Sylvania Platinum — Massive free cash flows post-spike in PGM prices

SLP is a PGM producer with six chrome beneficiation and PGM processing plants in the Bushveld Igneous Complex in SA. Unlike miners, the core business of SLP is the retreatment of PGM-bearing chrome tailings material at its six plants, although the group also holds mining rights for several PGM projects and a chrome prospect on the Northern Limb of the Bushveld Igneous Complex in SA. The chrome tailings material is sourced from chromite tailings, dumps and some run-of-mine (ROM) ore from chromite producers, in particular Samancor, which is one of the major chrome and ferrochrome producers globally. These are life of mine contracts with Samancor.

Our valuation of the productive assets of SLP is 163p/share to which we add E&E assets valued at 12p/share.

We value the productive operations using a dividend discount model (DDM) method, which we compare to the result using a discounted cash flow (DCF) method, both using a discount rate of 10%, which is our normal approach for a mining company. Our base value for the producing assets is 163p/share based on a discounted dividend stream. Given the low operational risk nature of the company (being a retreatment operation of already-mined tailings material), the key sensitivities relate to the discount rate use, PGM prices (in particular rhodium) and production costs. We note that, because the company predominantly recycles mine dumps, it does not disclose a formal resource estimate, which creates some uncertainty around sustainable production.

We take a conservative approach to forecast dividends to 2024 by allowing the low c 15% payout ratio to continue and not allowing for any windfall dividends (which are a distinct possibility). The company’s dividend policy is based on six key metrics including financial and pricing elements. In our forecast we assume at least nominal growth in dividends per share. From 2025 onwards, we allow for 100% of free cash flow to be distributed as dividends, which our modelling shows is well supported. Anything short of this would lead to an unreasonable build-up of cash position, which we do not consider likely. Our DDM valuation is very close to our DCF figure as a result of this approach.

We include SLP’s E&E assets (ie its other PGM assets and the Grasvally chrome prospect) at their year end-June 2021 balance sheet value of 12p/share which, if added to our core producing assets valuation of 163p/share, brings us to a total valuation to 175p/share. We have also examined the upside to this by applying an analysis using a resource-based method, which we calculate could lift the E&E valuation from 12p/share to 34p/share with a resultant 12.5% impact on the overall valuation.

FY21 was an exceptionally strong year, driven by an upsurge in PGM prices and rhodium in particular. This, combined with a low cost base, propelled FY21 revenues, gross margin and EBITDA to $206m, 69% and $145m respectively, strongly up from FY20. Over the four years from FY18 to FY21 revenues have almost quadrupled. We forecast a moderation in FY22 with the reduction in PGM prices, which has already been demonstrated in the Q122 results, affecting revenue and net profit. Our FY22 forecasts allow for production challenges in Q122 to be addressed and for PGM prices to continue recovering after the dip in September 2021, accelerating towards the end of FY22. This results in a forecast gross margin of 61% for FY22. Cash flow generation remains three times higher than it was in 2018; we forecast average net annual cash flows of c $53m over FY22 to FY24 (average operating cash flows of c $82m), building on the end-June 2021 cash balance (no debt) of $106m, which had increased to $132.7m by end September 2021.

SLP treats existing dumps from chrome mines on the Middle Group (MG) reefs of the Bushveld Igneous Complex (MG 1 to 4 reefs) and the Lower Group 6 reef, (LG6). This source of dump material is termed ‘current arisings’, which it processes on behalf of Samancor, a large SA chrome producer whose tailings from the chrome recovery process contain PGMs that SLP recovers in exchange for returning recovered chromite to Samancor. Current arisings will continue for as long as Samancor remains in operation; this is likely to be many decades, given Samancor is one of the largest chrome product producers in the world and the enormous remaining resources in the Bushveld Igneous Complex.

The main sensitivities to our valuation are the potential loss of current arisings and the prices of the PGMs that SLP recovers. We calculate that a loss of current arisings would result in a 43% fall in our valuation to 93p/share (105p/share with E&E assets), very similar to the current share price. This suggests the share price may be discounting any potential loss of current arisings, a situation which we consider unlikely because all contracts with Samancor are life of mine contracts, that is, SLP is entitled to the tailings as long as Samancor continues to mine. SLP’s basket of metals comprises 63.8% platinum, 23.4% palladium, 12.5% rhodium and 0.3% gold. A cyclical PGM price downturn is the main concern, which we anticipate in the latter part of this decade for palladium and rhodium. A 10% shift in all PGM prices can swing the valuation of SLP by 15%.

Rhodium dominates the basket with 60% of the revenue coming from this metal and is an important factor in the valuation of SLP as shown in the metal split (Exhibit 2) and the revenue from each metal (Exhibit 8). Rhodium demand has risen enormously over the last three years because it is the best metal to treat nitrous oxide emissions from gasoline engines. New emissions levels requirements in the form of Euro 6 and China 6 legislation have seen a seven-fold increase in the loadings of this metal in autocatalytic converters. As this market is only for c.1Moz per year (compared to the 8Moz per year for platinum and 12Moz a year for palladium), the demand spike caused a massive deficit, which resulted in prices spiking at $29,800/oz in April this year. The worldwide computer chip shortage led to a surplus of rhodium appearing in the market. We think the chip problem will be solved in mid-2022, that car demand is exceedingly strong and that rhodium prices will rebound from the current $14,000 level to around $15,000/oz in 2022 and staying at more or less that level until 2030. Note, this is still 15 times higher than the price was before 2019 and will have a significant effect on the revenue of SLP for the foreseeable future. A 10% lower Rhodium price shaves 9.5% off our valuation.

A stronger SA rand versus the US dollar could crimp margins (we assume constant currency in our base-case forecast and valuation). The valuation is also sensitive to the grade of its tailings dumps and the current arisings. A 10% change in the forecast grade changes SLP’s value by 15%. Other sensitivities to consider include tonnage milled and cash cost during this milling, with a 10% change in each affecting the company’s valuation by 11% and 4% respectively.

SLP is a producer of PGMs including platinum, palladium and rhodium. Unlike miners, SLP’s core business is the retreatment of PGM-bearing chrome tailings material from chromite tailings, current arisings, dumps and some ore supplied from underground mines, called ROM ore, from chromite producers, in particular Samancor, which is one of the major chrome and ferrochrome producers in the world. Samancor also transfers its tailings, the residue left after the removal of chromite, to SLP, which recovers PGMs left and returns any additional chromite recovered in the process to Samancor. The current arisings from Samancor are distinct from the other sources of ore such as pre-existing dumps acquired by SLP, or in some cases, ore supplied from underground, termed ROM ore. The latter ore is crushed and milled and the chromite is removed by SLP and is returned to Samancor at marginal cost. After the chromite has been removed from the ROM material, SLP recovers the PGMs. Historically, chrome miners never recovered PGMs from chrome tails and hence Sylvania commercially acquired the right to PGMs when it identified the opportunity in 2006. SLP has six plants, most of them right alongside Samancor’s plants and mines, to process the ore, some of which have crushers and mills to treat ROM ore.

Samancor mines at a steady state level of 4–5m tonnes a year of chromite from the MG chromite seams (which have four chromite seams in total) and the LG chromite seams (which have six chromite seams) of the Bushveld Igneous Complex. The MGs and the LGs contain PGM that SLP is entitled to extract from these so-called current arisings, which are the tailings of Samancor’s chromite recovery plants. Chromite recovery is around 65–70%, the remaining tailings of which are then immediately treated by SLP as they come out of the Samancor plants (which are alongside SLP plants). SLP treats roughly 0.5m tonnes of these arisings and around 0.5m ROM tons a year, or roughly half of its total milled annual tonnage, and is highly likely to continue to do so for the foreseeable future. The Bushveld Complex has vast reserves of chromite and PGM in the MGs and LGs and we estimate Samancor has at least 30 years of reserves and resources left on these seams alone. SLP has provided three years of guidance with tonnage estimates of current arisings from Samancor mines and we have forecast production to 2040. Given the longstanding synergistic relationship and infrastructure at Samancor's operations, SLP is confident that Samancor would be supportive of SLP adding more capacity to its current operations. The group also holds mining rights for several PGM projects and a chrome prospect on the Northern Limb of the Bushveld Igneous Complex in SA, shown in Exhibit 1.

SLP produces around 70,000 ounces of PGM per year with the product mix of metals it mines in its basket of metals called the ‘prill split’ shown in Exhibit 2.

SLP’s strategic aims as a leading mid-tier, low unit cost, PGM mining company include:

Chairman Stuart Murray is a veteran of the platinum industry in SA having worked at Implats as consulting engineer, with responsibility for new business and M&A. He then served as CEO of Aquarius Platinum, a junior platinum miner that was bought by Sibanye Stillwater in January 2016. He is chairman of Imritec, an aluminium recycler, and a former board member of Talvivaara Mining Company.

CEO Jaco Prinsloo was appointed in March 2020 after serving in senior positions at SLP since 2012. Before this, he was a metallurgist at Anglo American and Anglo American Platinum in various senior positions. He has a wealth of experience in the operational and technical aspects of precious and base metals metallurgy. We observe the depth of experience and expertise in SLP’s Management, with many of the operations managers and metallurgists having been employed by Anglo American Platinum in the recent past.

CFO Lewanne Carminati joined Sylvania in 2009 and in 2011 was appointed executive officer of finance for SA operations. She is a qualified chartered accountant and has substantial experience in aspects of financial management at a senior level, with a particular focus on compliance, governance and financial reporting, and has taken leadership roles in corporate finance transactions.

SLP’s sustainability report focuses on stakeholder engagement, safety and health (the company remains fatality free since inception), employees and communities and the environment. Its environmentally friendly approach is aligned to, and dependent on, the policies of the host mines where they operate. Energy and water consumption is actively managed and efficiencies have been achieved over recent years. We note the materials produced by SLP are used in reducing global emissions from motor vehicles fitted with catalytic converters, which are used on virtually every vehicle on the planet (of which there are currently 1.4 billion according to Wards, an automotive research company).

From the social aspect, in SA, Black Economic Empowerment (BEE) is a prerequisite for mining companies where historically disadvantaged persons are allocated a certain percentage of the company. A recent Pretoria High Court ruling has established that if a mining company was once empowered, it will always have been empowered. SLP had BEE partners who have since sold their shares. However, it is not a requirement for surface dump operator such as Sylvania Dump Operations (SDO) to have any BEE as it is Samancor who holds the PGM mining rights and SLP becomes the owner through a commercial arrangement. In terms of SDO’s exploration projects, at Volspruit, Grasvally and the Aurora project, each company has a BEE shareholding in place for the respective individual projects.

Sylvania produces around 70Koz per year, roughly 0.5% of the annual global production of platinum, palladium and rhodium. The largest producer is Anglo Platinum at around 5Moz/year 4E, followed by Norilsk (the large Russian producer) at near 4Moz and Implats at around 2.5Moz/yr.

Around 90% of global palladium and rhodium demand and 36% of platinum demand is used in auto catalyst emissions control. After two years of steep price rises in all six PGMs, 2021 saw a sharp correction mainly because of the global computer chip shortage and the resulting drop in production and sales of motor vehicles. From the 96m vehicles produced a year in 2019, we estimate that only 80m will be sold in 2021, of which 75% are gasoline powered. Gasoline cars use only palladium (4.2 grams per autocatalytic converter) and rhodium (0.7 grams); hence, these metals will be most affected by the lack of demand. Platinum, iridium and ruthenium are needed to produce hydrogen, which will be increasingly used as global carbon emission strategies are implemented. Platinum has other uses due to its catalytic properties in the chemical, petroleum, electrical, bio-medical and investment sectors and is largely protected from the problems in the auto sector. By mid-2022 we expect the current chip supply problems to be overcome and see moderate demand for palladium and rhodium until around 2025, when we expect battery electric vehicles (BEVs) to take significant market share away from gasoline-powered vehicles. We forecast BEVs having 20% market share by 2025 and 50% share by 2030. As a result, we expect palladium and rhodium demand to decline rapidly as they are the two metals that are used almost exclusively in gasoline engines. Our long-term price forecasts are for palladium at $1,500/oz and rhodium in a range of $15,000/oz to $16,000/oz.

Taking these dynamics into account, our price forecasts for the PGMs are shown in Exhibits 3 and 4. Recent movements in PGM prices have seen the rhodium price falling from a spike of just under $30,000/oz in April 2021 to $11,250/oz in mid-September but recovering to around $14,000/oz recently. Palladium has fallen from near $3,000/oz to under $2,000/oz. Platinum has held up as it is not that exposed to the production of vehicles. The reasons for the price declines are the worldwide computer chip shortage, which is constraining vehicle production and excess supply from producers despite falling prices. This is because revenues for SA producers are around US$2,587/oz for their basket price of PGM, while all-in sustaining costs are US$989/oz, a margin averaging 62% (Edison/ALG Research). With this margin, earnings and dividends are still at historically high levels and there is little incentive for the producers to cut back.

PGM prices may need to fall another $1,000/oz before mine closures are forced on the producers. We think there is very little chance of this happening because of the pent-up demand for motor vehicles due to chip shortages, which could turn into a surplus by the first half of 2022. When this occurs, demand for PGMs will likely surge and prices will rebound strongly. Continually tightening tailpipe emissions legislation have resulted in emissions legislation right around the world imposing set amounts of gasses allowed to be emitted in stages. Currently, Europe and China are at level 6 and the US at tier 3, is at a broadly equivalent level. These three regions are the biggest in terms of car sales and are therefore important to recognise in any demand projections that are made. In China and Europe, the next stage is set for 2024 for China 7 and Euro 7 followed by China 8 and Euro 8 by 2028. Every four years, governments set tighter emission standards. Johnson Matthey has published in its forecasts of emission standards that China 7 and Euro 7 will be implemented in 2024 and we think this trend will continue in future.

The move to an emissions-free hydrogen economy, in which demand for platinum, iridium and ruthenium will play a significant part, will support these PGM prices at much higher levels in the future than was historically the case. Palladium traded mostly around $500/oz, rhodium around $1,000/oz and platinum $1,000/oz in the last 20 years. The surge in prices over the last two years has been propelled by tighter global emission standards from compliance with Euro 6 and China 6, which both stipulated a seven-fold increase in the loading of rhodium and a 50% increase in palladium loadings for a gasoline car. Gasoline cars represent around 70% of all vehicles sold. This increase in loadings resulted in the historic spike seen when rhodium reached $29,800/oz and palladium $3,000/oz in April 2021. The 2021 computer chip shortage caused a correction, which we see lasting well into 2022. However, there is substantial pent-up demand for cars and prices are likely to rebound somewhat. Despite this outlook, we are conservative in our forecasts and have used lower prices.

Rhodium is especially important to the future revenue stream of SLP, as it contributes 60% of revenue at current and forecast prices. We forecast rhodium prices in the range of $15,000 to $16,000/oz out to 2030 (Exhibit 4), much higher than the price before 2019. We keep our forecasts at this level because emissions legislation has seen a seven-fold increase in loadings to 0.7 grams per catalyst as mentioned above, and we see a further increase with China/Euro 7 to over 1.0 grams per catalyst. However, post-2026, we see electric vehicles taking market share mainly from gasoline vehicles and we then see demand for rhodium declining. Rhodium is a very thin market (only 1Moz versus 8Moz for platinum and 12Moz for palladium) and it is very sensitive to demand, or lack thereof. With the current chip shortage, a large deficit turned very quickly into a surplus that we think will reverse very quickly when chips again become available in mid-2022. As mentioned previously, car demand is extraordinarily strong and when the turn in demand for rhodium comes, it will, in our view, likely rebound to above $20,000/oz quite quickly. We have, however, conservatively forecast prices of around $15,000/oz to $16,000/oz until 2030.

Chromite is used in the production of ferrochrome, which in turn is used in the production of stainless steel. The outlook for chromite is therefore linked to that of stainless steel. China is one of the main customers of SA chromite and ferrochrome and hence demand depends on the outlook for that economy, which we expect to return to pre-pandemic levels with GDPs of around 6% a year.

Global chromite demand is around 30 million tonnes a year, with supply coming from SA (60%) and the balance from third world countries. More than 90% of demand is from metallurgical industries (production of ferrochrome), the rest of demand being from chemical, foundry sands and refractory industries. We estimate that chromite market deficits of around 6% of demand in 2018 and 2019 became surpluses of around 6% in 2020 and so far in 2021 as demand has reduced to an estimated 26.5 million tonnes due to COVID-19 shutdowns of stainless-steel plants. As a result, chromite prices, which averaged $169.93/tonne in 2018, fell to an average of $130.33/tonne in 2020, and have recovered to average $156.49/tonne to end September 2021. We consider it likely, barring any unusual events, that a chromite price of $155/tonne can be sustained, given demand from China should be driven by continued economic growth.

Half of SLP’s c 2.5m tonnes milled is from historical dump tailings, while the other half comprises a combination of chromite tailings (current arisings) plus ROM fines (roughly 50% of each source). SLP does not publish the resources of its existing tailings. However, according to Samancor’s currently approved mining rights, most operations where SLP currently operates have a 30-year term from the date of the initial grant of the mining right, up to 2040, whereafter Samancor will need to apply for renewal according to the normal Mineral and Petroleum Resources Development Act (MPRDA) requirement. SLP removes the chromite from its ROM ore and returns it to Samancor at marginal cost. The tailings from the ROM ore are then fed into SLP’s own PGM recovery plants, from which SLP has the right to the PGM recovered.

In our view, the company has sufficient ore/tailings sources to justify DCF forecasts for a 20-year life, conservatively. From 2033 onwards, SLP will be running off current arisings only (source: SLP management) when tonnage treated will reduce by approximately half, but recoveries will increase as current arisings are not oxidised compared to old dumps, which have been subjected to rain and humidity for many years and have relatively low recoveries for their PGMs. The risks associated with the fact that SLP does not publish a resource statement, for reasons we have explained above, are therefore only moderate in our view.

Our valuation of SLP is significantly higher than its current share price, despite forecast declines in PGM prices from the 2021 highs; gross margins are forecast above 60% and we forecast significant sustained cash generation.

We use a constant-currency DDM method to value mining shares at a 10% real discount rate. This is a method used by mining companies to assess the viability of a project. For a new project, mining companies require a 15–20% internal rate of return. Analysts typically use a weighted average cost of capital rate of return for an operating mine, which in reality is usually below 10%. We apply a 10% rate for a measure of conservatism to arrive at a value for the productive part of SLP. Our constant currency forecasts are in US dollars and produce a US$-based valuation. We convert our US$ denominated forecasts and valuation at spot rates to determine our forecasts and valuation in GBP. Our DDM methodology supports a valuation of $608m (163p per share).

The NPV of the dividends going forward to 2040 is shown in Exhibit 6.

Below we lay out our key assumptions underlying our valuation. These include tonnage milled, PGM pricing, capex and margins (revenue relative to cost). Retained access to current arisings is also considered.

SLP has a steady, highly predictable dump retreatment schedule that has been well planned and for which grades of the contained PGM and their different proportions in each dump and source material are well established. Our base case schedules of tonnages, grades, costs and capex from FY21e to FY35e are shown in Exhibits 7 to 9.

SLP has sufficient tailings material to mill at a rate of 2.5m tonnes a year until almost 2030. It is highly likely it will add further material to its portfolio to be scheduled for treatment over the next 10 years as this is an ongoing strategy of the company. Should it not be able to access more material, a combination of ROM and current arisings will suffice for a production rate of c 1.0–1.2m tonnes a year. We think the possibility of SLP not being able to access ore is highly unlikely as PGM and chromite mines have been in operation in SA since the 1960s and although many of these dumps have been processed, there remains ample scope for acquiring new dumps as we were shown during the site visit on 8 and 9 September.

PGM plant feed remains steady to FY29, after which the grade improves as a higher ratio of current arisings from Samancor are treated. The reason for this is that tailings dumps have a degree of oxidation, which depresses recoveries. When Samancor’s current arisings are processed, the very fresh nature of this material allows higher recoveries, hence the grade uptick.

Rhodium was and is still the biggest contributor to revenue at around 60%, as shown in Exhibit 8 and is likely to be at this level in future. This is because its prill split at 12.5% of total metal content (Exhibit 2) multiplied by the high rhodium prices results in the massive contribution of rhodium to revenue given our price forecasts shown in Exhibit 4. Palladium and platinum contribute around 20% to revenue to SLP’s revenue.

Limited project capex is being spent on the two exploration properties that SLP has in the northern part of the Bushveld Igneous Complex. The limited E&E capex forecast by the company is offset in our modelling by us not converting any of the E&E spend into production. This is because the decision whether to proceed with a mine or to sell the project is unlikely to be made before FY23. For example, the Volspruit project that SLP has near Mokopane may be sold. There is therefore little project capex likely after FY23, especially if the Aurora project is also sold. The Volspruit and Northern Limb (Aurora) mining projects will most likely be open cast operations, rather than underground. It is only the most northern deposit (at a property called Hacra) that is an underground deposit adjacent to the Waterberg PGM project. SLP’s expertise lies in dump retreatment operations and we consider it unlikely that SLP will want to engage in higher-cost underground mining with all the attendant risks regarding safety, high labour complements and high capital intensity.

Sustaining capex is ongoing as it is used to construct new tailings dams or install a second set of flotation cells in the plants that only have one set. This improves recoveries and the dump material treated by the single float cell plants may then be reprocessed to extract further PGMs. Project capex includes the roll-out of MF2 plants to Lesedi and Tweefontein during FY23 and future potential new dump acquisitions. We do not include the latter, nor any consequent additional ounces in our forecasts.

The gross margin trend for the business is shown in Exhibit 10. The gross margin was 69% for FY21 overall, but came under some pressure in Q122, dipping to 50% due to lower basket prices. Prices have subsequently recovered and we are forecasting gross margins of around 61% in FY22, allowing for a more conservative outlook after the recent dip.

The company’s exploration assets (the Aurora Project on the northern limb of the Bushveld Igneous Complex, the Volspruit project and Grasvally projects in the south of the northern limb). They are valued in SLP’s end June 2021 balance sheet at 12p/share. We have also valued the exploration assets using the resource-based method. We note that in SA, PGM producers are valued on a market capitalisation per ounce basis of between US$34.25/oz for Implats, the highest, down to US$8.35/oz for Northam, the lowest, for their resources.

In our assessment, we have used the lower value (US$8.35/oz) and applied it to the resources of SLP’s exploration projects as provided by the company. Using these measured, indicated and inferred resources, we arrive at a value of £0.34 per share for these assets. There is therefore a potential £0.22 upside to the carrying value of the E&E assets in the end June 2021 balance sheet. The workings are shown in Exhibit 11.

SLP had an industry-leading cash margin of 80% for Q421, by far the highest PGM production of 148oz 4E (platinum, palladium, rhodium and gold) per employee per year, the lowest cash cost at US$755/oz and the highest basket price at US$3,690/oz compared to its peers, as shown in Exhibit 12. This position has moderated in Q122 due to lower production (temporary suspension at Lesedi as new Lesedi tailings dump being commissioned) and PGM prices (29% lower vs Q421), pushing the margin to below 70%, which is still high relative to peers.

SLP has the highest rhodium content in its ore of any producer in the world, hence the high basket price it receives. It has a very low number of employees relative to the 4E PGM ounces it produces; at 116oz 4E PGM per employee per year, is significantly above its peers in this measure.

Note that our selection in Exhibit 12 excludes Jubilee Metals Group (JLP), which is often compared to Sylvania; While JLP also processes chromite and PGM dumps in South Africa, it also treats copper ROM and dumps in Zambia. Given this, we do not view JLP as a pure PGM play. In addition, JLP does not provide sufficient financial detail to facilitate direct comparison.

The greatest sensitivity of SLP would be the potential loss of current arisings from Samancor, either through cessation of production at Samancor or curtailing of the contract with SLP, both of which we consider unlikely, especially in light of the good relationship between the two parties. Nonetheless, should either of these circumstances occur, the value of the share declines by 43% from our base case value of 163p/share down to 93p/share (105p/share including E&E assets). This suggests that the current share price may be discounting zero current arisings from 2033 onwards.

Another important sensitivity is PGM prices. If they fall by 10% or 20%, the value of SLP falls by 15% and 31%. Rhodium on its own is the biggest contributor to SLP revenue. Should rhodium prices fall by 10%, 20% and 30%, the value of SLP would fall 9%, 19% and 28% respectively.

A key sensitivity for SLP is a change in the discount rate with a 1% and 2% increase, reducing valuation by 11.5% and 21% respectively. A lower discount rate increases value, but by more.

Grade sensitivity is very similar to PGM price sensitivity (especially to that of rhodium prices, which account for 60% of revenue), as would be expected because they both affect revenue. Other sensitivities are milling rate (11% valuation decline with a 10% fall) followed by the unit cash cost (4.0%), ZAR/US$ exchange rate (3.0%) and capex (0.5%). This is because of the very high gross margins of SLP and the 60%+ margins we forecast in the long term. Our base case valuation at 10% (real) discount rate of dividend flow to 2040 is 163p/share.

If SLP loses its ore feed from Samancor (termed ‘current arisings’) when it runs out of dumps and ROM material in the first half of the next decade, we have conducted a sensitivity analysis to examine the impact of this. The resulting 43% drop in value would be severe, although it is unlikely it will happen.

The valuation is sensitive to PGM prices with gearing of 1.6x (similar to that of its sensitivity to grade). Again, the PGM prices are a flag for the investor to watch for.

The sensitivity is high to any change in the discount rate. A 10% discount rate for a surface operation with low mining and labour risk even if domiciled in SA, is conservative in our opinion.

As rhodium accounts for around 12% of the metal basket but has a spot price of around USD13,300/oz, the sensitivity is not as pronounced as it would have been when rhodium’s price was close to USD30,000/oz (currently around $14,000/oz). Nevertheless, the gearing this metal has on the value of SLP is important and the fact that it represents around 60% of revenues, makes this an important factor in assessing the sensitivity of SLP’s valuation to the price of this metal.

The share is moderately geared to a change in the grade. This means investors should watch for a fall in grade.

The change in value is in line with the change in the milling rate with a similar gearing ratio, namely a 10% change in the milling rate leads to an 11% change in its value, hence a 1.1 gearing ratio.

As a result of the high margin of the business, the gearing of the share value to a 10% cost increase is only a 5% fall. This shows investors the share price is not very sensitive to rises in costs, which is a common feature of SA mines due to annual wage increases given to labour that account for most of the costs for an underground mine, a feature SLP avoids due to it having only surface operations.

The share is quite insensitive to changes in the rand versus the US dollar exchange rate, potentially reflecting the high margins of the business. Low margins result in very high sensitivities to valuation, but high margins much less so. Low margin miners like Harmony Gold company, for example, react almost perfectly in line with the ZAR/USD exchange rate, but a high margin mine like Anglo Platinum does not.

Our forecasts include very limited project capex. Consequently, our valuation displays little sensitivity to, say, a 10% change in capex.

Our forecast financials are shown in Exhibit 22.

FY21 results were unusually strong, as previously discussed, mainly due to the exceptional upsurge in PGM prices, roughly 30% higher on average in FY21 compared to the year before. As PGM prices have subsided, we see results normalising in FY22, but above the lower level of basket prices reported for Q122, which have recovered in October. Our forecast PGM prices for FY22 are 7.5% up on Q122 prices, which is largely in line with current levels and may prove to be conservative if the current computer chip shortage is resolved over the remainder of the financial year. SLP has guided to full production for the year at 70Koz despite a production decrease of 5% in Q122.

Revenue in Q122 of US$29.3m was down from US$44.1m in Q421 due to production and lower PGM basket prices, but exacerbated by the sales adjustment (lower prices received than stated in Q421). We forecast FY22 revenues of US$177m, driven by increased production, a recovery in the basket price and the reversal of sales adjustment.

In the medium term, we expect revenue declines as historical tailings dump revenue falls and the company becomes more dependent on current arisings and ROM sources. However, given the yields are higher on current arisings and ROM than on historical tailings dump, the rate of decline is less than the forecast reduction in tonnage.

We forecast gross margins declining from 69% to 61% (Exhibit 10) and flattening out at a normalised 60% from FY23 onwards. We expect margins towards the upper end of the peer group range of 60–70% (Exhibit 12), although we expect these to moderate for the whole group, given that PGM prices have subsided from the spring 2021 peaks.

Cost increases in FY21 were high, due to a significant increase in mineral royalties taxes, higher re-mining costs and higher consumables costs associated with increased treatment of oxidised tailings. Q122 results showed a 4% reduction in operating costs, with cash costs/oz also reducing despite a 4% decline in production of 4E PGMs, a commendable performance. We expect slightly higher costs in FY22, allowing for wage increases ahead of SA inflation.

There was also a positive impact from lower depreciation in FY21 as the write-off period was changed from 20 to 30 years. Royalties have also grown with the rise in revenue. The formula royalty of 7% on PGM revenue (a government charge on all mines in South Africa) results in a 5% royalty on total revenue. Higher tax rates and payments in FY21 resulting from the higher revenues also affects earnings. As a result of the lower forecast profits in FY22 and lower dividend withholding tax, we forecast lower tax payments in FY22.

After a very strong profit performance in FY21, net profit for Q122 of US$8.6m was reported to be down on Q421 (US$14.7m) due to revenue pressure, but this is set to recover to our forecast level of US$75m for the full year, on the back of a production increase and basket price increase-driven revenue recovery.

There is an impact of exchange rates on earnings, balance sheet and cash flow. Revenue is US$ driven, costs are in rand, PPE is largely rand denominated, E&E is largely US$ denominated and cash is c 50:50 split between ZAR and US$. We use a constant currency approach to forecast our financials, adjusting for large changes in the spot rates early October. We are therefore not allowing for any potential positive impact of ZAR depreciation on US$ costs.

We forecast continued high cash generation (net cash flow averaging c US$53m over FY22e to FY24e, shown in Exhibit 22). This assumes ongoing low capex requirements, leaving scope for most of the free cash flow being available to be paid out as dividends, including further potential windfall dividends (not assumed in our forecast). SLP has enough cash to fund the FY22 dividend at its current level without any ZAR transfers from the SA operation. However, in our view it will likely target a 50:50 ZAR:US$ cash position.

Based on a set of six key metrics, the company’s dividend policy implies that the normal dividend per share will be able to grow in nominal terms, with no explicit targets around the payout ratio. To avoid excessive balance sheet cash build-up inefficiency, we expect SLP’s payout ratio to steadily increase from the FY21 level of 15% to reach a much higher level between FY25 and FY30 (theoretically up to 100%). We expect the windfall dividend to be more common after FY23, being an important mechanism to drive a higher combined payout ratio. For our valuation purposes, we have forecast 100% of cashflows to be distributed from FY25.

The balance sheet is healthy with net cash at end June 2021 of US$106m. The end September Q122 cash balance increased strongly to US$132.7m, but benefited from working capital movements resulting from the lower PGM basket price. Our FY22 forecast allows for strong cash flow delivery over the rest of the year, offset by a partial reversal from the Q122 working capital contraction. The strongly cash-generative nature of the business is reflected in our forecast for cash to build at a material rate to US$199m by FY23 and US$255m in FY24. We forecast zero borrowings during this time.

The cash strong balance sheet that could easily fund higher dividends, E&E or even select corporate action (for example buying more dumps to extend its pipeline).