North American Palladium (USA) (PAL)

JakilaTheHun (99.93) Submitted: 10/13/2008 11:05:41 PM : Start Price: $1.65 PAL Score: +17.03

While there are lots of reasons to be down on palladium, North American Palladium is a great buy right now for a long-term investor. First let’s examine the bad: the price of palladium has absolutely plummeted. Back in March, the spot price for an ounce of palladium was around $600; now in October, it is under $200. Just as it looked like palladium miners might be able to turn significant profits, things look rather dismal now. The primary reasons behind this are likely: (a) the economic crisis and (b) demand destruction stemming from declining production and fears in the automobile industry. Indeed, 51% of the estimated demand for palladium comes from use in automobile parts, particularly catalytic converters.

There’s more bad news, too. Recently Ford and Nissan have both announced plans to incorporate nanotechnology in order to make catalytic converters that require a much lesser amount of PG metal consumption. Between these two trends, who knows how bad things will get; especially when you consider that GM looks to be on the brink of collapse (barring a somewhat probable government bailout). So why would I possibly consider a stock of a palladium miner right now given the scary and uncertain future prospects? The major reason is because there are reasons to believe that palladium will be en vogue once again and there’s very little to lose at the current prices.

As is right now, palladium producers can not profit given the current spot prices. Companies don’t stay in business if they’re losing money, however, so supply in the market is going to have to weaken in order to drive up prices again, even if we stay on an absolute worst-case scenario where demand is diminished permanently.

Then, there are other trends in the industry, including the depletion of the Russian palladium reserves. Its unclear how much Russia has left, but don’t be too surprised if their supply is gone in five years. Top it off with the fact that Norilsk (home of palladium and nickel mining company Norilsk Nickel) is an environmental disaster. Then there’s also the South African infrastructure nightmare that is slowing production of PG metals in that nation. This leaves North American Palladium (PAL) in a decent position.

While demand for palladium is current sagging, palladium has a lot of unique properties that could extend its use to newer products. It’s already used in catalytic converters, dentistry, watch making, surgical instruments, and a handful of other uses. If we ever start using vehicles with fuel cells, it would seem to have some high growth potential.

Given that, all that’s left is to look at PAL itself. Right now, PAL’s book value of equity is $3.49 --- yet the stock is trading around the $1 – 1.50 range, a very considerable discount. Debt-to-value ratio is 15.2% so they have a very low amount of leverage. Working capital ratio is 5.57 and cash over current liabilities yields a ratio of 1.91. Hence, they appear to be in very sound financial shape and can simply ride it out until things improve.

That is my main rationale for buying into this. Right now, it’s selling at a near 60% discount to book value. At the current price, you can basically buy in and wait-it-out for another decade. If demand stays static for another decade (which seems somewhat unlikely to me), one might not lose that much given the value of their assets. On the other hand, if the price of palladium and/or platinum skyrockets any time within the next decade, causing the price of PAL to spike up considerably, you just made an enormous return on your investment.

This is basically a commodity stock and those stocks are always highly cyclical. The chart on PAL is about as volatile as can get because of this, but that’s why you can make such an enormous profit when it’s bottomed out. Consider the prices at various points in time over the past decade:

Jan 1999 = $0.79
Jan 2000 = 5.16
Jan 2001 = 9.19
Dec 2001 = 3.89
June 2002 = 7.10
April 2003 = 2.55
April 2004 = 11.78
Sep 2005 = 4.88
April 2006 = 11.95
Jan 2008 = 3.28
Mar 2008 = 9.29
Oct 2008 = 1.10

The idea here is that you can buy in now, sit on it for another decade (if necessary) and simply play the waiting game. At some point, there is another spike in demand with not enough supply and the price jumps back up. One could easily triple their return, or even make a 6- to 10-fold profit if one got lucky enough. Even if it takes 10 years for that happen, it’s a worthwhile investment still. As such, I recommend this as a long-turn buy and hold only! Definitely do not buy in if you do not have a high risk tolerance or do not wish to jump aboard on an ultra-volatile stock, but if you want to take advantage of what looks like a considerable discount and wait it out, this seems like a fairly good bet.

Disclosure: I am long on PAL