Pan African Resources — Building steam

On 6 November 2020, Pan African announced it had entered into a conditional agreement with the liquidator of the Mintails group for the purchase of the total share capital and associated loans of Mogale Gold and Mintails SA Soweto Cluster (MSC), comprising a number of tailings storage facilities (TSFs) to the west of Johannesburg, for ZAR50.0m (US$3.0m at prevailing forex rates) and the assumption of a closure environmental liability of c ZAR120m. Since then, Pan African has successfully concluded both a fatal flaw analysis and a high-level financial evaluation of the project (which is similar in nature to Pan African’s flagship Elikhulu project at Evander). In July 2021, it subsequently completed a pre-feasibility study (PFS) on the Mogale Gold assets. On 30 June 2022, it announced that it had successfully completed a DFS on the same assets. Highlights of the DFS were as follows:

The operation would use a combination of proven low-cost hydro-mining coupled with a 0.8Mtpm carbon-in-leach (CIL) plant, similar in principle to that used at Elikhulu, albeit slightly smaller (cf Elikhulu’s 1.2Mptm throughput rate, for example). In general, the results of the DFS were similar to, or slightly better than, those of its prior PFS (see below):

PAF’s due diligence on the project has been extended to 31 August. Assuming no impediments and that the project is sanctioned in September, PAF would hope to bring the Mogale TSFs into production 18–24 months from the start of construction between July and December 2024. Addition of Mintails’ wider Soweto Cluster of resources into the project also has the potential to extend the life of the operation from 13 years to 21 years and further increase annual gold production.

On 6 November 2020, PAF announced that it was to acquire 100% of Mogale Gold and MSC from the liquidator of the Mintails group for ZAR50.0m (then US$3.2m, now US$3.0m) and the assumption of a closure environmental liability of c ZAR120m. The deadline for fulfilment of the conditions to conclude the transaction (originally six to nine months) was later extended to August 2022 and included the completion of a fatal flaw analysis, PFS and DFS (compiled by DRA).

In addition to the technical outcome of the DFS, the due diligence process has also sought to update Mintails and Mogale’s 7 February 2013 mineral resource declaration, to which end the following work was completed:

Combined drilling totalled 2,761m and resulted in 1,877 samples and 187 control samples and the re-modelling of all available resources as shown below:

While the overall size of the resource was barely changed as a result of the re-modelling, confidence in the resource in terms of its categorisation (ie 95.8% of the Mogale resource being in the indicated category), increased markedly. In the meantime, further technical work is being undertaken on the MSC TSFs.

The Mogale DFS envisages hydro-mining the larger dumps, using hydraulic guns of similar specification to those used at Elikhulu, cutting mine widths of 15m wide and 20m deep. By contrast, the smaller dumps (the North Sands and South Sands dumps) will be mined by load-and-haul techniques. The re-mined tailings will then be processed in an 800–900ktpm CIL plant similar in design to Elikhulu, with the addition of a water treatment section to limit corrosion and potentially improve recoveries.

For the purposes of our analysis of Mogale, we have made the following main (real terms) assumptions regarding throughput, costs, capex etc:

Readers should be aware that the schedule presented in Exhibit 3 does not reflect the full life of operations at Mogale owing to space constraints, but only the first 10 of 13 years.

Tax is assumed to be levied according to the standard mining tax formula in South Africa:
Y = 34 - 170/x, where Y is the tax rate to be determined and x is the ratio of taxable income to the total income (expressed as a percentage). Note that these tailings dumps are largely pre-1 May 2004 dumps and, as such, are exempt from royalties.

Assets are presumed to depreciate in a straight line over the life of operations.

On the basis of the above assumptions, Edison has calculated the following valuation and financial parameters with respect to Mogale:

Note that, although we calculate a negative EPS contribution from Mogale in FY36–38, we also calculate that it will be cash flow positive during this period.

Although Pan African does not currently include MSC mineral resources in the Mogale mine schedule, a conceptual production schedule for this project was applied, based on available information, entailing the processing of reserves of the combined Mogale and MSC TSFs and demonstrated a more robust recovered ounce profile and an extended life of mine for the project in excess of 20 years. The conceptual MSC TSF model increased production by an average of 11koz pa from years six to 13, giving rise to a production profile of an average 54koz pa from year 14 to 20. However, confirmation of the feasibility of including the MSC dumps in the Mogale mine schedule will require further technical studies to be completed and no attempt has therefore been made to model this contingency in this report.

Mintails’ and Mogale’s aggregate resource of 2.36Moz compares favourably to Elikhulu’s original resource of 1.7Moz and its initial reserve of 1.5Moz, albeit at a fractionally higher grade of 0.30g/t (cf Elikhulu’s 0.29g/t).

By way of comparison, Pan African announced the results of an independent DFS on Elikhulu on 5 December 2016, which demonstrated an NPV9 of US$75.9m (or, then, 5.0c/share, or US$40.95 per resource ounce) at a gold price of US$1,180/oz and a forex rate of ZAR14.50/US$. At the time, we estimated Elikhulu to be worth US$69.9m (or 4.6c/share) at a 10% discount rate and to be capable of adding 1.33p to EPS in the first eight years of its operation (albeit there are now 27% more shares in issue). Now, however, with capex having been expended (albeit with not all associated debt having quite been repaid), we estimate a valuation for Elikhulu of c US$145.97 per initial resource ounce or US$213.19 per remaining resource ounce. As such, and with appropriate caveats, Pan African could acquire for US$2.55/oz (for Mogale alone) an asset that should be worth US$9.88/oz as an in-situ resource (see Gold stars and black holes, published in January 2019), could be worth US$53.11/oz (pre-development) and may be worth up to US$171.05 per remaining ounce (see Exhibit 4) or US$94.09 per initial ounce, post-initial capex and debt repayment; that is, it could be worth approximately an additional c 75% of Elikhulu to the company on the basis of the development of only half the resource and with the remaining (MSC) half providing additional valuation optionality (potentially of the same order of magnitude as Mogale) around subsequent development.

Pan African reports that it has received a number of offers from financing institutions and third-party financiers for project funding and expects to finalise a funding package for Mogale later this year. Following in-principle approval by Pan African’s board to further progress the project, the company will commence with the environmental authorisation process and stakeholder engagements. Other critical path timelines are anticipated to be achieved approximately as follows:

As part of the DFS, the Pan African has already conducted extensive engagements with community representatives and other interested organisations from the affected area, including regulatory authorities. This information and the associated Environmental Management Programme Report (EMPR) is being used to compile an action plan to remediate past environmental damage and restore the surface for productive land use, while at the same time investigating effective socio-economic development projects to stimulate the local economy.

PAF will also conduct feasibility studies into the merits of using renewable energy for the new tailings retreatment plant’s energy requirements (as at Elikhulu).

As a result of the inclusion of Mogale’s production profile into our group financial model, whereas we had forecast that group production at Pan African would reach 235.8koz in FY26 previously, we now forecast that it will reach 288.6koz and remain at approximately this level until at least FY30 (with production from Egoli still pending):

In the light of our inclusion of Mogale into the Pan African production profile (as well as revised external factors such as the gold price and forex rates), our absolute value of Pan African (based on its existing four producing assets including the 24 Level and 25 & 26 Level projects and Mogale) has increased by 10.78c (or 31.9%) from 33.79c/share to 44.67c (albeit excluding any contribution from Egoli, which we are valuing separately, for the moment, as a standalone project at 12.64c/share), on the basis of the present value of our estimated maximum potential stream of dividends payable to shareholders over the life of its mining operations (applying a 10% discount rate):

A bridge chart of the evolution in our valuation is as follows:

Notable within the context of the above bridge chart is the material effect of forex on our valuation under the influence of a weak rand and an even weaker sterling versus the US dollar compared with our last note (in particular, the rand-dollar rate has increased by 13.0%, from ZAR14.5595/US$ in April to ZAR16.4531/US$ currently). Including all of its other growth projects and assets as well, our updated total valuation of Pan African as a whole is as follows:

Exhibit 11 below depicts Pan African’s average share price in each of its financial years from FY10 to FY21 and compares this with normalised headline earnings per share (HEPS) in the same year. For FY22 and FY23, the current share price (19.60p) is compared with our forecast normalised HEPS for FY22 to FY23. As is apparent from the graph, Pan African’s price to normalised HEPS ratios of 5.2x and 5.5x for FY22 and FY23, respectively, (based on our forecasts, see Exhibit 15) are very close to the bottom of its recent historical range of 4.1–14.8x for the period FY10–21:

Stated alternatively, if Pan African’s average year one price to normalised EPS ratio of 8.9x for FY10–21 is applied to our normalised earnings forecasts, then it implies a share price for Pan African of c 37.83p in FY22 followed by 40.78p in FY23.

In the meantime, it may be seen that Pan African remains cheaper than its South Africa- and London-listed gold mining peers on 72% of comparable common valuation measures (26 out of 36 individual measures in the table below) if our forecasts are applied or 69% (25 out of 36 individual measures) if consensus forecasts are applied.

Alternatively, applying Pan African’s peers’ average year one P/E ratio of 8.6x to our forecast normalised HEPS forecast of 5.20c/share for FY22 implies a share price for the company of 36.9p at prevailing forex rates. Applying its peers’ average year two P/E ratio of 7.4x to our forecast normalised HEPS forecast of 5.54c/share implies a share price of 33.7p.

According to our estimates, Pan African will have the 16th highest dividend yield of any precious metals mining company in the world in FY22, rising to 12th highest in FY23. To broaden its strategy to return value to shareholders and given the quality and profitability of its existing operations and growth projects, on 1 April, Pan African announced the initiation of phase one of a share buyback programme to purchase up to ZAR50m (then c £2.6m) of ordinary shares of the company over the course of the month, starting on 1 April 2022. The shares were to be repurchased at a price (excluding expenses) that did not exceed the last independent trade or the highest current independent bid on the relevant trading platform and were to be cancelled as soon as practicable thereafter. It was the company’s intention that the repurchases would occur on the London Stock Exchange (LSE) and the Johannesburg Stock Exchange (JSE) in approximately equal aggregate amounts.

Subsequently, on 12 May, the company announced that it had completed Phase 1 of its share buyback programme, repurchasing a total of 11.8m shares for a total consideration of ZAR50.3m (c £2.55m). A total of 7.6m of these were bought back on the LSE at a volume weighted average price of 21.67p per share, while a total of 4.3m were bought back on the JSE at a volume weighted average price of 418.21 South African cents per share. All shares purchased under the programme were subsequently cancelled, such that the company now has 2,222,862,046 ordinary shares in issue, of which 306,358,058 ordinary shares are held in treasury to result in a post-consolidation figure for shares outstanding of 1,916,503,988 shares.

Although small in initial scale (0.5% of shares in issue prior to the announcement), this initiative nevertheless signalled the company’s preparedness to consider share buybacks as a means of retuning capital to shareholders as and when it is appropriate to do so.

Pan African reported cash flow from operating activities in excess of US$100m in both FY20 and FY21 and we forecast that it will continue generating cash at or above these levels into the foreseeable future. At the same time, it reported net debt to financial institutions of only US$13.3m at end-December 2021, which equated to a gearing ratio (net debt/equity) of only 4.9% and a leverage ratio (net debt/[net debt+equity]) of just 4.6%. Notwithstanding its capex (now including Mogale), share buyback and dividend commitments over the course of the next two years, we are continuing to forecast that the company will be, to all intents and purposes, free of net debt to financial institutions by the end of FY22 and will remain so by the end of FY24, when capex relating to Mogale is scheduled to decline sharply:

Note that, including all other components, total net debt as at end-December 2021 amounted to US$28.2m.