This Stock Is Ready To Be Short Squeezed in 2013

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Stillwater Mining Company (NYSE: SWC), which engages in various stages of pruducing and marketing palladium, platinum, and platinum group metals (PGMs), has exposure to one of the most compelling 2013 supply/demand stories among the mining industry. It is entering the execution phase of its company-specific investment cycle, following two years of acquisitions and financings. I believe the execution mode will be much more shareholder-friendly than the acquisition and financing mode. I also believe Stillwater is well positioned as the only U.S. equity investment vehicle poised to benefit from the improving platinum group metal's (PGM) supply/demand fundamentals and underappreciated growth potential.

The Business Drivers

Stillwater shares should benefit from what I believe will be the emergence of a prolonged deficit in palladium driven by:

1) The production constraints and cost pressures in South Africa, which accounts for ~35% of global palladium supplies;

2) Dwindling Russian strategic stockpile sales which have historically accounted for ~15% of annual global palladium supplies; and

3) Recovering global demand, driven in large part by the improving global automobile sales – automotive demand accounted for 67% of total PGM demand in 2012. The US Auto SAAR hit a 15.52 million mark in November, marking the highest SAAR since five years.

I believe Stillwater will also benefit from the transition from investment and financing mode to execution mode. During 2010-11, Stillwater acquired two large greenfield growth projects (Marathon and Altar), began development of two near-mine brownfield expansion projects (Blitz and Graham Creek), and completed a number of JVs and external financings. I believe this has helped Stillwater to fill its project pipeline and reposition the balance sheet. Looking ahead, in my view, 2013 will be a year of execution, progressing on project development while managing a steady-state production at Stillwater’s two core assets (Stillwater and East Boulder). This should result in relatively greater commodity-driven share price movements.

Competitive Analysis

It is important to understand the end markets for PGM products. Platinum and Palladium have four major end markets.

<img src="/media/images/user_15211/capture1_1_large.PNG" />


As we can see, automotive demand is a key driver of platinum and palladium given that both metals are used in the production of catalysts in order to control exhaust emissions. With a dramatic rise in the awareness regarding environmental related issues, the use of these metals is on the rise to produce environmentally-friendly engines.

Given the tension surrounding the economic environment, we know that demand for gold jewelry will be on a decline for the time being. Tiffany & Co., one of the high-end jewelers has already stated that the industry will be facing difficulties in attracting demand from high-end customers due to concerns regarding the fiscal cliff.     

Therefore, it is important to analyze the different revenue sources for the various PGM players. I have shortlisted Impala Platinum Holdings (NASDAQOTH:IMPUY) and North American Palladium (NYSEMKT: PAL) to compare their exposure to Stillwater.

<img src="/media/images/user_15211/capture2_1_large.PNG" />

The chart shows that Stillwater has the best mix of revenue sources to benefit from the surge in platinum and palladium demand. Also its 1% revenues coming from gold signifies that its revenues will not be affected by a decline in the demand for gold in the near future. Impala also seems a nice stock to benefit from an expected rise in demand from platinum and palladium given that 83% of its revenues come from the two metals (lesser than 94% of StillWater’s revenues, but more than 75% of North American Palladium’s revenues).

Upside/Downside Scenarios

The upside case of $18 assumes a 1.3x P/NAV (Stock price/Net Asset Value), based in part on the forecasted 2013 palladium price estimate of $850/oz, and a forecasted long-term palladium price estimate of $900/oz. The downside case of $9 assumes a 0.8x P/NAV, based on a lower 2013 palladium price assumption of $580/oz.

Valuation Analysis

The NAV for Stillwater stands at $15 per share, driven in part by the long-term (i.e. 2016 and beyond) palladium price forecast of $900/oz. Given significant cost pressures in South Africa coupled with expected supply constraints, I believe the longer-term palladium pricing should improve and approach historical highs. In summary, Stillwater stands to be the derivative beneficiary of what I believe to be the most compelling supply/demand outlook within U.S. metals & mining.

It is important to note that the stock has been shorted in large quantities. Currently, 14% of the float has been shorted. However, given a bright future and a 150% expected rise in 2013 earnings, the stock is ready to be short-squeezed.  

AnalystX has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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