Metallovoric Companies Set to Gorge Themselves

Nihar is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

A metallovore feeds on metal, which is a lesser known feature in some science-fiction stories. I think it is an apt analogy for mining companies. They eat metal and excrete cash, hopefully. Mining for the most part is all about raw materials. I like the simplicity of that. You extract raw materials that keep the engine that is our economy running. It is like farming in that sense. It does get complicated when you factor in things like politics and the environment. Mining companies operate internationally, which adds another layer of potential problems.

Miners sometimes present an opportunity to take a position in a metal less than what you could get from the actual metal. That means that the companies have more of a range in their prices, with the price of the metal signaling you about the future. It is not uncommon to see the cost per ounce of gold extracted by a miner and the price per ounce of gold compared. If it costs a company $400 dollars to extract one ounce of gold then their profit is almost 4 times their cost. That is common for gold and other precious metals like platinum. For more industrial metals like copper and aluminum you do not see that comparison too much. The reason is that for gold the numbers are so high and striking. Industrial metals are more volume oriented, meaning they are measured in tons.

United States Palladium

Stillwater Mining Co. (NYSE: SWC) is the only US-based palladium miner. It operates two locations in Montana. If you read my metal ETF article you know that I like palladium the best. Other than being pretty it is useful, and rare.

Stillwater was burned by the Japanese tsunami. The hit to the global auto industry led to a decline in demand and perceived demand of palladium. That means that there is room to rise. Right around the time of the tsunami in March 2011 Stillwater was hitting a high of $25. Well I am looking to retake that. I would choose an entry below $12, but if it starts going to the upper part of $12 I would jump in there too. Then I will sit on it till it is time to reap my rewards. I hope Stillwater is conserving cash and reserves for when palladium bounces back. They can crank up production when prices improve.

Stillwater has a quarter billion in cash, which is more than its long-term debt. I always like to see that. The debt to equity ratio is 0.2102. That is within reason for something as capital intensive as mining. That equipment is expensive, and depleting cash reserves to pay for it might not be the best choice if you can get a loan backed by the hardware. Stillwater is in a good position if the palladium market starts improving.

Stillwater is not an undervalued stock. I am not looking at the "price to" metrics. Stillwater needs to improve earnings. The good thing is that earnings have stayed positive, though the trend is at best flat or weakening. Still with cash, developed ground assets, and rare in-demand metal the company has the potential to post some strong earnings. Stillwater has published a white paper explaining something about palladium, which shows that management is willing to engage with uninformed analysts. If you have never looked into the platinum group of metals check out Wikipedia because they have interesting chemical properties.

As the economy improves Stillwater should be able to cash in. Other good things include being in the stable United States in a mining-friendly jurisdiction, because it is Montana not California.

Aluminum Foundation

Alcoa, Inc. (NYSE: AA) is much hated, but the stock price is depressed because the economy has been terrible and the demand for aluminum has been limited. Alcoa has a lot of things to hate about it. My eyes almost fell out of my head when I saw that long-term debt was around 5 times cash on hand. At least debt to equity is at 0.5641, but that is not enough wiggle room to make me chomp at the bit to take a position in Alcoa. I like Alcoa, though. I have written about it before. I think the prolonged slowdown and weak manufacturing data have done a number on it. When it peeks above $10 it should be something to watch, but by then it will be a spectacle not a buy. The time to get in is now, but there are so many yellow flags that worry me. One of the flags is an $85 million charge for environmental cleanup. Considering Alcoa's recent lack of substantial earnings, that should be a real hole in the next earnings report.

The company's earnings per share is barely positive, its profit margin is at 0%, and its price to equity is over 100. Alcoa has so much revenue, but so little profit. That needs to change.  At least the price to book is 0.5638, which means it might be trading at a discount to its assets. Though there is no way to know if there is useless property or derelict equipment on the books. Not to sound false alarm bells, but going by the price to book is not enough. More digging is required to find out exactly what caused Alcoa's assets to be so undervalued.

Once you do your own research and you have a tolerance for risk, Alcoa might be good stock to take a small but solid position in and just wait for the next boom time to start. Wait for the QE3 bump to fade though. You do not want to overpay on false appreciation. Things can't stay bad forever. Risks are necessary to capitalize on all the fear, but not absurd risks so do further research.

Investment and Industry

Freeport-McMoRan Copper & Gold Inc. (NYSE: FCX) is another company disliked by many. At least that is true of environmentalists, although what environmentalist doesn't hate mining companies. Also, Freeport is much hated in Indonesia, at least by some. Obviously, Freeport has some political issues you might have to worry about.

Freeport's products are in its name. Copper and gold cover the metal spectrum. Copper is not an investment vehicle, but is used for construction and manufacturing. Gold makes pretty jewelry, but is also one of the most popular stores of wealth right up there with property and cash. Both of those worked out great. My cynicism about gold aside, it is a valuable material.

Aside from their political squabbles and some macroeconomic issues, Freeport seems to be in good shape. It has a billion more in cash than long-term debt, a low debt to equity ratio of 0.1771, and a nice profit margin of around 15%. Freeport may have lower revenues than Alcoa, but it has some really nice profits. What does scare me is the negative revenue growth, though given the troubles it is understandable. Shrinking revenues are not an immediate red flag if the company can remain profitable. It is something to watch for if it does not turn revenue growth around. It has been negative for the last few quarters. It makes me want to turn and run, but having about $3 billion in net income makes me keep them on my watch list. After the QE3 bump disappears and we get some bad news, Freeport might be a good buy. Allow the new Indonesian mining regulations to do some damage before taking a position. If you want to take a risk play Alcoa is far cheaper on an absolute basis.

Conclusion

Stillwater is my winner of this mining company rundown. All of them have their benefits though, and with some choice entries all are potentially good investments. Stillwater focuses on the metal I like best, and is fairly cheap. Also, the demand was weakened by a natural disaster, which is easy to understand. As the auto industry bounces back with the economy palladium should do well, and so will Stillwater. Alcoa has been so beaten up it almost looks like a no-brainer, almost. Research is key with Alcoa, and I think a better entry point awaits. Freeport has its charm too. Being extremely profitable is a great way to get on my good side, but their political troubles concern me.


TheArchivist has no positions in the stocks mentioned above. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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