Is This Palladium Producer a Buy?

Palladium prices have risen in the first quarter of 2014 because of strong automotive demand in North America and China. With more than 70% of 2013 gross palladium demand coming from the market for catalytic converters, strengthening auto sales have helped benefit palladium prices. While most of the world's palladium comes from South Africa and Russia, Stillwater Mining Company is North America's primary palladium producer. Is Stillwater Mining a buy?

Stillwater's business
Stillwater Mining operates in two main segments, its palladium and platinum mining segment, and its platinum group metals recycling segment. Revenues from the mining segment for the first quarter of 2014 were $125.7 million, down slightly from $128.3 million in the first quarter of 2013. The recycling segment reported first-quarter revenues of $93.5 million, down 23.5% from the $122.3 million it reported for the first quarter of 2013. 

Stillwater Mining reported first-quarter net income of $19 million, which is an improvement over the $14.3 million reported in the first quarter of 2013. Revenues actually declined 12% from $250.6 million to $219.5 million. Mine production of palladium and platinum totaled 130,700 ounces in the first quarter of 2014, an increase of 2.8% from the 127,100 ounces produced in the first quarter of 2013. Net cash provided by operating activities was $4.8 million for the first quarter of 2014, compared to $15.5 million in the first quarter of 2013. The low amount of net cash has to be a bit of a concern for investors as Stillwater Mining has had difficulty in the past generating cash.

Stillwater's strategy
To this end, Stillwater Mining appears to be focusing on value generation as its key objective as opposed to growth. In an interview with The Wall Street Journal, Michael McMullen, CEO of Stillwater Mining, said, "The demand for palladium and platinum is very strong. People are looking to secure long-term supplies." Despite the strong demand, McMullen said Stillwater Mining does not intend to increase its mined production, and instead will focus on reducing costs. "We don't want to fall into the trap of suddenly trying to increase our mined production.. While the market reacted negatively to this announcement, it appears Stillwater Mining is focused on long-term objectives rather than chasing short-term profits, which investors should cheer, as many other miners have been hurt by this shortsightedness in recent years.

Stillwater Mining has a solid balance sheet, with $224.6 million in cash and cash equivalents at the end of the first quarter, and it appears to be making a concerted effort to reduce costs. It has reduced first-quarter all-in sustaining costs per ounce by 6.7% to $788 per ounce, compared to $845 per ounce in the first quarter of 2013. This is mainly because of lower corporate costs and non-project capital spending during the first quarter of 2014. Stillwater Mining recently laid off 48 workers and has also done a voluntary buyout of 35 more workers in order to reduce costs further.

New contract
Stillwater Mining announced in May that it had signed a five-year contract with Johnson Matthey under which Johnson Matthey will purchase all of Stillwater's mined palladium and a significant share of its mined platinum. The contract is based on an annual pricing mechanism linked to various industry benchmarks. This is good news for Stillwater Mining, as it has secured sales for all of its palladium production and can focus its full efforts on cost reduction and maximizing free cash flow.

Stillwater Mining has a big advantage as it is the world's largest primary palladium-producing mine operating in the stable mining jurisdiction of Montana. In South Africa, workers have been on strike since January at the three largest platinum producing mines, which also produce significant amounts of palladium.

In Russia, Norilsk Nickel is the single largest producer of palladium in the world, having produced 2.66 million ounces in 2013, which accounted for 41% of the world's total palladium production. Norilsk Nickel is primarily a nickel producer, but it also produces large amounts of palladium as a by-product. Its palladium production has decreased every year since 2005, and the amount of palladium produced by Norilsk Nickel is highly dependent on its nickel production since the palladium is a by-product. In Canada, North American Palladium produces palladium at its Lac des Iles mine in Ontario. It is a much smaller operation than Stillwater Mining and it's guiding for 2014 palladium production of 170,000 to 175,000 ounces. North American Palladium has been plagued by poor performance, having lost money for each of the last eight quarters.

Foolish takeaway
With Stillwater Mining having locked in a five-year contract with Johnson Matthey for all of its palladium production, things seem to be looking up for the United States' sole palladium producer. Investors will want to see if Stillwater Mining is able to further reduce costs, since it's not planning to expedite its development projects. Investors will also want to see if Stillwater Mining is able to generate better cash flows over the next few quarters. With the market for palladium looking strong, Stillwater Mining looks like a company investors should keep on their radars.

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