225Research

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Our Picks

North American Palladium – in short supply so to the sky?

Catching a large bid early on in the year due to skyrocketing palladium prices, North American Palladium (PDL on the TSX) has pulled back and looks poised to go on another run, as palladium prices continue their move higher. 

North American Palladium

PDL is our choice to play a continued bullish move for a variety of reasons. For starters, their mine in Northern Ontario has been operational for over 20 years, showing longevity even with a lower palladium price in the past to work with. This also happens to be one of the largest primarily palladium mine in the world. Management seems competent in their abilities, as well as confident in the business. A nice sign was management not selling any shares on the big run-up, meaning they are bullish for more price action in the future. It also helps that Brookfield Business partners, an Arm of Brookfield Asset Management own over 80% of shares, even after their secondary offering off the back of the last run-up.

Returning Value

The other aspects of the company we are like is their ability to return cash to shareholders. For starters, the company raised its dividend from 12 cents annually to 40 cents annually, showing managements belief in a long term elevated palladium price. This represents close to a 3% dividend, as well as the company has the potential to offer special dividends or share buybacks as cash continues to build. Unlike other miners who get trapped in the never-ending spend to grow production, PDL doesn’t outspend cash flows. This common practice has led to shareholder destruction for other miners. This is partially because of the scarcity of palladium, meaning the company doesn’t vie to undertake additional risky exploration. To go along with this, the company is net debt free with net cash of around 20m. 

Rising demand and limited supply

For the overall commodity, the upside still looks good. Supply is very limited and much of the outstanding supply is in areas with less geopolitical certainty, with Russia being the largest supplier of the metal, as well as South Africa. The overall end market for palladium continues to grow, with catalytic converter in cars accounting for over 85% of demand. This should only continue to grow as countries progress to becoming more green, initiating new emission standards. This accounts for large tailwinds for catalytic convertors and therefore palladium, because of their use to burn gas cleaner in cars such as hybrids. As the growth of trucks and SUV’s continues versus traditional smaller cars, the larger engine sizes mean even more palladium is needed. Mix this along with the strength in precious metals such as gold as a result of lower rates, and the overall commodity is lined up to do well over the next 12 months and beyond. 

Steady Demand

With such small ability to get more supply onstream, coupled with increasing demand secularly, the already very scarce metal should only continue to remain at elevated levels. Usually the main thing that causes a commodity to come back down to earth is a shift in use to avoid the commodity, which seems unlikely in the short to medium term, or increasing production, which is not possible with such trouble to find it. As stockpiles continue to decrease, we could see another leg up over time.

Still some risk

The 2 things that could possibly hurt this strong price is a global economic slowdown, in which car sales would slow down, possibly enough for demand and supply to balance out. This would likely be a short term headwind in a secular long term story, yet still poses a strong risk. Another big risk is the switch to platinum, a potential replacement trading over $500/OZ cheaper than palladium. However, it is shown that palladium is the resounding choice to automakers, and this large of a switch would likely take some time to implement to production and supply chains, meaning its a medium-term risk. 

Margin of safety

With a company such as PDL, all one needs to believe is that palladium stays around this price or over $1300/oz because at these prices the company is making more money than it needs to grow with. Any breakout in palladium price is just gravy on top that pads the bottom line even more. Part of the reason for the large spike in price to over $22/share was part of the media attention to the palladium price, and if we can break out over the previous high, it’s not crazy to think a little more media coverage to come back to the metal, which should lead to a trickle down in interest right to PDL. With PDL being the largest North American public company to mine primarily Palladium, they will by default be the most popular name for investors in North America to bid up, in the hope of getting in on the rocket ship that is palladium.