Sylvania Platinum — Massive rhodium gearing to exploration assets

The investment case for 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 first quarter results confirming its cash generative ability and that it is also focused on cost controls, targeted capex and dividend payments. Newly published Exploration Results include an updated JORC-compliant MRE for the FNL projects and a scoping study focused on the NB of the more advanced Volspruit project, which we value in this report.

Q123 production showed an improvement on an already strong Q422. The first three quarters of FY22 had been quite poor, mainly because of tailings dump instability issues at the Lesedi SDO and water shortages, which are now resolved.

Q123 results outstripped our forecasts in the areas of plant feed, total 4E production and by-product revenue, with a large rise in EBITDA due to increased production ounces and a sharp rise in by-product revenue and calculated cash costs as shown in Exhibit 1, below. Our estimate for the basket price increase had been slightly higher than the actual outcome.

Plant feed increased by 6.9%, resulting in 1.9% higher 4E PGM ounces produced in Q123 relative to Q422. We have, however, not changed our production forecast for the full year as the next two quarters include several public holidays, which may affect production.

The basket price per ounce increased by 2.4% in US dollars, albeit being slightly below our expectations. At this point we are leaving our forecast gross basket price for FY23 unchanged.

We consider it likely that prices will improve in Q223 as supply chains are improving and forecast vehicle demand for 2022 by industry consultants LMC Automotive and IHS Markit was increased in October to around 82m vehicles from the previous 76m in January.

Calculated cash costs (which include direct and indirect costs) in US dollar terms were 11% below our estimates, reflecting the weakening of the South African rand during the quarter, which resulted in lower US dollar costs. Our outlook for the rand is that it will continue to weaken during FY23 supporting lower US dollar costs. We have increased our rand cash costs in our model as inflation in South Africa is running at around 8% and the cost of chemicals, a large cost component for Sylvania, has increased significantly. Despite this, a weakening local currency will support lower US dollar costs.

Overall, we leave our FY23 group forecast unchanged. Even though Q123 was a strong result, there are a number of factors leading us to err on the side of conservatism. We observe the negative effects of high global inflation are leading to high cost increases even for a low-cost operation like Sylvania. Other challenges include the possibility of Eskom’s ongoing load shedding and consequent power cuts worsening and the possibility of a global recession affecting PGM prices, albeit offset by a weakening currency.

Having said this, management is optimistic that its new MF2 circuit programme, whereby a second flotation circuit is being installed in all its plants over the next two years, will lead to significantly increased recovered grades and, with maintained throughput, will result in higher production over the course of the next few years.

Exhibit 1 shows the quarterly results and differences between them and our prior forecasts:

In addition to producing PGMs, Sylvania Platinum has exploration projects on the Northern Limb of the Bushveld Igneous Complex, which in its entirety, contains some 80% of the world’s PGM resources (source: P. Crowson, Minerals Handbook 2000–01: Statistics and Analyses of the World's Minerals Industry, Kent, UK, 2001).

The exploration assets comprise the advanced Volspruit project and the FNL projects, Aurora and Hacra. We discuss below the recently published Exploration Results, which include an updated JORC-compliant MRE for the FNL projects and a scoping study focused on the NB of the more advanced Volspruit project.

The results of a JORC-compliant Scoping Study carried out by EARTHLAB Technical Division for the Volspruit project were published by Sylvania in October 2022. This ascribes a pre-tax NPV value of US$27.3m (10.2 US cents/share or 8.8p/share) at a real discount rate of 12.5%. Importantly, this valuation does not include any contribution from rhodium, which, as yet, does not qualify for inclusion in the Scoping Study as it is not at inferred stage at Volspruit and was not included in the historical analyses, and is still being assessed, with insufficient sampling to fulfil JORC requirements. Peak funding required is US$147.4m (ZAR2.5bn) with a payback period of 4.25 years from the first production. AISC to produce platinum (Pt), palladium (Pd), and gold (Au) ounces is US$979/oz and US$39.8 per tonne milled (ZAR675/t). The yearly projected EBITDA is US$30.6m (ZAR520m) with a pre-tax internal rate of return (IRR) of 17.9% and a life-of-mine of 8.7 years.

Furthermore, Volspruit is divided into two project areas, North and South. The scoping study includes only the NB as the SB results are still being reviewed. The NB comprises 58% of the project area and hence the Scoping Study only includes 58% of the total potential Mineral Resources of the project. Importantly, the Volspruit NB Scoping Study allows for a life of these resources of 8.7 years; hence the US$27.3m pre-tax value ascribed to this project is for this very short period of mining, which we feel optimistic will be extended to 15 years or more as MREs are updated in the future.

Even though the Scoping Study results do not meet the company’s internal investment criteria as they stand, Sylvania has already commenced a Preliminary Feasibility Study (PFS), showing management’s confidence in the project. Furthermore, the company states that rhodium could add 5–6% of additional ounces at no additional capex (Exhibit 2). With the rhodium price currently at c US$14,100/oz compared to platinum at US$950/oz and palladium at US$1,890/oz (we are estimating US$14,000/oz for Q223 (October to December 2022)), the value of the project using a 12.5% discount factor (as used in the scoping study by Sylvania) could increase by orders of magnitude according to our calculations, if rhodium is added.

The Far Northern Limb Projects will add value in the future, but for now we value these at only 1.0USc/share using a value of US$2/in-situ resource ounce. This is based on our assumptions in the Edison study Gold stars and black holes, published in 2019. Given market conditions, in this case we have adopted the same valuation assumptions regarding the in-situ value of resources that we set out in that report. We will update our Far Northern Limb valuation as and when a Scoping Study is published or more resource ounces are added to the MRE.

The Aurora project’s La Pucella asset has a declared resource of 1.37Moz 2E+gold. Very significantly, the T-Zone has been discovered near surface on the property, which contrasts to the nearby Platinum Group Metals’ (PTM’s) Waterberg project where the zone is included at depth. PTM’s thick bulk-mineable reef zone could allow longhole open stoping, a low-cost massive mining method planned at PTM’s project. A Scoping level mining Study amenable to open-pit mining methods is being carried out at La Pucella, with results due in early 2023, after which we will be able to ascribe an NPV to the project. Again, further studies are aimed at improving analytical confidence to include rhodium and base metals in the MRE.

The Hacra Project is also showing encouraging signs, with 2021 Exploration Results showing attractive grades between 2.3g/t and 7.4g/t 2E + Au and a true intersection thickness from 3.4m up to 11.9m. This appears very much like the T-Zone that was discovered by PTM on the neighbouring Waterberg project. A maiden MRE declaration is targeted for early 2023.

We have slightly revised our valuation for producing assets and have used the newly published Exploration Results to assess the potential valuation uplift of Sylvania’s exploration assets. The latter was carried at a book value of US$46m (14.9p/share) by Sylvania as at end FY22. The Scoping Study provides very strong support for this book value, considering that it excludes the SB of Volspruit and the Far Northern Limb assets, as well as the rhodium upside for Volspruit.

Key sensitivities to the valuation lie mainly in the prices of the PGMs, in particular the rhodium price. For context, rhodium is a key revenue generator for South African precious metals and PGM industries, contributing, by our estimates, around 39% to national industry revenues at current spot prices. Its revenues are almost twice those of palladium and platinum (Exhibit 3).

We highlight that Sylvania has more rhodium in its prill split than the average South African producer, as it re-treats the Middle Group No. 4 reef and the Lower Group No. 6 reef dumps around the Bushveld Complex. These are tailings dumps that have been mined by South African Chrome giant Samancor, its main supplier of dump material. These reefs are around 50% higher in rhodium content than the Upper Group No. 2 (UG2) reef, which most other South African producers mine.

The critical importance of rhodium to Sylvania can be seen in our updated assessment of the potential valuation of the Volspruit project, which we examine both with and without rhodium as a future revenue contributor.

In Exhibit 4 we show the value of Sylvania’s Volspruit NB exploration project, using the NPV both with and without rhodium. The results of our NPV calculation indicate that the NB project alone could be worth 73.1p/share if rhodium (not yet in the JORC Mineral Resource) is taken into account. Sylvania’s own valuation uses a 12.5% discount rate, whereas the normal discount rate used by Edison is 10%, as shown in Exhibit 4.

Sylvania’s FY22 book value of its exploration spend was US$46m, with c 60% of this value ascribed to Volspruit and c 40% to the FNL projects according to the company.

While we conservatively continue to value exploration assets at the company’s book value of 14.9p/share, 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 rhodium upside could boost our valuation by up to 64.3p/share, which is the difference between our with-rhodium NPV of 73.1p/share and the 8.8p/share NPV without rhodium provided by the company in the Scoping Study. Further upside is possible with the inclusion of the Volspruit SB, which is currently being assessed and has been excluded from our calculations.

Edison values operating mining resources companies at a 10% real discount rate based on the dividend discount method (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 onwards and a pay-out ratio of close to 100%. Our PGM price forecasts remain very close to those we forecast in December 2021 and we see little need to change these at this stage (for further information, please see our PGM market report).

Our valuation is down to 164p/share from our previous 169p/share, largely driven by a large 8p/share dividend paid out in October 2022. The key risk to the downside lies in inflationary costs, although any cost increases at the operations in South African rand terms would likely be offset by a weakening of the local currency. We have also left our PGM production forecasts at those previously estimated at end June 2022, as guided by the company, of 68,000–70,000oz 4E for FY23 despite the strong Q123 production (19,194 ounces) as the next two quarters include four public holidays and the festive season.

The potential value add of the Volspruit NB project with the contribution from rhodium is significant. The October Scoping Study for NB is based on what management states to be conservative assumptions, valuing it at 8.8p/share on an NPV basis, without any rhodium. This provides strong support for the June 2022 book value of exploration spend of US$46m or 14.9p/share, considering that the above value (and the Scoping Study) excludes the SB of Volspruit and the FNL assets, as well as the rhodium upside for Volspruit NB. With rhodium, the Volspruit NB valuation rises to as much as 73.1p/share (which is 64.3p/share higher than the 8.8p/share included in the Scoping Study). While we continue to include exploration assets at a book value of 14.9p/share on top of our 164p/share for producing operations, we see meaningful potential upside over time, especially if the company commences production and benefits from high rhodium prices.

End-September cash was US$138.6m having risen from US$121m at the end of Q4. The company is highly cash generative with sufficient funds to facilitate capex, process optimisation, exploration drilling and Pre-Feasibility Studies and dividends.

Exhibit 5 shows our forecasts to FY25. Our revenue forecasts increase at a rate of around 10% pa as the new MF2 circuits are installed at each of the SDOs, which will improve metal recoveries.

There was a large increase in costs in FY22 over FY21. Consequently, EBITDA was down in FY22 but was strongly ahead in Q123 relative to Q422. We expect this to even out into slower EBITDA growth in FY24 and FY25. The company emphasises cost controls and has managed to contain Q123 unit cost increases in South African rand terms to low single digits, which resulted in US dollar unit costs falling by around between 4.2% and 10.9% across the unit cost categories. Our EPS forecasts for the next three years are around 25 USc/share each year. We expect ordinary dividends to reduce in FY23 as a result of the cost increases of more than 10% that we are anticipating because of global inflationary pressures

We expect the company to continue to be strongly cash generative with little or no debt over the next few years. We forecast cash levels in FY23 to reduce slightly, with high inflation rates globally affecting costs adversely and PGM basket prices softening from the levels of FY21 into FY22 and FY23, but picking up again thereafter.

The company’s dividend policy is variable and takes into consideration liquidity, forecast cash requirements, debt, capital expenditure, legal considerations as the company is domiciled in Bermuda, sustainability, metal prices, currency fluctuations and the mineral rights portfolio. The board takes into account these factors rather than any formulaic approach. We would like to see the company simplify its approach by instead targeting a percentage of free cash flow after capital commitments, strategic projects, etc. The company pays ordinary dividends annually.

Historically, a windfall dividend has been paid when the actual PGM basket price realised for the full calendar year has been higher than the consensus forecast for the year published in January. The actual basket price for CY22 might well be lower than what consensus was in January, which would, in our view, likely preclude a windfall dividend payment during FY23. Over the long term, our modelling points to strong cash flow generation adding to the company’s already healthy cash position and further windfall dividends are therefore likely, although we have not forecast any during our explicit forecast period to FY25.