Platinum Miners Won't Be This Cheap Forever

LONDON -- It's been a grim year for platinum miners, with rising costs, labor disputes, falling prices, and surplus supply all combining to wipe out billions of pounds of shareholder equity across the industry. Aquarius Platinum (LSE: AQP.L) has lot 85% of its value in the last year alone -- a truly dire result.

Yet every cloud has a silver (or silvery metal) lining, and platinum miners are more affordable now than they have been for some time. But are they a buy? I think that two of them may be, as I'll explain in this article.

Note: It's not gold
When looking at platinum, it's tempting to think of it in the same way as gold -- as a precious metal that's coveted and valued far beyond its practical applications.

In fact, platinum is far different. While 85% of gold production is used for jewelry or investment, only 36% of platinum is used in this way. The remaining two-thirds are used in industrial processes and the making of automotive catalytic converters.

What this means is that demand for platinum is far more closely linked to economic activity than that of gold. This helps explain why platinum has broken away from its long-term trend and been cheaper than gold since last September -- something that has only happened a few times before.

Rising supply and flat demand have created a surplus that has driven down the market price of the white metal and is causing some platinum miners to idle production capacity in order to cut costs.

Geographic risk
More than 75% of global platinum production takes place in South Africa. Unfortunately, conditions in South Africa are far from ideal for running a lean, efficient business. Over the last year, both labor costs and electricity rates have risen sharply.

At the same time, power outages, industrial unrest, and absenteeism are regular problems, and the industry has serious safety issues. In 2011, 17 Anglo American (LSE: AAL.L) employees died in workplace accidents. Of these, 12 worked in the FTSE 100 company's platinum business, which was subject to 81 regulatory safety stoppages last year.

Where's my barge pole?
By now, you might be thinking that the last place you would want to invest your hard-earned money is in a South African platinum mine. Yet platinum is essential to the world's economy, and most of it comes from South Africa -- where it is an important source of tax revenue. All involved have a strong motivation to resolve the current problems.

Mining will remain a growth industry over the next few decades as India and China continue to industrialize and their populations become wealthier and consume more. That's not just my opinion, either; a recent free report from the Fool's team of share analysts came to the same conclusion and tipped two miners as top growth prospects in 2012.

Whom to pick?
The key question is which platinum miner is best-positioned to manage its costs and ride out the lull before the surplus is absorbed and demand -- and prices -- improve.

I've restricted my search to London-listed companies with significant production assets -- which, as it happens, has produced a list of the world's four largest platinum producers:

Sources: Morningstar; Digital Look; company reports. NTAV = Net tangible asset value.

Platinum only accounted for 8% of Anglo American's operating profit in 2011, meaning that it can afford to ride out the downturn, especially as 60% of its platinum output is in the "lower half of the cost curve," according to CEO Cynthia Carroll. Anglo looks unlikely to cut production, but it may scale back capital expenditure.

Impala is the world's second-largest platinum producer. Like its peers, it has suffered from rising costs and industrial unrest. A strike at one of its mines this year cost about 155 million pounds in lost revenue. Impala has just gotten a new CEO, so changes could be imminent.

Lonmin is late to the cost-cutting party, has rising net debt, and needs to worm its way out of $2 billion of capital expenditure commitments for the next five years. No thanks.

Aquarius has suffered badly this year, but it has already idled its two unprofitable mines and has a clear plan (and budget) for the next year. It's also the only one among its peers that's trading substantially below its net tangible asset value, adding to its appeal.

Although Anglo American is a safe bet, my choice for a recovery play would be Aquarius Platinum. It has a $200 million cash balance -- much greater than that of Impala or Lonmin -- and trades at less than half its book value. Aquarius' management believes the company can be cash flow positive next year, so long as platinum prices don't drop much further.

I also like the open style of the company's communications with the market and the proactive stance it has taken in recent months. Aquarius' financial year ended in June, and full-year results should be out soon, which might provide an opportunity to review a possible purchase.

Something different
Despite my positive view on Aquarius Platinum, there are political and economic risks in South Africa, and if demand doesn't pick up, the industry could be in for a few lean years.

An alternative play on platinum is FTSE 100-listed chemicals group Johnson Matthey (LSE: JMAT.L), which is a big buyer of platinum but doesn't mine it. The company is one of the world's main catalytic-converter manufacturers, and increasingly tight emissions regulations in Europe and the U.S. should help keep demand firm, even if the automotive market remains flat.

Johnson Matthey had a bumper year in 2011 and even paid out a 100 pence special dividend, but this year is set to be a little quieter, and the company's share price has slid back slightly in recent days, although it remains relatively pricey on a P/E of 13.8. Despite this, it should be a safe bet for long-term growth.

Finally, for two more hand-picked mining tips, don't forget to check out the free Fool report I mentioned earlier: "Top Sectors for 2012." It's completely free and can be yours in a few seconds.

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