PICK OF THE MONTH

MONTH

If Joburg had a “golden corridor” for property, it would extend from north to south. The corridor for gold is west to east, evidenced by DRDGold’s operations that stretch from Roodepoort to well past Brakpan.

Yes, there are areas beyond Brakpan, which may come as a surprise to some.

DRD’s plants comprise arguably the world’s largest gold surface tailings retreatment facility. Gold retreatment is the recovery of gold from mine dumps. The dumps are the result of less efficient mining processes that were used in the early years of the Joburg gold rush. Thanks to improved methods, slime dams have also become economically attractive to recover.

DRD is an unhedged gold producer by choice, so you ride the downswings and upswings along with the rand gold price. The company has guided that the June 2020 results would’ve shown a 25% swing in operating profit if the average gold price had differed by just 10%. The joy (or curse) of operational leverage is clear.

Considering the large free float and the volatility of the underlying inputs that can drive significant movements in the share price, this stock isn’t for widows and orphans.

The latest trading statement shows the bright side of mining, with revenue up 41% thanks to a 42% increase in the rand gold price.

Based on the similarity of those numbers, it’s no surprise that DRD’s share price is highly correlated with the gold price. Earnings more than doubled in the past six months of 2020 versus the comparable period.

DRD cannot control the gold price, but it can manage volume throughput and extraction efficiency. In the 2020 financial year its gold production was up 9%, but the interim trading statement reveals that yields have dropped at its core operations due to depletion of highgrade reserves. Investors will need to watch this carefully, especially if the gold price drops and margins get tighter.

Historically, efficiency gains have been clear, with a compound annual growth rate of just 2% from 2016 to 2020 in cash operating cost per kg of gold produced. DRD incurred an average cost of R482,417 a kg in the 2020 financial year, versus a current gold price of about R875,000 a kg. Margins are juicy at these levels.

Materials cost contributes about 30% of total cash cost while labour and electricity contribute a combined 37%. Eskom is a systemic risk and labour unrest can have a catastrophic impact. The current three-year wage agreement concludes in June this year, so there is risk of disruption over the next 12 months. This is mitigated to some extent, as DRD claims it pays well above the industry standard and runs its operations with 21% of total operating costs attributable to labour versus 50% as the industry standard.

Labour issues crippled the mining industry a few years ago but have thankfully stabilised. However, unions will take notice of the resurgence in this sector and won’t hesitate to fight for a bigger piece of the pie if they can.

The relationship with Sibanye-Stillwater (SSW) is important, especially as SSW is also flying. In July 2018, DRD acquired Far West Gold Recoveries from SSW in exchange for a 38.1% stake in DRD. In January 2020, SSW exercised its option to take its stake to a controlling 50.1%, injecting over R1bn in cash, which greatly strengthened the DRD balance sheet and cemented the relationship. Potential diversification into platinum group metals through this relationship could make DRD more attractive to investors.

After peaking at R29.50 a share in mid-2020, DRD has come off to R16.35 a share at time of writing. It languished at around R3 a share from 2018 to mid-2019, so the first SSW deal didn’t initially drive the share price. There’s no getting away from the fact that DRD is a gold price play. Trading statements and the like are formalities, already reflected in the price.

The gold price seems to have consolidated its gains above $1,800 an oz. Of course, there are arguments for and against ongoing gold price strength this year. Forming a view on DRD is complicated — you need a view on gold, the rand-dollar exchange rate, the SSW relationship, Eskom realities and the labour unrest risk.

As a leveraged play on the rand gold price and with a 13year track record of uninterrupted dividends, DRD is worth a look for investors seeking gold exposure. We might even see some corporate actions for DRD with the backing of SSW as anchor shareholder. Perhaps the personalities in question can find a way to merge DRD and Jubilee Metals? ●

“DRD cannot control the gold price, but it can manage volume throughput and extraction efficiency