SQM BUY. Lithium industry fundamentals remain strong, buying opportunity after market

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1 COMPANY REPORT - CHILEAN EQUITIES July 3rd, 2017 BUY Target Price CLP 26,206 Current Price CLP 22,023 DATA Bloomberg SQM/B CC Reuters SQM.B-SN Rating (Feller) AA- 52 weeks Hi/Lo (CLP) 25,101-15,751 Current Price (CLP) 22,023 Upside Potential 19.0% Shares outstanding (M) Market Cap (USD M) 8,563 Float (%) 36.0% ADVT 6M (USD M) 6.2 RATIOS E 2018E EV/EBITDA 10.9x 11.0x 10.2x EV/Sales 4.3x 4.5x 4.2x P/E 28.2x 19.4x 18.3x P/BV 3.4x 3.4x 3.4x Div. yield 5.0% 3.0% 4.4% SQM Lithium industry fundamentals remain strong, buying opportunity after market correction In this report we are updating our SQM valuation, incorporating a more favorable scenario in lithium prices and also introducing in our valuation Exar Lithium Project in Argentina, increasing our target price to CLP 26,206 and our recommendation to BUY. In the lithium segment, the ramp-up of Mt Marion and Mt Cattlin has been slower than expected, while demand has maintained its aggressive growth, so the expected moderation in lithium prices has not materialized so far. According to the latest available customs figures, exports of lithium carbonate and hydroxide remain in values of about USD 11,000/MT and USD16,000/MT respectively, which coincide with press information regarding spot prices in China. On the other hand, LAC has managed to close the financing to begin the construction of Exar project, kicking-off the engineering works in 2H17, and the first dispatches are expected in According to our estimates, with a price of USD 10,000 the project could generate about USD 185 Mn in EBITDA, which using a conservative multiple of 6.5x EV/EBITDA represents an EV of USD 1,220 Mn once it starts operating in On the supply side, there have been some short-term sales corresponding to the most inefficient segment of the supply curve, in addition to the ramp-up of Mt Cattlin and Mt Marion, coupled with the expansions in Orocobre and Greenbushes, which could lead to a mild oversupply next year. We believe that as long as current demand growth continues, prices are unlikely to decline aggressively, as price signals are needed to encourage the development of additional projects. Regarding the relationship with CORFO, there has been no positive news, and we have no expectations that this will change during the current administration. In the medium term, we believe that the most rational solution would be a renegotiation of the agreement in similar terms to those recently awarded to Albemarle (Rockwood). CONTACT Agustín Álvarez aalvarezma@bice.cl On the valuation side, SQM is currently trading at 11.0x EV/EBITDA 18E, a 10% discount respect to its 3 year average, favorably comparing to lithium producing companies that trade at +14.0x. The main downside risk is lower than expected lithium prices or an eventual loss of concession in the medium term, which could generate a substantial negative impact on the valuation. On the positive side, there is currently a very negative view on fertilizer prices, which could change if the potassium cartel is reunited.

2 SQM COMMODITIES SQM is private mining company based in Chile and founded in Is the world leader in specialty fertilizer, iodine, and lithium sector. Today the company has a strong global presence in a wide variety of industries through its main business lines such as Iodine, Lithium, Industrial Chemicals, Potassium, among others. SHARE PRICE RELATIVE TO IPSA LTM GROSS MARGIN (%) OWNERSHIP (%) IPSA SQM-B Potash 7% Industrial Quemichals 7% Iodine 6% Other 1% Free Float 36% Pampa & Kowa Groups 32% Jun/16 Aug/16 Oct/16 Dec/16 Feb/17 Apr/17 Jun/17 SPN 20% Lithium 59% Potash Corp 32% DATA INCOME STATEMENT E 2018E Bloomberg SQM/B CC Revenues 2,014 1,728 1,939 2,119 2,265 Reuters SQM.B-SN Chg% -8.6% -14.2% 12.2% 9.3% 6.9% Rating (Feller) AA- EBITDA weeks Hi/Lo (CLP) 25,101-15,751 Chg% -11.5% -1.8% 5.1% 14.4% 7.5% Current Price (CLP) 21,999 EBITDA Margin 36.6% 41.9% 39.2% 41.1% 41.3% Upside Potential 19.1% Net interest Shares outstanding (M) Associates Market Cap (USD M) 8,563 Net Income Float (%) 36.0% Chg% -36.6% -28.1% 30.5% 45.1% 6.0% ADVT 6M (USD M) 6.2 Net Margin 14.7% 12.3% 14.3% 19.1% 18.9% BALANCE SHEET E 2018E Current assets 2,512 2,697 2,335 2,324 2,371 Total assets 4,664 4,644 4,219 4,217 4,276 Financial debt 1,787 1,692 1,273 1,123 1,136 Total liabilities 2,364 2,243 1,911 1,938 1,972 Equity 2,300 2,400 2,307 2,280 2,304 Liabilities + equity 4,664 4,644 4,219 4,217 4,276 DEBT RATIOS E 2018E EBITDA/Fin. Expenses 11.6x 10.4x 13.2x 17.6x 21.4x NFD/EBITDA 1.03x 0.73x 0.62x 0.27x 0.25x Debt/Equity 0.78x 0.70x 0.55x 0.49x 0.49x ROE 12.9% 8.9% 12.1% 17.7% 18.6% FCF E 2018E + EBIT Dep and Amort Taxes CAPEX Working Capital TOTAL

3 There are no signs of fatigue in the price of lithium Certainly, the most relevant short-term trigger for SQM s valuation is the price outlook on lithium. In this regard, there is no sign of price fatigue. In China, the spot price of hydroxide remains close to USD 16,000 MT and of carbonate above 12,000. With a lag, this information can also be followed with data from Chilean customs exports, where the latest available figure for May shows that SQM export prices continue to rise, also topping USD 12,000 and USD 16,000 respectively for carbonate and lithium. 1 Lithium price (USD/MT) 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 Lithium Hydroxide Lithium Carbonate Q16 2Q16 3Q16 4Q16 1Q17 2Q17 Some analysts are forecasting a price drop in 2017 due to the ramp-up of Mt Marion and Mt Cattlin in Australia. However, this adjustment has not yet begun when looking at spot prices. The growth in supply will be relevant in the coming years The expectation of a price adjustment stem from an expected supply growth in the coming years, which can be broken down into: (i) organic growth in operating assets: Greenbushes (Tianqi / Albemarle - Spodumine) could increase its production from ~ 65 Th MT to about 80 Th Mt, Orocobre continues with a difficult ramp-up in Argentina (~ 12 Th MT in 2016 which could be doubled in the next few years) and SQM announced an investment in lithium hydroxide Increase capacity up to 63 MT MT; (ii) ramp-up projects: in Australia there are two ramp-up projects that should sustain short-term growth in global demand, Mt. Marion and Mt. Cattlin, with nameplate capacities of 30 and 20 Th MT respectively, in addition to another project in Canada of Nemaska with a nameplate of 20 Th MT but we see greater potential risks of execution in the medium term and; (iii) projects under study or construction: medium-term growth (> 2020) should be supported by new projects under construction, highlighting some brine producers such as Albemarle s La Negra II, Olaroz (SQM / LAC) and Sal de Vida that could conservatively add capacity of 60 Th MT, and two large spodumene projects in the Pilbara region (owned by Altura and Pilbara Minerals) that could theoretically add 70 Th MT. 3

4 2 New lithium mining projects pipeline (Th MT) Company Source Greenbushes ALB/Tianqi Spodumene Hombre Muerto FMC Brines Olaroz Orocobre Brines Olaroz Fase II Orocobre Brines Atacama ALB Brines Atacama SQM Brines Others Total - Current Production Mt. Marion Ganfeng Spodumene Mt. Cattlin Galaxy Spodumene Quebec Nemaska Spodumene Total - Rumping Up La Negra II ALB Brines Sal de Vida Galaxy Brines Olaroz LAC/SQM Brines Pilgangoora Pilbara Spodumene Pilgangoora Altura Spodumene Total - Under Development Total Supply Total Demand Comparing the expected growth in supply with reasonable expectations of demand for lithium, there s potentially a mild oversupply from 2018 onwards which slowly converges again to a balanced market in the year This is essentially the analysis that explains the more cautious view of some analysts regarding the medium-term prospects in lithium. 3 Lithium supply and demand forecast (Th MT) Under Develop. 400 Rumping up Current Supply But there are execution risks and upward revision potential in demand that would keep a tight supply and demand balance However, previous analysis assumptions are not extremely optimistic on the demand side, and to considers that the pipeline of new projects can be reasonably executed. 4

5 Nevertheless, there have been historically significant lags in execution (occured also in Mt Marion and Mt Cattlin) and demand side could easily surprise on the upside under more optimistic assumptions of electric vehicles adoption. On the other hand, in a medium-term perspective, price signals are needed to encourage the development of additional projects, which represent significant financial and execution risks and which will, therefore, require a major price signal to be financed and executed. 4 Projects under study Company Nameplate Capacity (Th MT) La Negra III Albemarle 25 Jadar Rio Tinto 20 Rincon Enirgi 50 Sonora Bacanora 35 Sal de Los Angeles Lithium X 15 Centenario - Ratones Eramet 20 In summary, we believe that in a conservative scenario a moderation in the current price level is expected, but in a medium-term perspective, we believe that the current pipeline of projects supports prices well above historical averages to stimulate growth in supply able to cope with the high expected growth. Changes in EV policy subsidies in China increased uncertainty and hit demand during 4Q16 and 1Q17 China has been committed to deepening electric vehicle adoption (targeting 5 million EVs by 2020), and the Chinese government has been offering substantial subsidies to this end. Following the introduction of these policies, EV sales skyrocketed from 2,300 in 2009 to 507,000 in However, an investigation conducted by the Chinese government in early 2016 found that some manufacturers had cheated to receive the subsidies, and as a consequence, the Chinese government announced its decision to redesign its incentives scheme during 2H16. 5

6 5 Global EV Sales 120, , ,000 60,000 40,000 20,000 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec The new policy hit EV production during 4Q16 and 1Q17, however, since then there has been a normalization of growth rates. In China, the market continues to grow at rates close to 50% YoY, while the global market is growing at around 30%, due essentially to some weakness that has been experienced in the European market. 6 EV Sales in China (YoY Growth) 250% 200% Overhaul of EV Subsidies in China 150% 100% 50% 0% -50% Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May % No doubt the dynamism in the Chinese market will be critical, however, recent data would have confirmed that the bump in demand is behind and the segment continues to grow at very high rates that justify an optimistic medium-term view. SQM s relative valuation looks attractive against its peers Currently, SQM trades at 11.0 EV/EBITDA 18E, which compares with an average of its lithium peers of 14.6x and 9.1x of leading fertilizer players. Now the lithium business represents 61% of consolidated gross margin, so a blended multiple would be close to 12.4x. 6

7 7 Comparable companies valuation multiples EV/EBITDA 18E P/E 18E Mkt Cap FMC ,834 ALB ,613 Tianqi ,883 Ganfeng ,958 Average Lithium Potash ,683 Agrium ,525 K+S ,913 Mosaic ,940 Average Fertilizers SQM We believe that it is reasonable to include Exar project in the valuations after LAC secured its funding LAC recently confirmed an agreement with Ganfeng to finance its share of the investment in the lithium project it is developing jointly with SQM. This deal includes a sale of a percentage of its stake, a loan at attractive rates and an off-take agreement which eliminate a major source of uncertainty for the project. Hence, we believe that it is reasonable to begin to include this project in our SQM valuation. The first phase would enter full production in the year 2020 with 25 Th MT, firm expects a cash cost of USD ~2,500/MT so that in a scenario of USD 10,000/MT the project could generate EBITDA of USD 185 Mn. Using a WACC of 15% the project (without considering the option of an extension to 50 Th MT) could generate an NPV of 632 Mn. 8 Olaroz valuation scenarios Li Carb. Price 20E (USD /MT) 10,000 10,500 11,000 11,500 12,000 EBITDA 20E EV/EBITDA EV 19E 1,220 1,301 1,382 1,463 1,545 Capex Equity 19E 970 1,051 1,132 1,213 1,295 Ke 15% 15% 15% 15% 15% NPV 18E ,055 1,126 SQM Stake 1sr Stage Sec. Stage option EXAR - SQM Stake

8 Political and regulatory scenario: it is the largest source of uncertainty, but in a rational discussion we should have a win-win situation for the government and the company. Currently, Corfo (government development agency that manages the lease of SQM mining concessions) is in an arbitration with SQM. In simple terms, Corfo claims SQM paid a lower quarterly payments than stipulated in the contract, among other administrative failures, and is requesting a cancellation of the lease. SQM pays Corfo a percentage of the sales of lithium and potassium products derived from Atacama s Salar concession assets, of 5.8% and 1.5%, respectively. Recently Corfo renegotiated a contract with Albemarle that has a variable component that depends on the average sale price, although in simple terms, at current prices would mean a fee for Corfo of ~16% in lithium and ~3% in potassium. 9 Li Carbonate Price vs Lease Payment (% Lithium Revenues) 25% 20% 15% 10% +10 pp. comparing SQM's vs Albemarle's deal 5% SQM Current Conditions 0% 0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000 On the other hand, the concession contract that expires in 2030 caps the total accumulated production on 958,672 MT / LCE during the whole period, having accumulated at the end of % of the total production quota. Taking into account that SQM intends to increase its annual production from 50 to 63 Th MT, the company could deplete by 2023 the total cumulated contracted production. On the other hand, the current price cycle is likely to moderate from that date, so we believe that in a rational negotiation, Corfo could propose to SQM a renegotiation in the short term of the lease giving similar conditions to Albemarle, which would allow Corfo to take vantage of current super cycle in lithium prices. In the alternative scenario, a lengthy litigation period could arise, and the agency would have to compensate SQM in addition to seeking a partner to operate the assets. This scenario would imply a loss of income, greater investment and a negative impact on the local economy, which is a situation in which neither side would win. 8

9 II. VALUATION To value SQM, we performed a DCF model for its operational assets from 2018 to 2028 and a perpetuity value after that period. Besides, we consider the Exar project separately and add it to our previous valuation. The main assumption is a long-term lithium carbonate price of USD 10,000, a medium-term recovery from KCL to USD 300 and a WACC of 8.73%. We also assume that the concession is renegotiated under the same terms to those of Albemarle. With this valuation, we obtain an 18E target price of CLP 26,206, which, coupled with an 18E dividend yield of 4.4%, delivers a potential return of 21.7%, consistent with our BUY recommendation. Regarding relative valuation, the company would be trading at an EV / EBITDA 18E multiple of 10.2x and P / E 18E of 18.3x. WACC 10 Valuation Summary 19'-30' Assets Perpetuity Exar NFD 2018 Minorit. Interest Equity Stock Price 2018 (USD) Stock Price 2018 (CLP) 8.28% 4,750 6, , , % 4,688 6, , , % 4,626 5, , , % 4,566 5, , , % 4,508 4, , ,915 9

10 SALES TEAM Felipe Figueroa E. Equity Sales and Trading Jacinto Laso P. Equity Sales and Trading Sebastián Torrealba D. Equity Sales and Trading Andrés De la Cerda G. Fixed Income and Currency RESEARCH TEAM Agustín Álvarez M. Head of Research Aldo Morales E. Equity Research Analyst Sebastián Carvallo I. Equity Research Analyst Paulina Vargas J. Equity Research Analyst Jonathan Fuchs N. Equity Research Analyst Sebastián Senzacqua B. Chief Economist Antonio Acha R. Economist Juan Pablo Castillo C. Strategy Felipe Muñoz F. Strategy Contact Follow Download Visit App BICE Inversiones biceinversiones.cl

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