Pan African Resources — FY17 results in line

Pan African’s FY17 and FY16 financial results were restated to reflect both Uitkomst (sold in the FY17 financial year) and Phoenix (expected to be sold in the FY18 financial year) as ‘discontinued operations’. Notwithstanding this change, net profits of £17.9m for the full year were within 3% of Edison’s estimate. In general, gold revenues and costs of production were close to our expectations. Between the top and bottom lines, a negative variance in ‘other expenses’, impairments, the net finance expense and the contribution from discontinued operations was almost exactly offset by positive variances in the depreciation charge, profits on disposals of assets and, in particular, the tax charge. As well as taxation, the other noteworthy variance was that in other expenses – especially within the context of a pre-tax mark-to-market fair-value gain of ZAR94.7m (£5.5m at the average ZAR/GBP forex rate for the year) relating to the company’s hedge positions over the course of the year. In addition, the proposed dividend was exactly in line with our expectations, at 0.49p/share. An analysis of PAF’s FY17 results compared to both the previous, restated FY16 results and Edison’s prior expectations (similarly restated) is as follows:

After producing 173koz of gold in FY17, management has now indicated that it expects production in FY18 in excess of 190koz of gold. Edison’s group-wide production estimate is 197koz in FY18, apportioned between its four remaining producing operations (ie excluding Phoenix), as follows:

Clearly, within the historical context, there must be a degree of risk attached to our production forecasts with respect to PAF’s underground operations (Barberton and Evander). However, this is balanced (in our opinion roughly equally) by the opportunity (or upside risk) presented at its tailings retreatment operations. More significantly, the development of Elikhulu (which is now underway and fully funded) should increase output to c 250koz over the course of the next two financial years, which will underpin our longer-term earnings and cash-flow expectations:

In the meantime, PAF’s shares remain noticeably cheap, within the historical context, when considered relative to our (ostensibly unchanged) forecasts of normalised headline EPS in FY18 compared to prior years:

Self-evidently, this historical cheapness relative to earnings becomes more apparent as the commissioning of Elikhulu drives EPS towards the 3p mark from FY20 onwards:

In relative terms, PAF also remains cheaper than its South African and London-listed peers on 90% of valuation measures (ie 27 out of 30 measures in the table below on an individual company basis) regardless of whether consensus or Edison forecasts are used:

Note that Edison’s forecasts are based upon an estimated average gold price realised by Pan African of US$1,248/oz in FY18 and US$1,252/oz in FY19.

Finally, PAF has the tenth-highest consensus, forecast dividend yield of the 56 precious metal mining companies paying dividends to shareholders, globally (including selected royalty companies). Note that, in the event that it achieves Edison’s anticipated performance and dividend pay-out in FY18, PAF will actually have the highest prospective dividend yield of any company in the sector:

Note that, in this respect, Pan African’s forecast dividend yield is 1.3 standard deviations above the average yield of the population of 2.2%.

In addition to Elikhulu, which “is progressing according to plan with project completion and first gold expected in the last quarter of the 2018 calendar year”, Pan African has two significant growth projects, namely the Barberton Mines Sub-Vertical Shaft Project at Fairview and the Evander Mines 7 Shaft No. 3 Decline and 2010 Pay Channel project.

The Fairview mining operation is currently restricted by the hoisting capacity of its No. 3 Decline, which is used to access workings below 42 Level. This decline is currently used to transport employees, material and for rock hoisting and, with no modifications, future mining at depth will be compromised by increased travelling distances, reduced employee face time and a lack of sufficient capacity to ensure both adequate ore replacement and exploration development. With this in mind, Pan African has now completed a study with DRA to investigate the feasibility of constructing a raise-bored, sub-vertical shaft from Fairview’s 42 Level to 64 Level and, potentially, in future, to 68 Level (Note that resources extend down to 74 Level). The sub-vertical shaft will then be used to transport employees and material to the working areas, while No. 3 Decline will be used exclusively for rock hoisting, thereby significantly increasing overall capacity and production from this high grade mining area.

Estimated capex for the project (including contingencies) is ZAR105m (£6.1m) and would result in estimated, additional output of 7,000oz gold per annum, which “can be optimised further to more than 10,000oz per annum.”

Assuming that construction takes place in CY18 and CY19 and that production begins in CY20 with cash costs of c US$800/oz over 15 years, we estimate that this project could be worth in the order of US$29.3m (1.63c/share) to Pan African, rising to US$43.5m (2.42p/share) in the event of optimisation (at Edison’s standard 10% discount rate) – which compares with a current valuation in the order of US$1.0m if valued at PAF’s current group-wide resource multiple.

The 2010 Pay Channel contains an estimated 2.19Moz of resources and is c 4.5km in tramming distance from 7 Shaft, which is currently used by EGM for hoisting to the Kinross metallurgical plant (cf 8 Shaft, which is c 12km distant). Harmony Gold Mining had previously developed the 7 Shaft mine working towards the 2010 Pay Channel, but discontinued the initiative in 2009, allowing the controlled flooding of the development ends and 7 Shaft’s No. 3 Decline, from 21 Level to 18 Level.

To date, two boreholes have successfully been drilled into the 2010 Pay Channel, intersecting the Kimberley reef at a depth of c 2km. The first yielded a reef intersection with a width of 49cm and a grade of 36.04g/t (a metal content factor of 1,766cm.g/t), while the more recent recorded a width of 6cm and a grade of 36.8g/t (a metal content factor of 221cm.g/t). Additional drilling deflections will be performed to further delineate the orebody. In the meantime, in order for mining to commence, the infrastructure would need to be dewatered and only standard footwall and on-reef development (with associated engineering infrastructure) completed. With this in mind, a Pan African project team has been created and has commenced a feasibility study relating to the 7 Shaft No. 3 Decline and 2010 Pay Channel resource, which will initially consider the following issues:

The feasibility study is expected to be completed in the first quarter of the 2018 calendar year (ie H218). In the meantime, Pan African’s management is of the opinion that, “The 2010 Pay Channel can potentially increase Evander Mines’ underground gold production significantly at a relatively low capital cost, using Evander Mines’ established shaft and metallurgical facilities.”

Pro-rata to its resource of 1.48Moz, at Pan African’s group-wide average resource multiple, the 2010 Pay Channel project should be worth in the order of US$13.1m, or c 0.7c/share. In all probability, management would hope and expect that this project would yield an NPV10 to the company of several times this value in the event that its development is sanctioned by the board, subject to capex, opex etc.

Pan African has a target dividend pay-out ratio of 40% of net cash generated by operating activities, after allowing for the cash-flow effect of sustaining capital, contractual debt repayments and one-off items. In FY17, the board took the view that the proceeds from the sale of Uitkomst were eligible to contribute to the dividend payout on the grounds that they constituted a return to shareholders of the profits realised on the original investments. Hitherto, Edison had assumed that the same would apply to proceeds from the sale of Phoenix Platinum in FY18. However, we have now tentatively revised this viewpoint to exclude Phoenix proceeds from inclusion in the FY18 dividend (at least for the moment) pending developments throughout the course of the remainder of the year, including Competition Commission approval for the transaction. We have therefore for now lowered our FY18 dividend estimate from 1.14p/share to 0.87p/share. We have also introduced our FY19 financial estimates for the first time (see Exhibit 8).