North American Palladium (PALDF)
There is a growing shortage of palladium in the world. I decide to look for a way to capitalize on the shortage by buying stock in a company that produces palladium. I could have bought the metal but a doubling in the metal price would result in a quadrupling in mining profits. I focused on several criteria when selecting palladium mining companies. I looked for public companies where palladium was its primary production and that were external to South Africa and Russia. Most palladium in Russia is a byproduct of nickel mining and thus not the main driver of corporate profits. A company where palladium is a byproduct means that the impact to profits is much lower than a pure palladium play. I also wanted to be outside of South Africa due to the internal political uncertainty and outside Russia due to some international uncertainty.
The only company that passed these filters was North American Palladium (PALDF) located near Thunder Bay in Ontario Canada. It has at least 10 years of verified ore mining reserves and has a low debt to equity ratio and a relatively low cost of production compared to today's palladium costs. Its primary production is palladium and a small amount of platinum and gold byproduct. PALDF seems to be a well run company with a carefully planned execution strategy for the next ten years. PALDF is excellent opportunity to capitalize on the recent rise in the cost of palladium.
PALDF’s recent Q4 and 2018 yearly reports were released February 15, right before the Presidents Day holiday and the market had yet to react. This overlooked gem has no analysts following it and has a share price of $11.76 as of closing February 15. The price in my opinion does not reflected the surge in earnings it reported.
At the time I started writing this paper, the data on both the Google and Yahoo web sites for PALDF still show the old earnings numbers. They were about $0.64 per share for 2017 as compared to the new numbers of $2.04 per share for 2018. The and P/E ratio for 2017 was 18 compared to the 2018 of 5.8. What is most significant is that the 2018 Q4 profits alone were $77.5 million and the total 2018 profits were $119.2. The average price per oz of palladium sold was $1028 per oz for 2018 with 237,461 oz produced.. The price of palladium is now over $1,400 per oz. Assuming the production of palladium for 2019 is the same with the average price of palladium being $1400 per oz then the profit should rise to around $350 million. That would give the PALDF a forward P/E ratio of around 2. This assumes palladium will remain at $1400 per oz and the auto production does not hit a recession. The price of PALDF stock as of this date is $11.76 and, in my humble opinion, is about one third the price it should be. The wild card is South Africa, as discussed below, could make these projected profit numbers look small.
Palladium prices have climbed steadily for the last few years. Historically the Russians have had stockpiles which they dumped and drove the price of palladium below the cost of production. The worlds stockpiles of palladium have since been severely depleted and its price has reflected this. It takes 5 years and sometimes up to a decade to open a new mine and that assumes there are still locations where there is ore to mine. So a new supply that will drive down prices is not on the horizon. South Africa produces about 70% of the worlds platinum and 40% of its palladium. Russian produces 20% of the platinum and 40% of the palladium. Other countries including Canada, the United States and Zimbabwe producing the remaining 10%.
Stockpiles and ETF holdings of palladium are being depleted as illustrated in the graph below presented at the North American Palladium shareholders meeting. The green line represents the worlds stocks and the blue line represents the price of palladium. As you can see the high price of palladium is a long term supply and demand issue.
The world-wide demand of palladium is increasing. This is driven by several factors creating a squeeze in the palladium price. The Chinese have been increasing auto production and now represent the second largest automobile producer in the world. They have disastrous pollution problems and as a result have implemented much tougher pollution rules that mandate more palladium use in their catalytic converters. In Europe the new Nitrogen Oxide limits will impact the production of diesel cars forcing the switch to gasoline cars. As a result Europe will also be using more palladium in the future. Palladium is primarily used for gasoline auto catalytic converters while Platinum is used for diesel auto converters. Platinum can be used for gasoline autos but is is less efficient than palladium. The recent scandal with Volkswagen and their diesel engines has caused a switch in Europe from diesel to gasoline cars. The electric auto introduction represents a insignificant portion of auto manufacturing and will for the next few years. The palladium price should maintain the current price levels and probably continue to appreciate.
The wild card in platinum group metals is South Africa. South Africa is undergoing turmoil at the moment. The politicians are clamoring to “redistribute” the farmland but also industry. New laws recently passed allows government confiscation of land without compensation. Property ownership is a foundation of any capitalist system. As a result of these new laws, banks will not loan money on land, investment in existing businesses will slow, and foreign investment will dry up.
The level of corruption has risen dramatically and has impacted government functionality and ESKOM, the country’s supplier of electricity. There are rolling blackouts that last for 8 hours or more that have tremendous impacts on the countries industrial base including the mining and refining of platinum group metals. Corruption and lack of maintenance has taken ESKOM to the point of bankruptcy and it is estimated it will take 65 billion dollars to fix the problem.
Corruption has grown exponentially and will impact productivity as has been demonstrated in many other countries. In the best case the mining of Platinum group metals will be curtailed with worsening electrical power supply, crumbling infrastructure and corruption that impedes the efficiency of any capitalist’s system. Some socialist South African politicians are calling for the mines to be confiscated. They want them to be turned over to people that may not have the skills to run a complex mining operation. Other politicians are calling for racial violence in the extreme which will lead to a civil war. There is a high probability of decreasing supply of both palladium and platinum. The ability to switch to a cheaper less than optimal use of platinum in gasoline catalytic converters will not be possible. The elimination of any supply in this tight palladium market or even appreciation due to increasing SA risk will potentially drive Platinum group metals much higher.
I recommend that you link to North American Palladium companies website and watch the 2018 earnings presentation and read the 2018 earnings report.
