My favorite stock (given the risk/reward potential) remains PAL (North American Palladium).
It is currently trading at $1.17, which is a bit lower than where I expected it to bottom ($1.20-1.35 area), although it has been trading below $1 for some days lately.
However, in my opinion those last couple of cents don’t matter that much. I will tell you why.
NAP has received financing to finish its Phase I expansion of its Lac Des Iles mine.
It took on 130M of debt, on which it pays a very high interest rate of 15%, which could add up to 19% if interest is accrued.
I am not very happy with this high interest rate, but on the other hand, in my opinion, its a better deal than diluting shareholders massively by issuing shares at these price levels.
In order to raise the same amount of money by issuing shares, the company would need to issue about 130M shares (given that price usually drops in anticipation of share dilutions).
They had about 170M shares outstanding, so another 130M shares would be extremely dilutive.
On the other hand, 15% per year on 130M = 19.5M on interest expenses. If they produce about 160.000 ounces per year, Palladium would need to rise 122$ to make up for this expense.
(19.5M/160.000 ounces = 122$), which is not unlikely.
I have always asked Investor Relations why they claim NAP is highly leveraged to higher Palladium prices, while it kept diluting its shareholders, and even though Pd was at $700+, PAL was still trading around $1-$2. Not really leveraging higher Pd prices if you ask me.
However, I think that is now about to change with the recent debt they took on.
That is, because Debt = leverage. the interest rate is fixed, while your earnings rise (and fall) dramatically with a rise (or fall) of Pd prices.
Pd is trading at $735 right now. If it rises to $857, that would cover for the interest expenses.
Every $1 Pd rises above that level adds $$$ to the bottom line.
However, what I like the most about the company is that they have said that Phase II could be deferred without compromising growth.
Thinking about how they would be able to do so, I think they will go for an “open-pit” type of mine whereby they can increase output dramatically and reduce costs.
I am thinking of at LEAST 250,000 ounces and potentially as much as 400,000 ounces at cash costs below $300.
Let’s be conservative and do the math:
250,000 ounces at cash costs of $350 with a Pd price of $700 (5% lower than spot prices).
250,000 x (700$-350$) = 87.50M dollar cash flow.
Deduct the 19.5M in interest expenses, and we still have 68M in cash flow… And that for a company with a market value of only 200M right now…
I hope management will soon clarify what they are planning to do, but I expect a first outlay during the conference call (7th or 8th of August if I remember correctly)…
