Pan African Resources — Update 18 August 2016

Continuing its tradition, Pan African (PAF) has released a trading statement under paragraph 3.4 (b) of the JSE listing requirements in which it states that FY16 results will differ by at least 20% from those of the prior period (ie FY15).

Traditionally, PAF reports EPS and headline EPS, or HEPS (which principally excludes impairments), in accordance with South African practice. In this case, however, it has also provided an indication of normalised HEPS, which also excludes certain financial items. A summary of the financial instruments excluded from the normalised HEPS estimate (cf the HEPS estimate) for FY16 is as follows:

In this case, PAF has indicated that headline EPS (HEPS) for FY16 will be 114-134% higher than the 0.65p per share reported in FY15 in sterling terms (ie in the range 1.37-1.50p) and that normalised HEPS (excluding financial instruments) will be 208-228% higher (ie in the range 2.00-2.13p). Among other things, the implication of the announcement is that the difference between EPS and HEPS is small and/or negligible.

In addition to its earnings guidance, Pan African also released production numbers for the full year. Overall production was 213,267oz of precious metals for the 12-month period, of which 204,928oz was gold and the balance was platinum group metals. This compared with management’s prior guidance of 209,000oz of precious metals for the full year and Edison’s forecast of 213,934oz of precious metals, including 204,653oz of gold. In addition, management reported 136,102t of coal produced from underground sources at the Uitkomst colliery (ie excluding coal bought in from third parties for blending and further processing). Uitkomst was acquired by Pan African on 1 April 2016 for a consideration of ZAR176m (gross of net working capital of ZAR26m), or £7.1m. Hitherto, Uitkomst has made a post-tax profit and an operational cash flow of c £1.6m (or 0.11p/share, post-the Shanduka transaction; see below) per annum. Production from Uitkomst is consolidated from 1 April 2016, although note that this is specifically excluded from Edison’s forecasts, which consider Pan African solely as a precious metals company.

A summary of Pan African’s individual operations’ outputs for the year compared with Edison’s prior forecasts is as follows:

Edison’s interpretation of this production data is twofold:

On 1 June, Pan African advised shareholders that Jadeite had accepted Pan African’s offer to acquire its interest in Shanduka Gold, with the result that PAF purchased substantially all of Jadeite’s interest (33.0% of 33.6%) and Standard Bank’s interest (16.9%) in Shanduka Gold for a consideration of ZAR547m (£25.2m). A diagram of the ownership arrangement between Pan African, Shanduka Gold and the latter’s shareholders prior to the ‘Shanduka transaction’ is as follows:

Shanduka Gold’s 23.8% interest in Pan African Resources is effectively its only asset, with the exception of a c ZAR500m vendor financed loan for Mabindu’s 49.5% interest in Shanduka Gold. As such, Pan African’s acquisition of Standard Bank’s and Jadeite’s interests in Shanduka Gold is, in effect, if not quite in reality, equivalent to a buy-back into treasury of its own shares. At the time of the transaction, the value of Shanduka Gold’s 23.8% shareholding in Pan African Resources would have been approximately ZAR1,391m (£64.3m) and the pro-rata values of Standard Bank’s and Jadeite’s combined interests in Shanduka Gold therefore c ZAR702m (£32.5m).

Mabindu is a black owned and controlled trust and is a “Historically Disadvantaged South African (HDSA)” entity for the purposes of South Africa’s BEE legislation. Shanduka Gold (and, indirectly, Mabindu) is Pan African’s primary BEE shareholder. Pursuant to legislation governing BEE and the granting and retention of South African mining licences and rights, Pan African is required to have a minimum level of HDSA ownership, to which Shanduka Gold contributes. The Shanduka transaction therefore ensures that Pan African’s current HDSA ownership structure is unaffected by retaining Shanduka Gold (and, indirectly, Mabindu) as shareholders.

From an accounting perspective, however, Shanduka Gold (post-transaction) is now deemed to be controlled by Pan African, with the result that Shanduka Gold’s full shareholding of 436,358,059 shares in Pan African will be eliminated upon consolidation for accounting purposes.

Mabindu’s 49.5% interest in Shanduka Gold was acquired at a discounted value, but created a notional loan, to be settled by Mabindu, in the amount of ZAR536m as at 11 December 2015. The notional loan accrues notional interest at the South African prime rate (currently 10.5%) plus 5% and is required to be notionally settled on 11 December 2018. While the notional loan is outstanding, 95% of dividends payable to Mabindu are waived and the notional loan is reduced by the aggregate value of all dividends paid and payable to Mabindu (estimated to be c ZAR24.7m relating to Pan African’s FY15 dividend, payable in December 2015).

At ostensibly the same time as the details of the Shanduka transaction became public, Pan African also announced a placing of 111,711,791 shares at ZAR3.25 (c 14.25p) per share – being a premium to the 30-day volume-weighted average traded price of Pan African shares as at 25 May 2016 – to raise a maximum of ZAR363m.

As a result of the above two transactions (the Shanduka transaction and the share placing), Pan African reports that the weighted number of shares in issue in FY16 was 1,811,427,377 (vs 1,831.5m previously) and that, all other things being equal, the number in issue in FY17 will be 1,506,848,495.

Investors should note that a draft Mining Charter has been published by the minister of mineral resources, which is intended to form the basis of future mining legislation. Comments by interested parties were submitted before 31 May and it is anticipated that there may be a number of significant amendments to this draft version of the charter following the submissions made by the mining industry. As a result, it is unclear in what form the final version of the charter will be published. Nevertheless, the Shanduka transaction should provide Pan African with flexibility in terms of ensuring compliance with any future BEE regulations.

Pan African’s interim results having already been reported, Edison’s prior forecasts for FY16 were predicated on H216 forecasts of ZAR22.5969/£ and ZAR16.0841/US$ and an average gold price for the period of US$1,224/oz. In the event, actual averages for H216 were ZAR22.0942/£, ZAR15.4132/US$ and a gold price of US$1,221.4/oz – ie (somewhat unusually) the South African rand was stronger than expected against both sterling and the US dollar and the gold price was fractionally weaker. Adjusting for these factors alone reduces Edison’s prior estimate for FY16 EPS and HEPS of 1.74p/share to 1.62p/share. In addition, the rand has been markedly strong against both sterling and the US dollar since the UK’s ‘Brexit’ vote on 23 June 2016, which resulted in the rand rising to ZAR19.4908/£ and ZAR14.6890/US$ and the gold price rising to US$1,320.75/oz as at 30 June. In particular, this will have had an effect on the mark-to-market loss relating to Pan African’s strategic short-term hedge at Barberton Mines. Including these effects on financial instruments as well (see above) reduces our FY16 EPS estimate further to 1.47p/share for the year (note that the effect of normalisation is approximately 0.5p/sh post-Shanduka transaction, see page 2). As a result, our revised forecasts for FY16 are as shown overleaf (note that changes to our forecasts on account of differences between actual and expected production were negligible).

Since 30 June, the rand has continued to strengthen against both sterling and the US dollar, to ZAR17.5976/£ (the same as January 2014) and ZAR13.5455/US$ (the same as March 2015), at the time of writing. At US$1.2993/£, sterling is at its weakest since June 1985. For FY17 therefore, our HEPS and EPS forecasts have moderated from 3.04p/share to 2.94p/share – mostly on account of increased costs as a result of the less favourable forex rate. Note that this forecast is made on the basis of an unchanged average gold price assumption of US$1,372/oz (note: the effect of normalisation in FY17 is predicted to be 0.16p/sh). In the event that the gold price remains at US$1,337/oz (the price at the time of writing), these forecasts moderately reduce to 2.76p/share.

Note that current consensus forecasts for earnings per share are 1.737p in FY16 within the range 1.38-2.00p and 3.132p in FY17 within the range 1.77-4.58p (source: Bloomberg, 10 August 2016).

Updating our long-term forecasts to reflect these changes, our absolute value of PAF moderates slightly, to 23.59p (from 25.33p in February), based on the present value of our estimated maximum potential stream of dividends payable to shareholders over the life of mining operations (applying a 10% discount rate), the change being primarily a function of Edison’s policy of applying the current, real £/ZAR forex rate to future costs, rather than assuming future rand weakness.

The above profile assumes that the grade profile at Evander will average 6.43g/t from FY17-30, in which case we forecast an average EPS over the period of 3.06p/share (vs 3.10p/share previously). We assume gold prices of US$1,372/oz in FY17 and US$1,378/oz in FY18.

Pan African remains the second best performer of the London-listed gold miners and one of only four counters to have outperformed the gold price since March 2010, its share price having risen by 233% in US dollar terms, outperforming the gold price by 174% (see graph) and being more than one standard deviation in excess of the average share price performance of its peers (-25.9% in US dollar terms) over the same period:

Nevertheless, within the historical context, it remains below its peak current year P/E ratio of 14.83x HEPS in FY15:

In addition, it remains notably cheap (based on our updated estimates) when compared with its immediate peers in Exhibit 7, below.

On these measures, it can be seen that Pan African is cheaper than its peers in at least 90% of cases in which P/E and yield measures are considered (whether using Edison forecasts or consensus forecasts). In the meantime, Pan African has the third highest (consensus) forecast dividend yield of the 40 ostensibly gold counters paying dividends to shareholders (including royalty and streaming companies), out of 679 publicly listed gold mining companies, globally:

Pan African had £16.2m of net debt on its balance sheet as at 31 December 2016, since which time it has raised an estimated £14.9m (net) via its share placing and expended £7.7m on acquiring Uitkomst and £25.2m on acquiring its 49.5% stake in Shanduka Gold. According to its trading statement, Pan African had net debt on its balance sheet of ZAR347m (£17.8m) as at 30 June, thereby implying a cash inflow from operations of c £16.4m in H216 (in line with Edison’s expectations).

As at the date of its trading statement (2 August 2016), Pan African reported that the group’s net debt had reduced to ZAR255m (£14.1m), which implies an approximate £3.7m inflow from operations over the course of approximately one month, or approximately £44.4m on an annualised basis, which is again consistent with Edison’s forecasts for FY17. All other things being equal therefore (and in the absence of any further, major acquisitions) we would expect Pan African to be in a net cash position once again by the end of FY17, notwithstanding an additional dividend payment for FY16.