Stillwater awaits OK for Norilsk deal

Vancouver — Timing is crucial in the ever-volatile metals market, and this lesson is not lost on Stillwater Mining (SWC-N).

Less than two years ago, when the price of palladium was soaring, the company appeared to be doing the smart thing by expanding its two mines in Montana. However, palladium prices soon tumbled, and with operating costs rising steadily, the embattled company fell right into the arms of Russia’s Norilsk Nickel.

Stillwater, which is waiting for U.S. regulators to approve its decision to sell a 51% stake to Norilsk, incurred a net loss of US$1.8 million (or US4 per share) in the three months ended March 31, compared with a profit of US$16.6 million (US40 per share) in the corresponding period last year. Revenue between the two periods plunged 17.6% to $62.6 million.

In the first quarter, the company received an average of US$363 per oz. for palladium and US$580 per oz. for platinum, compared with US$455 and US$493, respectively, in the first quarter of 2002. The combined average realized price was US$411 per oz. — a US$70-per-oz. premium over the combined average market price of US$341 per oz., owing to long-term sales contracts.

“Results in the first quarter were affected, as expected, by the transition to our new operating plan, announced at the beginning of the year,” says Stillwater CEO Francis McAllister. “The company met all its production, development and cost targets under the revised plan, which focuses on costs rather than production.”

Last year, Stillwater earned US$32 million, down from US$66 million in 2001. Although production of palladium and platinum totalled 617,000 oz., compared with 504,000 oz. in 2001, falling palladium prices and rising operational costs took their toll. Palladium has dropped from a high of US$1,090 per oz. in January 2001 to below US$200 per oz. since the end of March 2003.

By mid-2002, it was obvious Stillwater required a cash infusion to keep operations going. Norilsk, the world’s largest producer of palladium, stepped up to the plate in November 2002 by offering to take a 51% stake in Stillwater for US$100 million in cash and 877,000 oz. palladium, which at the time was worth US$241 million (T.N.M., Dec. 2-8/02). Since then, prices for the precious metal have fallen substantially, cutting the value of the Russian palladium to US$189 million at the end of March.

The Norilsk deal has yet to be approved by two federal agencies, including antitrust regulators, as well as shareholders. In January, U.S. regulators asked the company for more information on the proposed sale. Stillwater expects the deal to close by the end of the second quarter. Following the deal, Stillwater will have 89 million shares outstanding, or just over twice as many as it now has. Noril’sk will own between 51% and 56% of those shares.

Stillwater will hold a special shareholders meeting in mid-June so that the deal can be discussed. This meeting is subject to completion of the U.S. Security and Exchange Commission’s review of the proxy statement.

Rights offering

The only other offer of interest came from a major international investment bank, which proposed a US$100-million rights offering. The idea was to issue six new shares for every one in issue at a price of US30 per share. The bank suggested an offer of up to 262.8 million shares for US$78.8 million, while it would buy 70.5 million shares of stock to raise an additional US$20.2 million. The bank would fund any shortfalls in order to achieve the targeted US$100 million, including potentially purchasing a new series of redeemable preferred shares in the event that the rights offering does not reach target.

In terms of Stillwater’s credit agreement, the banks would immediately be entitled to 60% of the $100 million, leaving the company short of its projected cash requirements. But under the Norilsk deal, Stillwater must surrender half of the total proceeds, which, at current palladium prices, have dropped to US$231 million, leaving the company with some US$115 million to fund its operations. The bank’s proposal was received by Stillwater on April 8 and rejected almost immediately.

Stillwater says its funding is adequate to meet its liquidity needs through 2003, “barring unexpected or extraordinary events.” However, there are no rival bidders, and so if the Norilsk deal does not close, Stillwater would be forced to raise funds through a rights offering of stock. The company itself has acknowledged that this move probably would not stave off bankruptcy: “Management does not believe the capital that might be raised would be sufficient to sustain its longer term needs,” according to the proxy statement.

Says Stillwater Vice-President Terry Ackerman: “We are covered through 2010 for most of our production. Our focus now is on getting the (Norilsk) deal approved.”

At March 31, the company’s cash position was US$27.3 million, up from US$25.9 million at the end of 2002.

Stillwater managed to stave off creditors earlier this year after receiving an amendment, the fifth, to its credit agreement (T.N.M., Feb. 24-March 2/03). During the first quarter, it made US$5.4 million in principal debt payments, and US$1.5 million in amendment fees were paid on the company’s credit facility.

Currently, some US$181.7 million is outstanding under term-loan facilities, and US$7.5 million is outstanding as letters of credit under the revolving credit facility.

Operations

Stillwater operates two mines in Montana: East Boulder and Stillwater.

The Stillwater mine, which sits on the eastern end of the J-M reef, contributed 492,000 oz. of combined palladium-platinum in 2002, noticeably less than the 504,000 oz. produced a year earlier. The decrease reflects lower head grades, labour unrest and inadequate infrastructure. In 2001, the Stillwater operation was expanded in order to produce 2,500 tons per day. At the time, the operation was expected to produce 525,000-575,000 oz. PGMs per year at a total cost of US$230 per oz. Falling palladium prices forced a new operating plan, which concentrates on costs rather than output.

“The plan reflects our need to address the reality of a lower cash-flow environment while maintaining the flexibility to revisit this course if prices improve,” says McAllister. “It makes no sense for the company to increase output if the demand for our metal is down in the short term. We have a valuable resource and will not mine it unless it generates an appropriate margin.”

In the first quarter of 2003, the operation produced 84,000 oz. palladium and 26,000 oz. platinum, or 110,000 combined ounces, down from the 143,000 combined ounces recorded in the first quarter of 2002. Driving the decline was a slowdown in production to 206,000 tons from 260,000 tons in the year-earlier period, as well as a drop in the combined mill head grade to 0.59 from 0.62 oz. per ton.

The Stillwater mine produced about 2,030 tons of ore per day in the first quarter of 2003. Cash costs before royalties and taxes decreased 16% from the fourth quarter of 2002, to US$228 from US$271 per oz.

Lower production also took its toll on cash costs, which before royalties and taxes, hit US$228 per oz. in the recent first quarter, compared to US$217 per oz. a year earlier. Total cash costs between the periods rose to US$252 from US$243 per oz.

Going forward, the company expects to produce 450,000 combined ounces in 2003, with cash operating costs averaging US$241 per oz.

At the high-cost East Boulder operation, which sits on the western end of the reef, some 125,000 oz. of combined platinum-palladium were produced in 2002. During the first quarter of 2003, the 1,190-ton-per-day operation produced 28,000 oz. palladium and 8,000 oz. platinum for 36,000 oz. of combined palladium and platinum, compared with 23,000 oz. in the first quarter of 2002. The 57% increase in production reflects full capacity of 1,250 tons per day. In total, 104,000 tons were milled with a combined average grade of 0.39 oz. combined platinum and palladium per ton, up 46% from the comparable quarter last year.

Cash operating costs, be
fore royalties and taxes, totalled US$329 per oz., compared with US$382 per oz. a year earlier. Total cash costs for the first quarter decreased 12% from last year, to US$372 from US$422 per oz.

For the year, Stillwater expects production to hit 165,000 combined ounces with cash operating costs before royalties and taxes averaging US$300 per oz.

“East Boulder’s overall higher costs are a contributing factor to higher consolidated costs,” says McAllister, “but we expect these costs to come down as production increases at East Boulder.”