Should I buy this lithium penny stock?

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If a share trades in pennies, it might suggest that investors don’t value the company highly. But some very large companies are penny stocks – along with potential success stories whose business models remains unproven. One British penny stock in the lithium sector has been attracting a great deal of attention in recent months. Here I look at whether I should add it to my portfolio.

Lithium – a play on future energy needs

The penny stock in question is Bacanora Lithium (LSE: BCN). A lot of investors are interested in lithium because of its potential role as an energy source. It is in high demand from electric vehicle manufacturers such as Tesla. With increasing enthusiasm for alternative energy sources, lithium has been rising in prominence. But lithium resources are limited and current mining capacity is insufficient for future projected demand.          

That’s where Bacanora comes in to the picture. It has interests in several lithium projects, most importantly a large project being developed in Mexico. In theory, that could be highly lucrative. But as with all mining projects, first the site needs to be made ready for commercial extraction. Only then can mining start at scale – and investors can find out whether the company’s promising initial surveys are reflected in what it is able to pull out of the ground.

Takeover bid

But Bacanora itself might not be pulling anything out of the ground in future. That is because it has been subject to a takeover bid by Chinese mining company Ganfeng Lithium. Ganfeng was already a major shareholder in Bacanora. It decided to bid for the rest of the company. The offer for each Bacanora share was pitched at 67.5p in cash, along with around a quarter of a share in Zinnwald, a London-quoted lithium company. That would be worth around 5.4p at the current Zinnwald share price.  

Currently, Bacanora trades very close to the cash offer price, so the market seems to be discounting the attractiveness of the Zinnwald component of the bid. But the bid has not yet cleared regulatory hurdles. In fact, last week Bacanora announced that the takeover timetable has been extended as Mexican regulatory approval for the deal is not yet complete.

Not the penny stock for me

At this point I wouldn’t add Bacanora to my portfolio. I see limited upside from this point on.

If the deal proceeds, there is some upside in the form of the difference between today’s Bacanora share price and the total bid amount including the value of the Zinnwald share component. That difference is worth roughly 5p-6p per Bacanora share on top of the current price.

That is still a premium, but with it come significant risks. With a market capitalisation of just £55m, Zinnwald has a much smaller value than Bacanora. Its shares could fall in future, if for example its flagship project in Germany produces disappointing results.

If the Mexican regulatory approval doesn’t come through, Ganfeng’s bid for Bacanora might not proceed. In that case, the Bacanora share price may fall back to where it stood previously. Back in May, I explained how the bid could push Bacanora shares up almost 20% – and that’s what has happened. But I now see limited upside from the bid in the Bacanora share price, and risks if the bid collapses.

The post Should I buy this lithium penny stock? appeared first on The Motley Fool UK.

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Christopher Ruane has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Tesla. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.