Pressure leveraged miners
Rand Merchant Bank (RMB) launched a f ive-year, goldbacked bond earlier t his month. Some R2bn worth of paper was issued, which can be realised in Krugerrands or cash at redemption.
That’s good news for those investors who like to physically hold their wealth and for the companies that mine the metal, especially Harmony Gold, a firm judged by Goldman Sachs recently as among the most leveraged in its investment universe.
A leveraged firm, especially a company that is marginally profitable or lossmaking at a certain gold price, responds more vigorously to changed economic circumstances. In the case of Harmony, a sudden weakness in the rand against the dollar or improvement in the dollar gold price will spark a significant increase in the company’s share price.
Goldman Sachs thinks that could make Harmony an attractive stock to own for investors bullish on gold, but it also believes there are many reasons not to own the stock such as safety-related stoppages and broken promises in respect of production and cost guidance.
The view comes in the wake of Harmony’s fourth-quarter and full-year figures published on 14 August in which it wrote down the expansion of its Phakisa mine, which it has stopped, for R1.31bn and which resulted in an annual loss of R1.27bn. This is better than the R2.35bn loss of the previous financial year, but it’s still a loss with seemingly little space to cut costs further, according to Goldman Sachs.
It said there were no growth plans and that gold production in the current financial year would be flat at about 1.2m ounces, a development that Harmony CEO Graham Briggs acknowledged was a result of having “over-promised and under-delivered” in the past. There were also no cost-saving plans with all-in sustaining costs expected to be f lat this financial year.
According to David Davis, an analyst for Standard Bank Group Securities, Harmony had taken some 31% in unit costs out from the June 2013 quarter to the March quarter this year, but much of it was in capital expenditure. “Savings of 34% achieved in stay-in-business [capital] may not be sustainable in the medium to long term [assuming low gold prices] at current levels of production.”
The implication is that at current gold prices, and in the absence of a material dip in the rand, Harmony’s mature mines are running out of steam.
UBS analyst Kane Slutzkin said that about half of Harmony’s production is loss-making at the average gold price in its 2014 financial year of R432,165 per kilogramme.
“We remain concerned that operating cash f low has not been sufficient to cover its capital expenditure requirements,” he said. Harmony’s net debt doubled to R1bn in the last financial year.
The biggest worry is that Harmony will have to take the axe to production and jobs. Goldman Sachs said restructuring was still not on the table at Harmony, suggesting that management was failing to respond to economic conditions appropriately. “Harmony has multiple mines which are burning cash at our gold price forecasts. No plans have been laid out to restructure, divest or close any mines,” it said.
Since that report, and subsequent to the write down at Phakisa, the company also said that it was stopping development at its Target 3 shaft in the Free State province with some 1 500 jobs at risk. The shaft had lost R280m in fourand-a-half years, said Harmony.
Perhaps that’s why Briggs said the company was looking for new production. One conclusion is that Harmony is seeking replacement ounces, not growth. Said Briggs: “When we look around the world of gold mining we see a lot of gold mining companies have got a lot of financial stress and debt. They need to repay that debt either by issuing equity or selling assets. There’s quite a few on the block. So we will look at them.”
Harmony’s Eland mine near Welkom