss from today’s price, and the preferred shareholders would end up with their $42 investment being worth $25.60, for a loss of 39%, not counting the dividends. But if that’s how things look in 2027, then the preferreds would win, just because the roughly $9 per share in dividends you would collect during that time would cut the loss to about 18%. (The common shares pay a dividend, too, but it’s much lower, currently 1.8%, so that would blur the lines a little, but not change the argument dramatically).

So really, this is a way to get partial protection if Albemarle falls apart… a little outperformance if ALB chugs along with a slight gain over the next couple years… and partial participation if it soars… with the most likely outcome probably being that your preferred shares will track the common shares fairly closely over the next two and a half years, up or down, but you’ll also collect a nice dividend along the way.

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And if things go super-ugly, because the world moves on from lithium entirely for some reason, or perhaps because all their mines are seized by foreign governments (mostly Australia[15] and Chile[16], so unlikely… but the future is unknowable), or we find out that lithium batteries cause cancer and that fuels a generation of lawsuits, maybe Albemarle actually collapses into bankruptcy. In that case, you’d probably lose all of your investment. Preferred shareholders are in line ahead of common shareholders during any kind of bankruptcy liquidation or reorganization, so you might end up with something, and you definitely won’t end up with a worse loss than common shareholders, but Albemarle has more than $4 billion worth of actual debt, beyond this preferred “hybrid,” and those bondholders are in front of the line to get repaid, and there might not be anything left over for either preferred or common shareholders after that. This is all hypothetical, but that’s how bankruptcy proceedings usually work out — if you’re in enough debt that you can’t go on, it’s likely that bondholders just end up owning the new company, after it gets reorganized and recapitalized, and the common and preferred shareholders are usually left with nothing. Not always, but usually.

Decent risk/reward scenario? Sure. You get to participate if lithium rebounds, maybe even doing a little better than common stockholders in some positive scenarios, and you suffer slightly less if lithium stays very low and Albemarle’s profit continues to be pathetic, as it likely will be this year. I’d probably consider buying ALB/PA before I’d consider buying ALB common stock. (I don’t currently own either, or any other lithium miner, to be clear.)

But with your money, of course, you get to make the call — so are you tempted to dip your toe into the lithium business again, after a disastrous year? Think they’re going to bottom out at some point and provide contrarians with a nice windfall, or expect even more downside ahead? Prefer to take the somewhat cautious approach of buying preferred stock here, or a more aggressive play to ride any possible lithium recovery? Let us know with a comment below… and thanks for reading!

(Note: I pulled those lithium prices and the stock prices at the beginning of the week… sorry if they’re a hair off by now)

Disclosure: I don’t own any of the investments mentioned above, and will not trade in any covered stock for at least three days after publication, per Stock Gumshoe’s trading rules.

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