Sunday, December 16, 2007

Valuation of SWC and PAL Compared

Both SWC and PAL are primary PGM metal producers. They are the only major PGM metal producers outside Russia and South Africa. I expect the PGM metals, especially palladium, to be extremely bullish in the near future, due to booming demand from jewelry and fuel cell applications, or even the exotic cold fusion application. Investing in the physical palladium metal is a very good idea. But investing in the stocks of these two PGM producers may bring in much higher leveraged return.

So if you are to buy stocks of PGM producers, which one you would choose at today's price, SWC or PAL? Let me compare the two here.

First, let’s look at SWC. Stillwater mine has a mine grade of as much as 0.55 ounces of PGM metals per ton of ores. That is the highest grade PGM mine in the world. But the SWC mine is mostly palladium, about 3/4 palladium and only 1/4 is the more expensive platinum. So for now it is not as profitable as the platinum mines in South Africa.

The mine grade of PAL is much lower at about 2.5 grams PGM per ton of ores. It contains way much less platinum, too, only 1/10. But PAL does have its advantages. It is mostly an open-pit operation, so the mining cost is way much cheaper than the underground mine of SWC. PAL produces way much more base metals, especially nickel, compared with SWC. Further, PAL has quite a few ongoing exploration and new mine development projects going on, while not much new mine development is going on with SWC.

Now let's look at operating results to compare the two. SWC has a current market cap of $839.72M, compare with PAL's $273.40M (with new shares from secondary offering counted in). For the first nine month of 2007, sales revenue of SWC was $470.50M, among which only $210.877M was from mine production. $247.977M of the sales revenue came from PGM recycling business, which is profitable but really a thin profit margin business due to competition in the recycling business.

Counting only the mining production, SWC has a 9 month price/sales ratio of 3.982. Annualized it is 2.987, a low ratio. But PAL reported $149.426M (in Canadian dollars) sales revenue for the nine months. That's an annualized price/sales ratio of 1.372, way much lower (cheaper) than SWC.

I believe the price/sales ratio is more important than the current P/E ratio, because as metal prices go up, the sales revenue will go up proportionally, while cost of producing the same amount of metals remains about the same. Any increase of sales revenue due to better metal prices will directly go into pre-tax net earnings. With a price/sales ratio less than half of that of SWC, PAL is a much better value to buy here. And I called a PAL bottom last Tursday.

Some folks may like to judgement stocks only based on P/E ratio; I think P/E is less meaningful here. PAL's quarterly results are extremely volatile. In Q1, 2007, PAL reported quarterly earnings of 10 cents per share. In Q2, 2007, it reported quarterly loss of 17 cents. And then in Q3, the loss widens to 25 cents. Some may wonder how PAL could report such increasing loss at a time when PGM metals are moving up.

In reality, the fluctuation of PAL's quarterly results is due to the way how PAL did its accounting. For Q1 through Q3, based on its reported metal productions and realized sales price, the produced metal values are respectively $59.911M, $51.041M and $51.327M. Not a big variation. However the reported sales revenues are respectively $68.439M, $44.495M and $36.492M. That's a gigantic difference. No wonder PAL went from 10 cents a share profit in Q1 to 25 cents a share loss in Q3. The results are really just some temporary aberrations that do NOT reflect the real operating results of PAL from the long term point of view.

What causes those aberrations? For one thing, PAL may not sell all of the metals produced in current quarter. It may decide to hold some metals back for better prices in the future. But the cost of all metals produced in current quarter is nevertheless booked in current quarter regardless when the metal will be sold.

Another reason for the quarterly aberration is PAL records sales revenue in current quarter, using current metal prices, while the metals still need to go through smelters. The actual closing of the sale of the metals will occur about 6 months later at the new spot price, which may be higher or lower than the originally booked sales price, also the sales revenue will be converted back to Canadian dollar at the time of the actual sale, which may be converted at a different USD/CAD foreign exchange rate. Because of this reason, PAL needs to record the commodity price adjustment, as well as foreign exchange adjust, to its quarterly sales revenue. Both adjustments exaggerate the volatility of quarterly results, making one quarter particularly good and the next one particularly bad. Over the long term, both adjustments should NOT have any long lasting effect on PAL's quarterly results.

Two factors pushed PAL from its recent high of $12.65 to recent low of $3.40, the seemingly disappointing Q3 result is one factor, and the recent secondary offering to dilute shares is another factor. Now let's see how bad the secondary offering dilution is.

Before the offering, PAL had 55.23M shares. After the offering, there is 18.67M extra shares, so the new number of shares is 73.9M. 55.23M divided by 73.9M is about 75%. So that's a share value dilution of 25%.

But don't forget that the secondary offering also brings in $74M in cash. That's an increase of book value of about $1 per share. PAL's current price is $3.70. Subtracting the $1 extra cash, the market is pricing PAL at $2.70 a diluted share, or $3.60 per share before dilution. That is a rather ridiculous valuation consider that PAL has been trading between $6 to $12.65 before this secondary offering fiasco!

In summary, I believe PAL is deeply oversold. People should jump right in and buy as much as they can afford at current price level.

Disclosure: The author owns a lot of long positions in PAL and some long positions in SWC.


Anonymous said...

Hey Mark, this is timsharperock from Yahoo boards. Your new post is quite perfect. How do you explain Kaiser's move? You said that they most probably invested in a future energy technology. Yes it is a reasonable view, but if their purpose is completely different than that? Such as blockade. Blockade to a new technology becoming reality. All we know there is a limited palladium supply. So if there is not enough palladium, there would be no need to fear new cold fusion tech... See ? It's a more real view. They may stop the new energy tech by owning the material sources first ... then they will finish this sources by using absurd productions such as jewellry or autocatalysts etc... what do you think?

JJ2000426 said...


There will be enough palladium for cold fusion, as long as people pay high enough price for it. The known PGM mineral reserve on earth is enough for a few hundred years, while other metals last much shorter time. As the price of palladium goes up, un-economical ores will become economical to produce. So palladium supply for a wide application of cold fusion is not a problem.

Kaiser Oil is NOT the one who depress PAL price recently. It's the other institution holder, for some reason no one understands.

Kaiser is a small oil player. They are not seeking blocking anything, nor can they. Kaiser must realize the extreme importance of palladium in the near future, that's why they own a big chuck. Not too many people have that wisdom. All those recognize the important of palladium, has been loading quietly for the past few years. That's why palladium price has been going up despite of Russian stockpile sale.


I have found many of your posts very insightful and I cannot question your fundamental analysis on these metals since I have little understanding of the production, sales, and use for them. As an investment, these specialty metals have a lot of potential down the road, no doubts about that. However, given the time value of money, don't you think parking your money in other commodities such as gold and silver will serve you better? The problem with palladium is that investor sentiment is really poor and a lot of people just don't holistically understand its purpose. Demand will take a while to return so put your money in stocks that are in an uptrend and get back into PAL later when it stablizes. It would be premature to call a bottom in PAL right now given the flight to quality into solar and oil. Yes, both these sectors are overvalued, but the market is often irrational.

I strongly suggest you study and incorporate technical analysis into your trading/investment decisions, if you are not already doing. Any person who disregards stock technicals and its importance is simply ignorant. Also, perception is a very powerful effect that can drive a stock up. Take for example stocks containing "solar" now or ".com" in the 90s. Fighting the trend by going short on fundamental analysis alone can be deadly, especially in a hot and volatile name like FSLR. I'm a believer too that it'll crash, but your timing of your short position is killing you. Everytime you call a top and fight the trend, you are increasing your exposure to risk if you don't use a stop loss. Without a stop loss and/or exit plan, your losses are getting compounded which eat up your gains and then some if the losing position is a short. It scares me to think you are fighting the trend without a stop and averaging up too. If learnt and utilized properly, charts and oscillators can provide clearly defined levels of risk-reward ratios. Keep your losses small so you can stay in the game. If you miss a move, so what, there's another play around the corner. Getting married to a position that is unloved by the market can be devastating. Whether or not you agree, I hope everyone takes this into consideration because fundamental analysis doesn't always hold true and/or takes a long time to come to fruition. I wish things work out well for you.

BTW, what is your outlook on gold, silver, oil, and uranium? I'd be very interested to here your comments.



Bruce said...

JJ/Mark : Platinum hitting alltime highs, palladium breaking up; yet your entire investment portfolio is hitting alltime lows, taking on water like the Titanic.

You don't get it son. Management & mismanagement is EVERYTHING. SWC & PAL magangement suck, to put it mildly. With the wind at their backs, they continue to lose money for their business & shareholders.

Which brings me to you, Mr. Mismanagement; no wonder you like these shit investment VEHICLES, and that is what they are; SHIT & VEHICLES. You got the direction of Platinum & palladium right & picked the wrong way to play them. Its one thing to make a mistake & its another to keep making the same mistake. Einstein said that idiocy is repeating the same mistake over & over again, thinking they will get different results the next time.

You are no dope. Stop acting like one. Be honest with yourself & everyone, for once. For your own sake. You are doing yourself & everyone a disservice with your glaring self-dishonesty.

And your short FSLR, has gone waaay against you & before its over, you will cover. This thing is going over $400.

Be a man already. Grow up.

wpeyton said...

RE Kaiser.

The guy is not at all stupid. From Wiki:

George B Kaiser (Born 1942) is an American self-made billionaire businessman and chairman of BOK Financial Corporation. Born in 1942, he attended Tulsa public schools, and went on to earn a bachelor's degree and MBA from Harvard University. He briefly considered joining the U.S. Foreign Service, but instead returned to Tulsa in 1966 to work for his father. Kaiser took control of Kaiser-Francis Oil Company in 1969. In 1990, Kaiser bought the Bank of Oklahoma, N.A. from the FDIC, the government agency that guarantees the soundness of the nation's major savings institutions. Buying the Bank of Oklahoma landed Kaiser on the Forbes 400 wealthiest Americans. By the end of 1998, Kaiser's ownership interests in BOKF were worth 917 million dollars. With an estimated current net worth of around $11 billion, he is ranked by Forbes as the 26-richest person in America.

He certainly bought the bank at the right price...

Bruce said...

SWC within a few % of yearly lows.
PAL at multi year lows.
FSLR punching through to new highs.

Try the Costanza approach to investing JJ: Do the exact opposite of what JJ would do.

BearOfLittleBrain said...

If you're wondering why the stock has utterly tanked, it's probably financial manipulation. It is worth checking out this week's FinancialSense "broadcast" (3rd hour) for an explanation.

In the 3rd hour they discuss just how stocks, particularly mining stocks, are driven down in advance of a financial injection/dilution, and explain the particular attraction of warrants in this regard.
I was fortunate enough to catch most of the advance a couple of years ago (in the metal only; I missed PAL's breakout, even though it was on my watch list, but because I do not have the nerve to chase a stock I let it go). I've been watching the price of palladium since then (including incurring a minor loss when the last potential breakout failed) and it could be shaping up for yet another leg up before too long. Platinum seems to be advancing quite nicely towards $1600, so it should soon be time for palladium to play catch-up. $480 would be a reasonable guess unless platinum collapses. It seems unlikely that PAL would remain immune to any advance in the metal price, even without the recent financial manipulation which, I believe is now a positive for the stock. So, besides all the technological reasons proposed, there seem to be good fundamental/conspiratorial reasons to buy PAL, which I did yesterday at $3.82 (it was supposed to be at $3.60, the day before; but that's another story of my UK broker's incompetence). I've only put in one third of my potential allocation and that's well below my threshold of pain, even if it falls considerably further. I'm not betting the farm, but it is likely to be one of my (slightly) larger individual mining commitments.
I'm also keeping an eye on SWC, as it is forming what could be a two-year basing triangle and the weekly OBV has been rising gently throughout (on my charts). Monthly OBV is less positive, but has recovered substantially. For better or worse (usually better), I think rising weekly OBV is one of the better indicators. My guess is that it indicates steady accumulation by the big players, FWIW. Well, it gives me a warm feeling, anyway!

drooyrich said...

I was just wondering about one thing..could the difference between production and sales revenue be explained by the fact that PAL hedges their production at lower selling prices ? Thanks for a comment

drooyrich said...

I was just wondering about one thing..could the difference between production and sales revenue be explained by the fact that PAL hedges their production at lower selling prices ? Thanks for a comment

drooyrich said...

PAL begining its upward trend ?
FSLR heavily down with Nasduq on Friday...mmm

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Nice post on SWC.