Pan African Resources — Record interim profitability

PAF’s results for the half-year to end-December 2020 were reported within the context of already known production from its operational update released on 22 January 2021. These are summarised in Exhibit 1, below. Full details are available in its interim results statement. However, particularly notable within the detail of the results were the head grade mined from underground operations at Barberton, which we estimate to have been 11.25g/t (cf the 8.79g/t that we estimate was mined in H220 – a 28.0% increase), and also the head grade recorded at the BTRP and Elikhulu, which were also both above our expectations, albeit to a lesser extent. In addition, Exhibit 1 provides our estimates of production in H221 and therefore also FY21e.

While production in H121 was 5.9% higher than in H120, it was 13.7% higher than H220, demonstrating an improving trend. In the case of Barberton underground, the improvement could be attributed to its three cycling production platforms. By contrast, while production at Evander underground exhibited a marked improvement over the previous four half-year periods, output was below expectations as production (now principally relating to the 8 Shaft Pillar project) was restrained by a ventilation shaft lining fracture as well as technical difficulties relating to the pseudo packs used for ground support (albeit these have now been overcome by filling the packs with a mixture dry tailings and fly ash rather than wet tailings). In addition, at 91%, metallurgical recoveries at Evander underground were below historical levels, although this was, to some extent counterbalanced by the head grade, which, at an estimated 8.51g/t, was 11.0% above our prior expectation of 7.67g/t.

The table overleaf presents PAF’s H121 results relative to historical results. Readers are reminded that production from Evander’s 8 Shaft Pillar project was capitalised until June 2020, when steady-state production was achieved. Nevertheless, with that caveat, a number of features of PAF’s financial results are noteworthy. In the first instance, it is apparent that earnings and headline earnings in the half year period are more akin to those typically earned within a full financial year – attributable, in part, to the relatively high gold price during the period (that is US$1,865/oz cf US$1,694/oz in H220). Within that however, there is some evidence of cost pressure in US dollar terms (not least as a result of the strengthening of the rand, which has now appreciated by some 24.2% against the US dollar since its nadir on 23 April 2020) in the form of costs of production rising by more in percentage terms than revenue. However, probably the main two features of the results are the dramatic decline in ‘other’ expenses (in this case principally relating to the rolling off of PAF’s revenue protection hedges, which have now been settled in their entirety), partially offset by a 21.7 percentage point increase in the effective tax charge. In the latter case, it is notable that 47.3% of the entire tax charge in PAF’s P&L was accounted for by a deferred tax charge and that actual cash taxes paid were considerably less, at US$6.7m (cf US$19.2m in the P&L statement – see below).

From an operational perspective, cost pressures were most apparent at Evander underground, where the shortfall of tonnes milled relative to prior expectations, superimposed on a cost base that is largely (c 90%) fixed, resulted in a material increase in unit costs from ZAR5,671/t (H220e) to ZAR6,496/t, rather than the decline as had anticipated. Even so, in the six-month period, we note that EBITDA at Evander underground of ZAR49.0m was its second highest (half year) level since H216, which bodes well for the future. In addition, Elikhulu experienced an increase in unit cash costs from an estimated ZAR36.33/t in H220 to ZAR45.63/t in H121 as plant throughput was constrained by preventative maintenance and improvement work to sections of the lower Elikhulu tailings storage facility compartment and the installation of elevated drains in this area. This work is anticipated (by management) to be completed this month, whereafter throughput tonnage is expected to increase once again.

In the light of H121 results, we have amended our FY21 results to those shown in Exhibit 2, now forecast on a half yearly basis, rather than the full yearly basis previously. Included among a number of changes in our assumptions are the following:

On the basis of these assumptions, our updated normalised FY21 HEPS forecast of 4.24c/share compares with a consensus EPS forecast for FY21 of 1.89c/share, within a range 0.06–3.72c/share (source: Refinitiv, 3 March 2021).

In the light of our revised assumptions, our absolute value of PAF (based on its existing four producing assets plus Egoli) has moderated to 36.42c/share ex-dividend (cf 39.03c/share cum-dividend previously), 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):

Including its other potential growth projects (eg the Fairview sub-vertical shaft project) and assets (ie the residual Evander underground resource and its shareholding in MC Mining), our updated total valuation of PAF is as follows:

Note that the increase in the value of PAF’s shareholding of 13.1m MC Mining shares relative to our previous valuation in October reflects the continued rise in the latter’s share price from ZAR1.38/share to ZAR1.60/share currently (adjusted into US dollars at the appropriate forex rate).

Readers should note that the 5.7% decline in Edison’s valuation of the company, to 38.19c/share (excluding the value of PAF’s other underground Witwatersrand assets at Evander), should be seen within the context of a spot rand rate that is 12.4% stronger than that prevailing at the time of our last major note on the company (see The sun rises over Egoli’s city of gold, published on 14 October 2020) and the geared effect that the rand rate has on PAF’s mining operations’ margins – that is, it represents fundamental outperformance on an underlying basis.

One of the assets with the most immediate optionality in the company’s portfolio is Mintails/Mogale, which could yet prove very similar in nature to Elikhulu and into which PAF is currently conducting due diligence with a view to acquiring. By way of comparison, 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, but at a fractionally higher grade of 0.30g/t (cf Elikhulu’s 0.29g/t). PAF announced the results of an independent definitive feasibility study (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 oz) at a gold price of US$1,180/oz and a forex rate of ZAR14.50/US$. At the time, Edison 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 28.0% more shares in issue). Now however, with capex having been expended (but with not all associated debt repaid), we estimate a current valuation for Elikhulu of c US$151.32 per initial resource oz or US$184.08 per remaining resource oz. As such, and albeit with suitable caveats such as the Mintails/Mogale assets developing in a similar fashion to Elikhulu, PAF could be on the verge of acquiring for US$1.31/oz an asset that might be worth US$9.88/oz, could be worth US$40.95/oz (pre-production) and may be worth US$159.33/oz (post-debt repayment, albeit after c US$71/oz in initial capex). For more information, readers should see our note, Entailed, published on 17 November 2020).

Exhibit 5, below, depicts PAF’s average share price in each of its financial years from FY10 to FY20, and compares this with normalised HEPS in the same year. For FY21 and FY22, the current share price (of 17.35p) is compared with our forecast normalised HEPS for FY21 to FY22. As is apparent from the graph, PAF’s price to normalised HEPS ratio of 5.7x and 4.4x for FY21 and FY22, respectively (based on our forecasts – see Exhibit 6, below) is very close to the bottom of its recent historical range of 4.1–14.8x for the period FY10–20:

Stated alternatively, if PAF’s average contemporary price to normalised EPS ratio of 9.1x in the period FY10–20 is applied to our normalised earnings forecasts, then it implies that PAF’s share price could be expected to rise to c 27.6p in FY21 and 35.4p in FY22.

Note that, within this context, our normalised FY22 HEPS forecast of 5.43 US cents compares with a consensus forecast of 2.74c, within a range 0.05–5.42c (source: Refinitiv, 3 March 2021).

Over the next two years, PAF remains cheaper than its South Africa- and London-listed gold mining peers on 63% of comparable common valuation measures (19 out of 30 individual measures in the table below) if Edison forecasts are applied or 43% if consensus forecasts are applied. Note: in this case, readers should note that the consensus appears to be discounting negligible normalised HEPS in H221 (c 0.05c/share) as well as a cut in the dividend which, at the current juncture, would appear unduly pessimistic, in our view.

Note that applying PAF’s peers’ average year 2 P/E ratio of 7.0x to Edison’s forecast normalised HEPS forecast of 5.43c/share for FY22 would similarly imply a share price for the company of 27.4p at prevailing forex rates.

Considering its liabilities to financial institutions, PAF had net debt of US$59.6m on its balance sheet as at 31 December 2020, which equates to a gearing ratio (net debt/equity) of 24.5% and a leverage ratio (net debt/[net debt+equity]) of 19.7% (cf 64.8% and 39.3% as at end December 2019, respectively). This figure includes gross debt and cash and is reflected in our financial summary (see Exhibit 11, below); however, it excludes a number of other items, which are summarised below.

Most notable within the context of the above table is the extinction of the liabilities relating to PAF’s gold loan and derivative financial instruments in H121, which represented the last vestiges of the company’s revenue protection hedging contracts, which have now all been terminated.

Notwithstanding the start of capex relating to the Egoli project, we continue to forecast that the company will achieve net debt free status during the FY22 financial year (NB on a post-FY21 dividend basis):

Debt is principally financed via a US$47.6m term loan facility plus a US$40.4m revolving credit facility and a general banking facility. Principal on the Elikhulu facility is payable in equal instalments until maturity in June 2024, while the revolving credit facility (RCF) has a maturity beyond mid-2024. The group’s RCF debt covenants and their actual recorded levels within recent history are as follows: