Gold Mining Stocks (XAU)

[JohnCM]

The Turnaround Story At North American Palladium Is Growing Legs

Nov. 24, 2014 3:17 PM ET
By David White S/A contributor

http://seekingalpha.com/article/2707655-the-turnaround-story-at-north-american-palladium-is-growing-legs

PAL produced 20,000 oz. of palladium in October 2014. This is far up from 32,560 oz. in all of Q3 2014.

PAL is projecting it will hit the low end of its guidance, or it will miss only slightly.

PAL hit 4,500 tonnes of ore produced per day from underground mining on some days in October 2014. This is far up from 2,900 tonnes in Q2 2014.

Q4 will either be the first profitable quarter for PAL in a long time; or it will come very close to being profitable.

The combination of cyclical and secular growth in the palladium market should be very positive for PAL.

North American Palladium Ltd. (NYSEMKT:PAL) is an established PGM (platinum group metals) producer. It has been operating its main revenue source, its Lac des Iles mine in northern Ontario, Canada, since 1993. If it has been in existence this long one might ask why it needs a turnaround story? The answer is twofold. First it formerly had a significant gold mining operation, which it only recently sold. This operation had been a money losing one for PAL for a long time. The sale appears to have been a very sound business move for PAL.

The second part of the turnaround story is that palladium prices have risen from about $200/oz at the depths of the Great Recession to as much as about $900/oz earlier in 2014; and they are expected to go higher and/or remain high for many years into the future. Nymex palladium futures closed at $794.90/oz. on November 21, 2014. It is hard to say exactly where palladium prices are going in the near term; but for Q4 2014 PAL says it is fully hedged at $855/oz. The table below shows many of the major analysts' forecasts.

As readers can see the more recent forecasts tend to be higher than the forecasts made early in 2014. This is at least partially due to the South African palladium mines strikes. These are over; but they have left palladium shortages in their wake.

The main source of world demand of palladium is automobile smog systems -- specifically catalytic converters. This demand has been growing steadily since the depths of the Great Recession. The chart on the left below shows the 67% of the world's palladium demand that auto catalytic converters represent. The chart on the right shows the recent growth and the expected future growth in demand from auto catalytic converters.

Light vehicle demand is expected to grow by about 4% per year. Much of this will be driven by China, which is expected to reach auto demand of 31 million vehicles per year by 2018. On top of this the specifications for catalytic converter effectiveness are becoming increasingly stringent. The higher effectiveness is expected to create still further palladium demand in the next five to ten years (and perhaps for a lot longer). Some think that electric vehicles will hurt this demand considerably. However, the goal of the 15 governments belonging to the Electric Vehicle Initiative is to have 2 million EVs on the road around the world by 2020. That would be only 2% of the total projected autos expected to be on the world's roads. There will be a lot of palladium demand for many years to come even after 2020. This should stand PAL in good stead with regard to its business prospects; and these projections agree well with the analysts' forecasts for palladium prices over the next several years.

A big advantage that palladium has over gold is that it is actually being used in the majority of instances for critically needed functions. As the demand for those functions grows, the price of palladium almost has to go up. At the very least the price is unlikely to fall through the floor as the price of gold has recently. This should mean that PAL will see stable to higher palladium prices over the next several years; and that should make running a palladium mining business a lot easier (and more profitable).

The question then is whether PAL has shown (or is likely to show) that it is making strong progress in its turnaround? I think it is. It is in the process of converting to shaft mining for its underground mining. This is already proving much more efficient. Aside from a death this summer and some major equipment down time, PAL seems to have been making steady progress. The table below gives the accounting details of the last few quarters.

Readers can see that the amount of Palladium production has been trending downward in the last two quarters, from the recent high seen in Q1 2014. This has kept profits lower than they were expected to be; and it has created a significant credibility problem for PAL. Still revenues did increase 39% year over year to $46.4 million; and PAL realized a palladium selling price of US$860/oz. With the Q3 2014 cash cost per ounce to produce the palladium, that left it with an operating margin of US$271 per ounce. This was healthy.

Unfortunately the death of a mine worker, converting to a new underground mining system, and some problems with equipment downtime slowed progress much more than expected. Due to these things, PAL produced less palladium than expected in Q3 2014 at only 32,560 ounces compared to 39,222 ounces in Q2 2014 and 42,641 ounces in Q1 2014. The trend since Q1 2014 has been ugly.

The good news is that the trend seems ready to change. With the underground lift now working well, PAL was able to produce approximately 3,800 tonnes per day of ore in September and October from its underground mines. Since it published a figure of 3,313 tonnes per day for September 2014 in its Q3 report, one might infer that October 2014 production from underground was approximately 4,300 tonnes per day given the average cited of 3,800 tonnes per day for September and October. This was up significantly from the 2,900 tonnes per day of ore for Q2 2014. Part of the explanation was that PAL went to a full time mill beginning in October 2014. This did away with the bottleneck the two week batch process had been creating.

PAL is aiming for 5000 tonnes of production per day from underground mining by 2014E. PAL has already seen 4,500 tonnes per day from the underground mines on good days in the September - October period. It is optimistic it can reach its 5,000 tonnes per day goal by the end of 2014. Even at an apparent 4,300 tonnes per day from its underground mines, it should see much higher palladium production in Q4 2014 than in Q2 2014. Indeed the company has already stated that it produced approximately 20,000 oz. of palladium in October 2014 alone, although it says that some of this was a stockpile from the end of September.

If one further posits that the grade in Q4 2014 will be roughly even to that in Q2 2014, then at roughly 4,500 tonnes per day from its underground mines in the last two months of Q4 2014 PAL should produce close to 20,000 ounces of palladium per month for all of the months of Q4 2014. This would allow PAL to surpass the bottom level of its FY2014 guidance of 170,000 - 175,000 ounces of palladium.

In its Q3 2014 earnings report PAL did not seem completely confident of reaching this number. However, the fact that it was still unsure at the time of that report tells investors that production in Q4 2014 is virtually assured of being over 50,000 oz. of palladium; and it is more likely to be 55,000+ ounces of palladium for Q4 2014. At $855 per oz., which is what PAL says it is fully hedged at for palladium for Q4 2014, the company should have additional revenues of more than 20,000 oz. * $855/oz. = $17.1 million more than it did in Q4. If it does in fact produce about 60,000+ ounces during Q4 2014 as PAL's statements and numbers indicate are probable, it may have revenues greater than Q2's revenues by approximately 27,500 oz. * $855/oz. = $23,512,500. Of course, one might want to subtract the approximately $3,000,000 in extra costs (for 60,000 oz.) to produce the palladium, which PAL saw in Q3 over Q2 2014. This would still leave PAL with extra revenues of approximately $20.5 million in Q4 2014, and I haven't even counted in the extra revenues from the other metals such as platinum, gold, copper, and nickel that would have also likely been present in the extra ore. The chart below shows PAL's approximate breakout in revenues.

As readers can see, non-palladium metals account for approximately 30% of PAL's revenues. If one added 30% * $23.5 million = $7 million to the approximate figure of $20.5 million in greater palladium revenues above (for 60,000 oz. of palladium production versus Q3's 32,560 oz. level), you would get additional revenues of approximately $27.5 million in Q4 2014. PAL had a net loss of $18.8 million in Q4 2014. The $27.5 million number should do away with the net losses; and PAL might be truly profitable in Q4 2014 for the first time in a long time. This would probably cause the stock to rocket higher. Even if PAL doesn't achieve profitability in Q4 2014, it is seemingly very close to it; and it should achieve it quickly. Irrespective of the achievement of profitability in Q4 2014, investors should at least be able to see the "light at the end of the tunnel" with the Q4 2014 earnings report. This makes PAL a buy.

The various exploration reports that will lead to increased reserves of all types with the new resources report (likely in January 2015) should also be encouraging. The results to date indicate that overall resources have increased significantly; and further exploratory drilling seems likely to increase them still further. Click on the link to the Q3 Drilling Results report for more information. This too indicates PAL is a buy.

The chart indicates that PAL has been in a strong downtrend for the last two years. Over the last six months that downtrend has started to flatten. With the Q3 2014 earnings report and the Q3 2014 Drilling Report, the fundamentals have changed to a much more positive outlook.

Unfortunately PAL has had credit problems, so it also has credibility problems. Investors likely will not rush into PAL until they see the likely great results from Q4 2014. Investors who are willing to take a chance can probably make some good money investing in PAL at this time. The turnaround story is looking substantially more solid after the Q3 2014 earnings report, the Q3 2014 Drilling Report, and the October 2014 unofficial production report. PAL is a buy even on low credibility.

I wouldn't put too much money into PAL; but PAL stock could easily reach $1 or more in the next year. If it did that it would be more than a seven-fold increase from the closing stock price of $0.14 per share on November 21, 2014. Some point to PAL's lack of ready cash; but PAL's management says it expects more of its $60 million credit line to become available in Q4 as it proves its production has increased. Plus it will get more money from sales during Q4 2014. I find management's argument very compelling. As long as there are no disasters in the near term, PAL would seem to have turned the corner. It is a buy.

To further back up this assertion, PAL has recently been negotiating the acquisition of equipment from Caterpillar (NYSE:CAT) using Caterpillar Finance at attractive rates. Caterpillar would not likely be willing to do this unless it viewed PAL as a reasonably stable concern. It seems a virtual certainty that Caterpillar has gotten a good look at PAL's books. PAL stated in its Q3 2014 earnings report, "a major recent agreement at very attractive rates was agreed to in the third quarter with Caterpillar Finance." This sounded like at least some purchases would be made soon without PAL having to go to find extra monies from anywhere but Caterpillar Finance. This is one more encouraging sign that PAL has finally turned the corner.