Pan African Resources — Advancing to 250koz in annual output in FY26

PAF’s FY23 results, announced on 13 September, were closely in line with our forecasts and also confirmed its production results (announced on 7 August), which, among other things, indicated all-in sustaining costs (AISC) for the reporting period in the range of US$1,325–1,350/oz (at an average exchange rate of ZAR17.77/US$) and reiterated output guidance of 178–190koz for FY24. Net senior debt of US$18.9m as at end-June, was also exactly in line with our expectations (see our note Dividend yield trending higher than P/E ratio, published on 18 August) and compared with US$49.9m as at end-December 2022 (see Exhibit 11).

In general, relative to our prior expectations, Barberton underground, Evander underground and the BTRP all recorded a greater throughput tonnage at a slightly lower grade, but also lower unit cash costs in ZAR/t terms (albeit Barberton will have been flattered in this respect owing to a higher proportion of material milled and processed being derived from surface material). At the same time, Elikhulu performed in line with our expectations in terms of output, albeit at slightly higher unit costs, owing to continued electricity supply disruptions and unfavourable weather conditions during the rainy season. The group also sold slightly more gold than it produced in H223, although not enough to make up for the shortfall in sales in H123. Our summary of the group’s aggregate operational results, relative to both H123 and also our prior expectations, is as follows:

As a result, PAF’s revenue in H223 and FY23 was slightly higher than our expectations. Royalties were materially lower and ‘other expenses’ slightly lower, albeit these (positive) variances were almost exactly offset by higher interest costs and a higher tax charge to leave earnings for both the six- and 12-month periods US$2.5m higher than our prior forecasts, translating into 8.5% outperformance for the H223 period and 4.3% outperformance for the FY23 period, as shown in the table below:

In addition to exceeding our forecasts, we observe that PAF’s FY23 EPS was also in the top half of the consensus forecast range.

From the perspective of PAF’s three biggest individual operations (86% of the total), there was a noticeable convergence of adjusted EBITDA around the ZAR358m level (US$19.6m at contemporary foreign exchange rates) in H223 at each of Elikhulu, Barberton and Evander:

PAF has at least two organic growth projects in prospect (namely the Mintails Soweto Cluster and Royal Sheba) for development in the immediate future. Beyond these, it also has at least the Fairview sub-vertical shaft, Rolspruit, Poplar and Evander South assets available for potential development.

Shortly before releasing its production numbers for FY23, on 1 August, PAF announced that all conditions precedent to its ZAR1.3bn (c US$68.8m at prevailing foreign exchange rates) senior debt facility, designated for funding the group’s Mintails project, had been fulfilled and that it had become effective. The senior debt facility was underwritten by Rand Merchant Bank (RMB), with Nedbank acting as co-financier.

As such, following the successful issue of the group’s inaugural Domestic Medium Term Note programme of ZAR800m (c US$42.3m) in December 2022, completion of a ZAR400m (c US$21.2m) derivative funding structure with RMB in March and the closure of the senior debt facility, the full upfront capital of ZAR2.5bn (c US$132.4m) for Mintails’ development has now been secured. At the same time, the South African Department of Mineral Resources and Energy has granted PAF an environmental authorisation for the project in terms of regulation 24(1)(a) of the Environmental Impact Assessment Regulations, 2014.

As a consequence, a process plant is being constructed and steady-state production remains anticipated by December 2024.

Mine layout optimisation and scheduling has now been finalised at Royal Sheba and requests for quotations issued for initial development and production activities. Preliminary optimisation work for life-of-mine planning has been completed at a cut-off grade of 1.7g/t, which implies an average mining grade of approximately 3.0g/t and c 235,000oz gold recovered over an eight-year life, with the orebody still open at depth and the potential for further extensions. In the meantime, DRA Global has finalised the feasibility study for placing a crushing and milling circuit at the Royal Sheba Mine site, together with the design to enable slurry pumping from the milling plant at Royal Sheba to the BTRP. The processing plant’s feasibility study and the project’s financial model are being updated and reviewed. A phased approach to capital spending, based on the availability of material to feed the BTRP plant, is also being considered, which will entail the phased development of the decline and production levels as well as the ventilation infrastructure required for initial stoping operations. First stoped ore is planned in 2025 at 5,000t per month, ramping up to 10,000t, 30,000t and 45,000t per month, every 12 months thereafter in line with a set lateral and vertical development schedule. A trucking cost trade-off analysis indicates that the onsite crushing and milling circuit and pipeline will only be required once production rates reach 45,000t per month. The internal feasibility study for the project is expected to be completed later in CY23.

In the light of these developments (including PAF’s unchanged guidance for FY24), we continue to forecast that group production at PAF will reach c 250koz per year in 2026 and push normalised headline EPS (HEPS) to around 6.00c per share.

In deriving our updated estimates for PAF over the life of its operations, we have made a number of changes, which are summarised below:

In addition to changes to our immediate operational assumptions, we have adjusted our long-term foreign exchange rates (in real terms), to reflect the recent strength of the dollar and the weakness of sterling (with the rand in between):

We have also updated our gold price forecasts to reflect the passage of another year and the fact that we are now expressing all numbers in real CY23 money terms. Our gold price forecasts in the light of this adjustment are as follows:

Finally, we have included deferred tax in our forecasts for FY24–26 (cf only FY23 previously). Readers should note that this has the effect of depressing earnings forecasts for those years. However, it makes no difference to our valuation of the company, given that these are non-cash expenses.

In the aftermath of these changes, our absolute valuation of PAF (based on its existing four producing assets plus the 25 and 26 Level project and Mogale) has risen by a relatively modest 1.0% to 34.59c (cf 34.24c previously), which is based on the present value of the estimated maximum potential dividend stream payable to shareholders over the life of its mining operations (applying a 10% discount rate to US dollar dividends).

While our valuation of PAF, based on these four assets, has not changed materially, we believe this is one of the strengths of such a real terms valuation methodology in an inflationary (or potentially inflationary) environment.

Stated alternatively, based on our long-term dividend forecasts, we calculate that an investment in PAF’s shares at a price of 14.28p today offers investors a (real) internal rate of return of 25.1% per year in US dollar terms to at least the end of FY39.

Including its other growth projects and assets, our updated total valuation of PAF as a whole is provided in Exhibit 7, below.

Exhibit 8 below depicts PAF’s average share price in each of the financial years from FY10 to FY23 and compares this with HEPS in the same year. For FY24 and FY25, the current share price (14.28p) is compared with our forecast normalised HEPS for those years. As is apparent from the chart, PAF’s price to normalised HEPS ratios of 3.3x and 3.1x for FY24 and FY25, respectively, are below the bottom of the range of recent historical P/E ratios of 4.1–14.8x for the period FY10–23:

If PAF’s average year one price to normalised EPS ratio of 8.4x for the period FY10–23 is applied to our normalised earnings forecasts, it implies a share price for PAF of 36.29p in FY24 followed by one of 38.22p in FY25. Stated alternatively, PAF’s current share price of 14.28p, at prevailing foreign exchange rates, appears to be discounting FY24 and/or FY25 normalised HEPS falling to 2.12c per share (cf 5.40c and 5.69c forecast, respectively).

In the meantime, it may be seen that PAF remains cheaper than its London- and South Africanlisted gold mining peers on at least 94% of comparable common valuation measures (34 out of 36 individual measures in the table below) if Edison forecasts are used or 86% if consensus forecasts are used (31 out of 36 individual measures).

Alternatively, applying PAF’s peer average year one P/E ratio of 9.6x to our normalised HEPS forecast of 5.40c per share for FY24 implies a share price for the company of 27.24p at prevailing foreign exchange rates. Applying its peer average year two P/E ratio of 8.1x to our normalised HEPS forecast of 5.69c per share implies a share price of 35.17p.

Readers’ attention is also drawn to the decline evident in the market’s year one yield estimate for PAF, which appears to suggest that it believes the company will cut its dividend in FY24 (or that the rand will fall very sharply versus the US dollar, but that this will not be reflected in the company’s results), which we regard as highly unlikely, except in extenuating circumstances.

Pan African reported net debt of US$22.1m on its balance sheet as at end-June 2023 (cf US$53.7m as at end-December 2022), which equated to a gearing ratio (net debt/equity) of just 7.5% and a leverage ratio (net debt/[net debt+equity]) of just 7.0%, after cash flow from operating activities of US$88.5m before dividends in H2 (cf US$31.6m in H1). However, this was in line with our expectations for the full year, given the company’s capex guidance of ZAR1.8bn for FY23 (plus investment into its newly acquired Mogale asset).

Capex guidance for FY24 is ZAR2.9bn (c US$152.2m at prevailing foreign exchange rates). At the same time, we forecast that PAF will continue to generate cash from operations at or above the US$100m pa level into the foreseeable future, such that net debt peaks at end-FY24 at US$76.8m (equating to a gearing ratio of 20.9% and a leverage ratio of 17.3%), before being eliminated in FY25 when we assume that capex will once again return to near-sustaining levels.

Readers should note that the implication of our forecast of a positive net cash balance at end-FY25 is that, all other things, being equal, PAF might be in a position to increase its dividend that year. For the moment, we have decided to leave our dividend forecasts flat in rand terms in FY24 and FY25. However, we will keep this assumption under review.

Including all other components, total net debt as at end-June was US$22.0m (cf US$53.7m at end-December), as shown below:

The US$0.1m difference between net debt, as apparent on PAF’s group balance sheet of US$22.1m, and its net debt of US$22.0m as per Exhibit 11 is accounted for by the US$0.1m in ‘other’ items.

In the meantime, the group remains very comfortably within its revolving credit facility debt covenants: