Pan African Resources — Update 10 February 2016

Further to its trading statement on 26 November 2015, Pan African (PAF) has now released an updated trading statement under paragraph 3.4 (b) of the JSE listing requirements to the effect that, principally as a result of rand depreciation since Nov/Dec 2015, H115 headline EPS (HEPS) and EPS will be in the range 0.57-0.63p per share cf at least 0.51p/share (including an estimated 0.12p in exceptional hedging profits), indicated at the time of its November statement.

In addition to its earnings guidance, Pan African also announced production results for the Barberton and Evander complexes, as well for as Phoenix Platinum.

Given that there is relatively little scope for variance in actual vs expected output from its tailings retreatment operations (and certainly not of such an order of magnitude), the implication of these production figures must be that output from Barberton’s and Evander’s traditional (ostensibly underground) operations must have been similarly higher than expected (see below).

In the meantime (albeit our forecasts were probably overoptimistic in that they exceeded guidance and depended on a continuation of a very strong implied H215 performance), the production figures for Phoenix Platinum appear to indicate that it has nevertheless been negatively affected by International Ferro Metals’ (IFM) business rescue process. Phoenix Platinum is located on IFM’s property and a portion of the feedstock for its operation (recently c 20%) originated from tailings arising from IFM’s processing activities. It also sources electricity, water and certain other services from IFM. On 27 August 2015, IFM announced that, as a result of deteriorating business conditions, its South African subsidiary had entered a Business Rescue programme – a statutory means of enabling a financially distressed company to continue business under the supervision of a Business Rescue Practitioner, protected from its creditors – and that it would be ceasing mining activity in South Africa. At the time of its FY15 results in mid-September 2015, PAF’s management stated that it was "not in a position to fully assess the impact of the Business Rescue proceedings" on Phoenix Platinum. At the time, Phoenix was (among other initiatives) investigating the feasibility of sourcing material from its Elandskraal and Kroondal tailings dams to maintain production and to mitigate any shortfalls arising from IFM (note that on 29 June it signed an agreement to secure the PGE rights to the Elandskraal surface resource).However, assuming approximately stable throughput and grades, Phoenix’s H1 production result appears consistent with a plant recovery of 30% – implying that it is once again processing oxide, rather than sulphide, material. On a group level, however, the difference is not material to PAF, accounting for only £1.5m (or 4.3%) of attributable earnings on an annualised basis, or 0.08p/share of HEPS and EPS.

Note that, on 15 September 2015, the administrator opined that there is a reasonable prospect of rescuing IFM (South Africa) via a sale of its assets/business and/or equity, albeit the process would probably take two to three months, to which end stakeholders are currently considering a bid for the company from Samancor.

Before this month’s updated trading statement, we were forecasting underlying H116 HEPS and EPS (ie excluding hedging profits) of 0.44pp and H2 HEPS and EPS of 0.99p to give a total for the year of 1.43pp. Adjusting for the final ZARGBP, ZARUSD and GBPUSD forex rates alone increases these estimates to 0.47pp and 1.00pp, respectively.

In addition, ‘traditional’ Barberton output (ie excluding the Barberton Tailings Retreatment Project [BTRP]) of 47,386oz would suggest a mill head grade of 11.32g/t vs a prior expectation of 10.26g/t. Similarly, ‘traditional’ Evander output (ie excluding the ETRP) of 40,017oz would suggest a mill head grade of 6.35g/t vs a prior expectation (based on guidance at the time of FY15 results in August) of 5.68g/t – indicating a sharper recovery from the low grade cycle than anticipated. Adjusting for this updated production guidance alone would increase our HEPS and EPS forecasts to 0.67pp in H1 and 1.05pp in H2, to give a total of 1.72pp for the full year. Inasmuch as 0.67pp is in excess of PAF’s guidance however, this suggests that costs were also higher than expected – eg Evander ZAR2,380/t for underground ore (vs an estimated ZAR2,376/t in H215) and Barberton ZAR3,535/t (vs ZAR3,206/t prior Edison forecast) to give underlying HEPS and EPS of 0.48pp in H1 (as expected) and 1.01pp in H2, to give a total of 1.49pp for the full year.

Estimates for FY16 increase once again, to 1.92pp, once likely H216 forex rates of ZAR23.2764/GBP, ZAR16.1133/USD and USD1.4439/GBP are applied (see Exhibit 6).

Finally, investors should note that all of the above calculations are performed at an assumed H216 gold price of US$1,225/oz. A spot gold price of US$1,141/oz for H216, by contrast, would suggest underlying, full-year HEPS and EPS of 1.60pp. Alternatively, a spot gold price of US$1,174/oz for H216 would suggest underlying, full-year HEPS and EPS of 1.73pp (as shown below in Exhibit 2).

According to Bloomberg (8 February 2016), the mean consensus EPS estimate for PAF for FY16 is 1.507pp, within a range 1.2-2.0pp. Note that our forecasts continue to exclude the Uitkomst colliery.

Updating our long-term forecasts to reflect the above changes, our absolute value of PAF increases from 25.05p to 25.24p, based on the present value of our estimated maximum potential stream of dividends payable to shareholders over the life of its mines’ operations (applying a 10% discount rate).

Note that the above profile assumes that the grade profile at Evander will increase to in excess of 7.00g/t from FY17. We assume gold prices of US$1,372/oz in FY17 and US$1,378/oz in FY18.

In the long term, the key sensitivity affecting our forecasts is the real gold price. Currently, the average of our forecasts for FY17-39 is US$1,454/oz and for CY17-39 is US$1,466/oz.

If the gold price remains at US$1,091/oz in real terms, however, our absolute valuation of PAF reduces from 25.2p to 14.0p (all other things being equal), as shown in the chart below.

In this case, we estimate that HEPS would average 1.79p/share in the period FY18-28 (vs 3.28pp at our long-term gold prices, above).

Of as much significance as its absolute valuation is PAF’s relative valuation. In this case, PAF remains notably cheap (based on our updated estimates) when compared with its South African peers in Exhibit 5, below.

Therefore, on both consensus and our forecasts, Pan African is consistently cheaper than its peers in terms of yield (100% of instances considered over the two years), P/E ratio (100% of instances considered) and EV/EBITDA (at least 87.5% of instances considered).

Pan African had £18.0m in net debt at 30 June 2015, which equated to a gearing (net debt/equity) ratio of 12.3% and a leverage (net debt/[net debt+equity]) ratio of 10.9%. Debt is financed via a ZAR800m revolving credit facility (£34.4m at current exchange rates), which can be expanded to ZAR1,100m (£47.3m). All other things being equal however, net debt is forecast to be ostensibly eradicated by June 2016, under the influence of the improved cash flows engendered by the improved operational performance described above, although before consideration relating to the acquisition of Uitkomst (assuming DMR approval) of ZAR200m (£8.6m at current exchange rates).