Sylvania Platinum — Lower PGM prices affecting results and forecasts

The investment case for Sylvania Platinum (Sylvania) is based on a low-risk dump retreatment operation to which the bulk of the valuation of the company can be ascribed. It also has exploration assets in the northern part of the Bushveld Igneous Complex of South Africa. Sylvania recently published third quarter results confirming its cash generating ability and that it is focused on cost controls, targeted capex and dividend payments.

Further upside to the share price may result from Sylvania’s announcement on 2 May 2023 of a share buyback programme, to purchase issued shares of the company up to a maximum consideration of US$10m.

Q323 production is usually lower than other quarters due to the slow resumption of operations after the December break, mainly due to the host mines’ run-of-mine ore delivery to the SDOs’ plants and slow resumption of delivery of current arisings (tailings material received from Samancor after extraction of chromite).

However, the Q323 results were lower than our forecasts for plant feed and feed grades, total 4E production and by-product revenue, with a large drop in EBITDA due to a combination of these factors.

Plant feed decreased by 11% q-o-q (13.6% below our estimates), resulting in 7% lower 4E PGM ounces produced at 17,926oz in Q323 relative to Q223. Because of the absence of the disruptive festive season restart of operations from the host mines’ feed to Sylvania’s plants, we have left our FY23 production forecast unchanged at 74,535koz 4E.

The basket price per ounce decreased by 21% in US dollars because of rhodium prices falling to an average of US$10,975/oz for Q3 compared to US$13,335/oz for the previous quarter.

On the back of a lower PGM basket price, Q323 group EBITDA was 51% below our forecast.

The cash balance increased to US$144.2m from US$123.9m.

Total operating costs differed by 1% from our forecasts, with group cash cost per 4E ounce increasing by around 12%. This is broadly in line with South African mining unit cost increases. The South African rand was virtually unchanged during the quarter. We expect the ZAR/US$ will continue to weaken during FY23, supporting lower US dollar costs. We have increased the rand unit costs in our model as mining cost inflation in South Africa normally runs at around 12%. The cost of chemicals, a large cost component for Sylvania, has increased significantly. The weaker currency will be offset by local inflationary pressures.

Despite the weaker quarter, Sylvania has guided to 72–74koz 4E production for FY23 (this compares to the guidance given at H123 results stage of 70–72koz 4E). In the first three quarters, production totalled 56,396oz so if the poor Q3 is repeated, guidance is likely to be met. However, we see a possibility of a stronger fourth quarter with production back to 19koz 4E, similar to the first two quarters.

Exhibit 1 shows the quarterly results:

With rhodium prices now at around US$9,000/oz, we have reduced our rhodium and palladium price forecasts for FY23 and FY24 as we think that there is some excess stock in the market, plus demand from China is likely to be lower due to the slower than expected recovery from COVID-19 shutdowns. In addition, the recessionary environment in the Western economies could persist for some time. We see platinum prices strengthening even in the short term with the positive impact of the hydrogen economy on demand and also substitution of platinum for palladium, especially in the new tri-metal catalyst (TMC) developed by BASF and Implats. Jewellery demand has increased, especially in China, and this will also increase demand for platinum. The strong gold price may also pull platinum along with it as a result of the strong correlation between them. Our updated commodity forecasts are given in Exhibit 2.

We have adjusted our rhodium price forecasts downwards by 18% for FY23, 20% for FY24 and 19% for FY25. From FY26 onwards, there is no change from our previous forecasts.

For palladium we have dropped our price by 8% for FY23, due to excess stocks in the market and lower demand because of substitution of palladium by platinum in the TMC, 12% for FY24 and 15% for FY25. From FY26, our forecasts are 14% lower.

For platinum, our price forecasts are very similar to our previous forecasts until FY26. From FY27, our price forecasts are higher – up 2% in FY27, 4% in FY28, 8% in FY29 and 11% in FY30 – mainly because we think that demand from the hydrogen economy and fuel cell electric vehicles (FCEVs) will increase at a more rapid rate than we thought, as the materials shortage for pure battery electric vehicles (BEVs) will see their market penetration limited, with the FCEV and hybrid vehicles taking the BEVs’ market share.

Our forecast revisions are shown in Exhibit 3. We forecast plant feed to reduce by 3.4% and the basket price to reduce by 14.2% from our old forecasts, as a result of our lower rhodium and palladium price forecasts. Consequently, our 4E revenue declines by 11.5%. Total operating costs in US dollars are slightly lower but EBITDA is significantly lower, 18.1% down on our old forecast. Net profit also declines by 15.5% and gross margins decline marginally though they are still a healthy 50%. Consequently, our basic EPS declines by 15.3%. The cash balance increases by 8.1%.

We have revised our valuation for producing assets and have used previously published exploration results to value the potential of the exploration assets. The latter was carried at a book value of US$46m (13.9p/share) by Sylvania as at end FY22.

Key sensitivities to the valuation lie mainly in the prices of the PGMs. In the past this was rhodium, which accounted for around 39% of the revenue basket earned by South African producers. This has fallen to 26% by our calculation and is now equal to platinum in contribution.

We highlight that Sylvania has more rhodium in its prill split than the average South African producer (Exhibit 4), so a softening of the rhodium price has a large effect on the revenue of the company. Sylvania re-treats the Middle Group number 1–4 seams and the Lower Group number 6 reef dumps around the Bushveld Complex. These are tailings dumps from ore that has previously been mined by South African chrome giant Samancor, its main supplier of dump material (called ‘current arisings’ by Sylvania). These reefs are around 50% higher in rhodium content than the Upper Group number 2 (UG2) reef, which most other South African producers mine.

Edison values operating mining resources companies at a 10% real discount rate based on the dividend discount model (DDM). In the case of Sylvania, while we do not forecast windfall dividends over our explicit forecast period (even though these have become a regular feature of this company), we allow for maximum supportable dividends from FY26 and a pay-out ratio of close to 100%. While our long-term PGM price forecasts remain close to those we forecast in December 2021 (for further information, please see our PGM market report), current market conditions have necessitated a more conservative view in the medium term, especially for rhodium.

Our valuation is down 7.1% to 159.9p/share, from our previous 173.7p/share, for operating assets only, largely driven by lower PGM (and specifically rhodium) prices in the short term. The key risk to the downside remains in PGM prices and inflationary cost pressures, although any cost increases at the operations in South African rand terms could potentially be offset by a weakening of the local currency.

We conservatively continue to value exploration assets at the company’s book value of 13.8p/share (down from the previous 13.9p/share because the pound has risen against the US dollar, from US$1.24/£ at out last publication to the current US$1.25/£). However, we flag that the scoping study could result in a write-up of this value over time and that if any of the projects, especially Volspruit, are converted into producing operations, the upside, if the rhodium content of the ore is included in the valuation, could boost our valuation by up to 59.1p/share. This has decreased from the 73p/share value we previously ascribed to the Volspruit project because of the lower palladium and rhodium prices that we now forecast (Exhibit 2) and the slightly stronger pound to US dollar exchange rate. Further upside is possible with the inclusion of the other exploration projects that are currently being assessed.

As mentioned above, rhodium and platinum are currently the joint lead revenue producers. Our sensitivity analysis of changing the rhodium price by 10% and 20% higher and lower shows that the value of the share would rise or fall by 11.5% and 23.1%.

This sensitivity applies equally to platinum. Our more conservative view on rhodium prices in the next two years is likely to be cancelled out by our more bullish outlook for platinum prices.

End-March (Q323) cash was US$144.2m having risen from US$123.9m at the end of Q2. The company is highly cash generative with sufficient funds to facilitate capex, process optimisation, exploration drilling, pre-feasibility studies and dividends.

Exhibit 6 shows our forecasts to FY25. Our revenue forecasts fall in FY23 by around 6.6% as PGM prices fall. The fall in revenue results in our forecast EBITDA declining to US$71m in FY23 from US$83m in FY22. We see a further decline to US$61m in FY24 due to our lower forecast PGM prices and anticipated cost increases. The new MF2 circuits installed at each of the SDOs bar Lannex, until H124, will improve metal recoveries, which should see revenues rising from FY24 onwards and EBITDA in FY25.

There has been a large increase in costs so far in FY23 compared to FY22. We estimate that costs will rise by 8% in FY23 versus FY22 and that in FY24 they could rise by 26% as a result of continued inflation and the possibility that ESKOM power cuts will become significantly worse from FY24. Sylvania is in the process of procuring back-up power generators for Lesedi and Millsell, and these should be commissioned during Q124. However, power costs are likely to add to total costs and cost increases are therefore likely to continue for many years.

As our PGM price forecasts rise in FY25 because of expected high vehicle sales combined with higher demand as EURO 7 legislation for light vehicles comes into force and Tier 4 standards come into force in the US and North America, possibly followed by China 7 emissions regulations (though the date of implementation is not yet certain), we see a sharp rebound in EBITDA from US$61m in FY24 to US$77m in FY25. Our EPS forecasts for the next three years show declining headline EPS (HEPS), from 20.4c/share in FY22 to 19.0c/share in FY23, falling further to 14.8c/share in FY24 and rising to 19.3c/share in FY25, in line with our PGM price forecasts and cost increases that we are anticipating because of the factors we mention above and global inflationary pressures.

We expect ordinary dividends to reduce in FY23 to 6.0p/share, from 8.0p/share in FY22, and to 4.9p/share in FY24, before rising to 6.9p/share in FY25.

We expect Sylvania to continue to be strongly cash generative with little or no debt over the next few years. We forecast cash levels in FY23 to increase to US$145m, for reasons already explained.

With the H123 results reported in February 2023, Sylvania announced that its board had reviewed the company’s dividend policy. The new dividend policy, effective from 1 July 2022, is to pay out a minimum of 40% of adjusted free cash flow for the financial year. The company states: ‘Adjusted free cash flow is the calculated cash flow from operating activities less capital expenditure for the reporting period, adjusted for debt commitments and covenants and committed future growth/expansion capital. Where annual dividends are declared, these will be paid in two tranches, with an interim dividend equating to one third of the forecast full dividend and the final dividend equating to the remaining unpaid balance of the minimum of 40% of actual adjusted free cash flow. The payment of dividends remains at the discretion of the Board.’