Pres­sure lever­aged min­ers

Finweek English Edition - - INVESTMENT -

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

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