Pan African Resources - Update
October 16th 2019
Sailing into calmer waters may sum up the company's situation for the year ending 30th June 2019. Incidentally, it should be pointed out that it has moved from Pounds Sterling to the US Dollar in terms of its presentation currency. This seems to have a clear logic to it - for starters, it makes peer comparisons a lot easier. That said, it does flatter the results. And it should be remembered that the average US Dollar rate against the ZAR increased by 10.4% over the period while the year-end rate increased by 2.6%.
Increased Production And Higher Margins
Its guidance production figure for the year ended 30th June 2019 was 170,000 oz. In fact, it marginally exceeded that with a little more than 172,000 oz, an increase of 54% on the previous year. Not only was production up but its all-in sustaining costs (AISC) were down by 27.2% to US$988 per oz. For the current year, the guidance figure is 185,000 oz, which appears very achievable.
Increasing Production And Margins
The increased production has resulted in a sharp increase in revenue. This is up 49% compared to the previous period to US$217.4 million which resulted in a profit after tax of US$38 million (2018: US$122.8 million loss). Considering that the average price of Gold over the period fell by 2.7% to US$1,266 per oz, it's clearly a more efficient operation. Around 58% of revenue and about 55% of operating profit was generated by the Barberton operation, with the remainder coming from Evander.
As it rightly points out, its Earnings Per Share (EPS) has improved dramatically to 1.97 US$ cents (2018: 6.79 US$ cents loss). And it might be useful to remember that this includes the impact of the reversal of US$17.9 million of the impairment charge that was incurred as a result of the closure of Evander's underground operations (Some of the relevant assets will be used in the 8 Shaft pillar project). This should have the effect of flattering EPS for 2020.
The strength of its cash generation (US$37.7 million, against US$13.4 million for 2018) can be seen in its year-end cash pile of US$5.34 million (2018: US$0.92 million). And this is after paying finance costs of US$15.01 million (2018: US$7.1 million) and does not include a full year's production from Elikhulu and excludes production from its newly producing 8 Shaft pillar.
The restoration of the dividend will surely be welcomed by most investors. The distribution of US$3.4 million represents 0.15169 US$ cents per share. Considering that many private investors will have issues reclaiming the 20% South African withholding tax, would it not make sense to have a share-buyback programme? Interestingly, the payment date for the dividend is 30th December 2019. Why? well, it could have declared a dividend in 2019 and then paid it in 2020 if it thought that it would come close to breaching its debt covenants (Its net debt: adjusted EBITDA must be less than 2.5:1 at 31st December 2019. As of 30th June 2019, it was 2.28). In my view, it sends a very clear message that it's in reasonable financial shape. It can pay a dividend and meet this key debt covenant. Going forward, it aims to pay some 40% of net cash generated from operating activities (After taking into consideration the cash necessary to maintain debt repayments, sustaining capital expenditure and major one-off costs). To its credit, it has restored its dividend as soon as practically possible.
A Focus On Debt Reduction
At the period end, its net debt stood at US$129.9 million (2018: US$118.0 million). To some degree, its success or failure will come down to its ability to control its debt - its net gearing now stands at around 70%. I would suggest that, thus far, it has done a good job buoyed by strong Gold prices. Its stated aim is to reduce its senior debt. Understandable, its debt has fuelled its expansion and restructuring and that has largely been delivered - the heavy lifting has been done. In 2019, its capex fell to US$56.7 million (2018: US$128.4 million). It has executed on its plans and is now paying down the debt. Aside from sustaining capex, it can largely choose whether or not to spend on capex. Putting that into perspective, its sustaining capex spend for 2019 was US$9.9 million (A decrease of 56% on the previous year).
Its debt is made up of the following: a Revolving Credit Facility (RCF) of ZAR1 billion that now stretches out to June 2022. A term-loan for the construction of Elikhulu of ZAR1 billion (This requires quarterly repayments of ZAR50 million of principal which began in September 2019 with the final repayment due in June 2024). And, finally, a general banking facility of ZAR140 million. At the year-end, it had reasonable headroom in place with US16 million of debt facilities available to it.
Its finance costs have, not unexpectedly, leapt. More than doubling to US$15.015 million. This includes interest repayments of US$14.1 million (2018: US$7 million).
As a result of restructuring the RCF which became effective on 3rd June 2019, the covenants attached to the RCF and the Elikhulu term loan have been adjusted and appear less onerous to the company considering the arrangement has been extended until June 2022. The closing balance on the RCF was US$62.7 million at the period end (2018: US$63.1 million). This gives it US$7.812 million of headroom.
After the year-end, the company entered into a Gold loan arrangement with RMB for 20,000 oz of Gold. In return for an upfront payment of US$28.3 million (ZAR394 million), Pan African will supply 1,666.67 oz of Gold per month for a period of 12 months commencing 31st July 2019 and with a final delivery on 30th June 2020. This locks in a Gold price of ZAR633,344 per kilo.
The company also holds zero-cost dollar derivative hedges for 120,010 oz of Gold covering the period 1st July 2019 to 31st December 2020. These have an average floor price of ZAR654,166 per kilo and an average ceiling price of ZAR828,303 per kilo. For the financial year ending 2020, it has put in place zero-cost collar derivatives covering H1 2020 for 25,000oz at a floor of ZAR594,000 per kilo and a ceiling of ZAR666,008 per kilo. And for H2 2020, 20,000 oz of Gold with a floor of ZAR615,000 per kilo and a ceiling of ZAR740,287 per kilo. It appears to use hedging to mitigate certain situations and the most obvious and recent was "Peak debt".
Taken together, its move towards overground operations and the collar derivatives coupled with the Gold loan give it a reasonably firm foundation in terms of predictable revenue over the short-term.
Cost Control Is Crucial To Its Success
The company's cost of production for continuing operations may have risen significantly (Up 42.9% to US$153 million) but so too as its revenue as it has focused on not just increasing production but also reducing its AISC. Basically, producing higher added value ounces of Gold.
Mining and processing costs represented the largest proportion of overall costs at 41.1% and they surged by 74.4% over the period to US$62.8 million. Not surprising given the 277% increase in the amount of material mined - the bulk of the increase coming from the Elikhulu operation. Going forward, the costs seem likely to fall as the 8 Shaft pillar operations at Evander replace the relatively expensive vamping and remnant mining (The cost of this operation has risen by 94% year on year to US$35 million). In the short-term, the milled tonnage will probably increase but not the overall mining and processing costs.
Unlike some of its other costs, Pan African has a degree of visibility when it comes to its wage bill. Useful as this accounts for around 30.3% of its total costs. It has reached a three-year wage agreement at Barberton (1,950 permanent employees and 620 contractors) which was put in place in September 2018 (Evander with 181 permanent employees and 873 contractors is non-unionised). Over the period, the wage costs at Barberton increased by just 0.2% to US$40.8 million (But by 10.5% in Rand terms). Overall, its wage bill is up by 11.5% while its total headcount has decreased by around 33.1% (But this includes contractors as well as employees - its total number of permanent employees has increased by around 3.8%). Essentially, it appears to be employing far fewer contractors and its permanent staff are better rewarded with greater numbers working above rather than below ground. In terms of permanent employee profile, there is an increasing proportion of women, now around 10.38% (2018: 9.66%) as well as employees in the 40+ age group (Rising from 45.3% in 2018 to 49.8% in 2019). Staff turnover is relatively stable at 10.6% (2018: 8.6%) - the figure presumably covers permanent and contracted employees.
Not only is the reliability of its electricity supplies sometimes erratic but it's also subject to major price hikes. And this makes up around 12% of its overall costs. Over the year, the cost of its electricity usage increased by 77.7% to US$18.3 million. In fairness to the company, its energy consumption has fallen by around 12% year on year (Largely as a result of ceasing underground operations at Evander) and it's now exploring the viability of using solar power at its Elikhulu unit (This is not pie-in-the-sky. Caledonia Mining, a Zimbabwe focused Gold Miner, is now putting out a tender for a photovoltaic generating unit to ensure energy supplies at its Blanket mine). But the reality is that for the foreseeable future it's dependent on ESKOM and the latter has issues.
Of little surprise, is its increasing Engineering and Technical costs. Considering the scale of its restructuring and the construction of Elikhulu, this is only to be expected. It also takes up some 7.4% of its total costs. Over the period, this rose by 56.9% to US$11.3 million (2018: US$7.2 million). I would suggest that this spending is in large measure correlated to its capex. Therefore, there is probably an expectation that it will fall going forward.
Its security costs rose by 71% to US$7.2 million compared to the previous year and now represents 4.7% of its total costs. Just how much of this is a recurring expense is not clear. And putting that into perspective, it was spending some 3% of its overall costs on security in 2015.
What I find striking is that even after all the above increases, it's still a profitable enterprise. The real issue is whether these increases represent a trend. I would suggest that it does not. It's also worth mentioning that the company has made significant progress in reducing its overall environmental impact - its water, electricity and greenhouse gas emissions have fallen by 19.8%, 12.1% and 75% respectively.
Overground Operations Increase Production And Profits
These now account for some 46.5% of total production. Not only are they safer than comparable underground operations but also give a degree of production as well as cash flow certainty. In addition, they offer the opportunity to buy-in material that can then be recycled.
It might be worth mentioning that the Lost Time Injury Frequency Rate per million hours have dropped dramatically over the last year to 1.62 (2018: 3.73). And there were no fatal injuries in 2018 and 2019 (2017: 3). This seems to underpin the company's move away from high-risk, expensive and dangerous deep mining. Incidentally, some 20% of the Board Directors' variable pay is linked to the Group's safety record.
Elikhulu Propels Its Growth Into Low-Cost Production
This game-changer with an expected life of mine of 13 years is now in full operation. Over the period (Production from September 2018 to June 30th 2019), it produced some 46,201 oz of Gold. And, importantly, this is low-cost production with cash costs of US$555 per oz and AISC of US$587 per oz. It added US$58 million to the company's revenue over the period as well as increasing adjusted EBITDA by US$31.1 million. Incidentally, for environmentally concerned investors this project is of significant value. Firstly, it consolidates several Tailings Storage Facilities (TSF) into one unit with the resultant reduction in footprint. And secondly, it deals with the environmental issues surrounding the dumps such as the seepage of sulphuric acid into the environment. Not resting on its laurels, the company is now examining ways of increasing production at Elikhulu and reducing water consumption.
Barberton Tailings Retreatment Plant (BTRP) Back In The Game
Largely as a result of the successful introduction of a regrind mill in May 2018, the company saw an increase in production of 37% to 24,007 oz of Gold for the period and a fall of 20.5% in its AISC to US$552 per oz. Although it's listed as having a nine-year life of mine, the company appears to be in the throes of upgrading its mineral resources at the Segalla and Camelot tailings dumps and so extending its life.
Underground Operations Are Still The Mainstay Of The Business
Barberton Offers Room For Growth
Comprising Fairview, New Consort and Sheba mines. This achieved production of some 75,356 oz of Gold for 2019 (2018: 73,125 oz of Gold). With a life of mine of some 20 years, it also offers substantial scope for development.
The sub-vertical shaft planned for Fairview is expected to introduce efficiencies that should increase production by 7,000-10,000 oz of Gold per annum. It also plans to introduce a gravity circuit (At a cost of US$1.3 million with an expected payback of two years) to recover the free Gold. The higher-grade ore bodies at the 272 and 358 platforms increased production from the early part of 2019 and so it seems reasonable for this to continue into the 2020 financial year.
New Consort appears to be operating below expectations. However, it offers the possibility of down-dip development. There may even be further scope to take in third-party Gold-bearing ore. The company is also looking at upgrading the surface plant of both the New Consort and Sheba mines to deal with low-grade surface material.
The company is now evaluating its cross-tramming Dibanisa project designed to link 38 Level Sheba and 23 Level (Fairview). The goal is to decrease costs and free up the infrastructure for the Royal Sheba project (The open-cast approach seems too expensive). It would allow the company to exploit its Royal Sheba orebody via its established Fairview workings thus reducing the time to production. The projected completion date is June 2022.
Underground Mining At Evander Is Far From Over
8 Shaft Pillar Offers Low-Cost Production Alternative
Expected to produce 20,000-30,000 oz of Gold per year with a life of mine estimated at three years. Although it only came into production in August 2019, it's expected to contribute some 20,000 oz of Gold in the 2020 financial year and with cash costs of under US$1,000 per oz. It aims to replace the high-cost Gold currently produced at Evander through remnant underground mining and vamping.
Egoli is an expensive proposition and so it's exploring funding options and looks at making a final decision in 2020. But it offers the potential of three million ounces of Gold - measured, indicated and inferred. And, more importantly from an investment perspective, proved and probable reserves of some 880,000 oz of God.
Board Remuneration - Probably Just About Right
Possibly high by South African standards. However, by international standards, I would suggest that shareholders are getting value for money. The two highest-paid Directors, the CEO and the Finance Director, received remuneration totalling US$692,400 and US$572,600 in 2019. However, both these packages contain incentive payments of US$299,500 and US$260,700. And both have three-year contracts ending February 2021. But, more importantly, they have delivered on the company's turnaround. As regards the substantial options granted to those Directors on 1st July 2018. With hindsight, the strike price seems too low at ZAR1.21 per share. However, the subsequent rise in the value of the company's stock is almost entirely down to delivery on its plans against a backdrop of a strong Gold price.
Lack Of Interest Impacts Stock Price
From an investment perspective, both South Africa and Gold have been out of fashion in recent years. And so, unsurprisingly, the company has also been out of vogue for some time. This is reflected in the volume of stock traded both in London and Johannesburg - this has fallen from ￡64.3 million (ZAR1,266.7 million) in 2015 to just ￡19.65 million (ZAR680.9 million) in 2019. Easy to forget but some of this is chicken and egg. The company was relegated from the MSCI Global Small Cap Index in May 2018. On current form, I would suggest that it's quite likely to re-enter. Should that happen then the stock will probably be picked up by Index-tracking funds. Simply being a constituent in the Index opens it up to a wider investing audience.
Not All Plain Sailing
As the company clearly states, there are risks inherent in its operation: the dependability of electricity supplies, illegal mining and regulatory change seem the most obvious. And, of course, the backdrop is the price of Gold. Unfortunately, these are to a large extent outside its control.
If we take electricity supplies. The company is dependent on the performance of ESKOM, a company with deep financial and managerial issues. In response to power cuts and hikes in power prices (Electricity makes up some 12% of its costs of production and its cost increased by 77.7% to US$18.3 million over the previous year), Pan African is now exploring the possibility of using solar power at its Elikhulu plant. But this is plainly a long-term proposition.
As for illegal mining, this appears to be a major issue at its Barberton mine. And the scale of the problem seems substantial. For the financial period ending 30th June 2019, some 2,500 people were arrested for theft at the Barberton site and around 400 at Evander. The proximity of the Barberton mine to the local community, the mine's geology, migration from neighbouring countries and high levels of unemployment seem to be conspiring to create a substantial problem. Over the period, the company lost no time to legal industrial action but 20 days production was lost "Following community unrest" (2018: 58 days). Worryingly, this appears to have a political dimension and it's not clear how it will be resolved. That said, it's reacting to the situation and has increased its spending on security. However, it should also be borne in mind that illegal mining and community unrest is an international problem in the resource sector. In this respect, Pan African is facing the same issue as many other miners globally.
The company can lobby against what it believes to be retrograde regulatory steps. But, as with the above, much is outside its control. It describes the Mining Charter III as offering "Problematic and ambiguous provisions". But it's not clear what the company can do to prevent what might be regarded as detrimental measures against the mining industry.
At an operational level, it's facing rising costs. At the same time, roughly one-third of those costs relate to pay and the company has agreed to a three-year pay deal that has been factored into its costings.
A Well Managed Business With Scope To Grow
Regardless of where the Gold price is heading, this appears to be a well-managed company that has delivered in extremely difficult circumstances. Interestingly, buried in the company's recent annual report is a throwaway line that seems to sum up its situation. According to its own calculations, should the price of Gold really slump (US$1,190 per oz was the figure suggested) at an exchange rate of ZAR14.19:US$ and there was a fall in production (No figure given) the company could still meet its financial obligations for the next 12 months and even conform with its banking covenants. So, even in a dire straits scenario, it can get through the next year. As I have mentioned before, the company may be regarded as fortunate in being run by an accountant rather than a geologist. And something that some investors do not seem to have picked up on. The CEO has had a reasonably close business relationship with Cyril Ramaphosa, South Africa's President, via Shanduka Resources. What this means in practice is difficult to tell but I would suggest that it's definitely a plus for a business that is closely entwined in South Africa's economy.
To the above, I would add an important proviso. To some extent, time is on the company's side. At least in the timeframe required to pay down its debt. It has delivered on its restructuring and now requires no major hiccups for say the next two years. Providing South Africa does not collapse into anarchy (In which case the Rand price of Gold will probably skyrocket) or Central Banks opt wholesale to divest their Gold reserves, the company seems set fair to become a debt-free, highly cash generative dividend payer within a reasonable time period. And its production profile is very different from what it was just two years ago with the move towards low-cost and safe output with a far greater weighting towards the overground and that means more predictable output. And although its mineral resource base has increased by 8% to 335.8 million tonnes with a Gold content of 3.33g/t, it has many development options available to it within its current licences. Sure, it's based in South Africa and comes with inherent risk. But it's essentially four separate cash-generating units (Two overground and two underground) at two geographically separate sites. This, in my opinion, does tend to mitigate the risk. There's also the real prospect of a fifth cash-generating unit, should the Egoli project go forward.
Looking further out, an African acquisition could significantly de-risk the business. However, it has stated that all potential investments need to meet its 15%+ return on equity hurdle. In the meantime, it still has the potential to substantially grow its established assets, pay down its debt and increase its dividends.
Most recent research:
February 25th 2019