Pan African Resources — Forecast upgrade

Pan African announced its FY23 interim results in the context of known production results, which were released to the market on 30 January and a JSE listing requirement paragraph 3(b) trading statement that indicated both earnings per share and HEPS in the range 1.40–1.64c at the interim stage. The operational review of 30 January provided both H123 output results as well as H223 guidance. Overall, output of 92,307oz for H123 was towards the lower end of the range of what would ordinarily be expected from full-year guidance of 195–205koz (on a pro-rata basis), but was consistent with our expectations, the normal variance in production at PAF’s operations in half-year periods and the fact that the company is still guiding towards production of 103–112koz gold for H223 and 195–205koz for FY23. The improvement in production in H223 will arise from a change in labour practices at Barberton, in particular, which will see the shift cycles at Fairview and Sheba reconfigured to continuous (24-hour) operations, seven days a week (cf five previously), while the Consort Mine will be converted to a contract mining model – a change that was the ostensible subject of a site visit to the Fairview mine on 1 February attended by the analyst and author of this report. At the same time, a new, modern computerised mine planning system will allow mine planning to be conducted as often as every 20 minutes (cf annually previously) and will allow weekly reconciliations between gold mined and expected gold mined.

Subject to the normal permitting process, Pan African will embark upon the development of its Mogale project later this year, which we believe will increase the group’s medium-term production to c 250koz pa in 2026 and push normalised HEPS to close to 6.00c/share.

A summary of both half year results for the period to 31 December and our expectations for H223e and FY23e relative to earlier and forecast periods is provided in the exhibit below:

Most apparent in H123 were the concurrent declines in output at both Barberton and Evander underground. In the case of the former, this could be attributed to increased travelling time to the deeper production stope platforms at Fairview, which resulted in reduced face-time and associated logistical constraints, adversely affecting productivity within the high-grade Main Reef Complex (MRC) section and depletion of the high-grade 42 Level block at Consort. In addition, the reduced strike lengths on the high-grade MRC platforms at Fairview (owing to geological complexity) resulted in a reduction in grades and a decrease in mined tonnes. In the case of the latter, the decrease in 8 Shaft pillar production resulted from the normalisation of mining face grades to c 8g/t (cf 13g/t in H121), in line with planned grades of 7g/t and reduced mining rates and face availability, which affected ore tonnes delivered for processing, following depletion of the mineral reserves in accordance with the geotechnical parameters for the safe extraction of the pillar. As a result, Evander overtook Barberton once again as the second largest contributor towards Pan African’s adjusted EBITDA:

Readers should note that on this measure of adjusted EBITDA, Pan African’s performance in H123 was nevertheless its fifth best on record since at least H116.

While production was lower than in the immediately preceding historical periods, costs (in rand per tonne processed terms) were well controlled at all of Pan African’s five major producing units, while the rand once again reverted to close to its trend rate of decline versus the US dollar (since at least H113):

In the light of PAF’s interim results (as well as the increase in the gold price to US$1,855/oz cf US$1,749/oz forecast at the time of our last note on the company in 2022 (see Setting the scene for FY23 and beyond, published on 14 November 2022), our revised forecasts for the group for H223 and FY23 are as follows:

Once again, deferred taxes accounted for the majority (93%) of the total tax charge for the year, with cash taxes paid amounting to less than half the total tax charge.

Full details of Barberton’s performance in H123 are available in Pan African’s results announcement. In summary however, the decline in production at Barberton relative to previous periods could be attributed to increased travelling times to the deeper production stope platforms at Fairview, which resulted in reduced face-time and associated logistical constraints, adversely affecting productivity within the high-grade MRC section and depletion of the high-grade 42 Level block at Consort. In addition, the reduced strike lengths on the high-grade MRC platforms at Fairview (owing to geological complexity) resulted in a reduction in grades and a decrease in mined tonnes. Of particular note at Barberton during the first six-month period of the financial year was the close control of costs, with unit working costs declining by 4.6% in rand terms, to ZAR4,523/t in H123 relative to the prior year period, against a background of otherwise generally rising costs in the industry. This was achieved as a result of cost-saving initiatives such as the implementation of new time and attendance software and a reduction in production bonuses and despite an increase in vamping and toll treatment costs and a 15.4% increase in engineering & technical costs (9.7% of the group total) owing to repairs and maintenance on its load, haul and dump (LHD) vehicles.

Nevertheless, multiple mining platforms remain available at the MRC and Rossiter orebodies at Fairview Mine. At a site visit attended by the analyst, it was confirmed that the shift cycles at the Fairview and Sheba Mines will be reconfigured from this month (February) to continuous (24 hour) operations, seven days a week (cf five previously), while the Consort Mine will be converted to a contract mining model. Agreements have been reached with representative unions at both Fairview and Consort, with the result that management is anticipating a materially improved second half, with output guided in the range 41–43koz for H223, as shown in the exhibit below. At the same time, a new, modern computerised mine planning system will allow mine planning to be conducted as often as every 20 minutes (cf annually previously) and will allow weekly reconciliations between gold mined and expected gold mined.

Note that Edison’s production forecast of 41.5koz for H223 is in the middle of management’s guided range of 40–43koz.

In the meantime, Barberton is maintaining its exploration focus on the down-dip extensions of its existing orebodies. In FY22, Barberton Mines conducted underground diamond core drilling programmes in excess of 9,000m and exploration metres drilled will remain at these levels in the foreseeable future. Specific focus is being placed on near-mine in-fill drilling, as well as down-dip reserve delineation drilling of underground mineral resources. Drilling into the down-dip extensions of the orebodies was reported to have yielded excellent results and improved the geological understanding of operations at Barberton as well as demonstrating their extent and quality, while continued drilling has also provided the opportunity for the grade control modelling protocols of the various operations to be upgraded to allow for improved mine design and orebody extraction in conjunction with the roll-out of more advanced and interconnected mining-related software packages to further optimise production. In the meantime, broader-scale exploration drilling is focused on the Hope, Main Muiden and Golden Quarry reefs, with desktop studies being conducted on various known but unmined lower-grade blocks in all orebodies.

Gold production at Elikhulu remained steady at 25,830oz (cf 25,900oz in H122) at an all-in sustaining cost (AISC) of US$947/oz (cf US$937/oz), despite electricity supply disruptions and inclement weather conditions during the November and December rainy season. Operations were once again characterised by near-record throughput despite the heavy rains and an increasing grade profile, which offset higher than expected concentrations of historically processed fine carbon in the lower benches of the Kinross tailings storage facility (TSF) that continued to adversely affect metallurgical recoveries, which remained at lower levels, compounded by the mining of the coarser but high-grade outer wall of the Kinross TSF. As a result, Elikhulu’s share of group adjusted EBITDA remained near 40% in H123 and easily covered capex, which remained high at ZAR159.9m (as expected), owing to the switchover of operations from the Kinross to the Leslie and Bracken tailings storage facilities (Phase 2). Notwithstanding its increase, capex at Elikhulu remained a fraction of that at Pan African’s underground operations and, despite peaking in FY23, will still only approximate sustaining capex at Barberton. With the completion of the TSF extension and the Leslie/Bracken pump station at Elikhulu during FY23, capital expenditure will once again revert to previous (negligible) levels of sustaining capital thereafter (until the transition to the Winkelhaak TSF in 2026).

Management expects gold production from Elikhulu to increase marginally in the second half of FY23, as material from the Leslie/Bracken TSF is re-treated, following the installation of the 6km pipeline and successful commissioning of the pump station in September 2022. A full analysis of Elikhulu’s performance in H123 relative to both previous half-year periods and our prior expectations is provided in the table below, including our updated expectations for FY23:

Re-mining of the Leslie/Bracken TSF will continue for the next five years, whereafter it will move to the Winkelhaak TSF for the remainder of its life. In the meantime, it remains one of the lowest-cost gold mining operations in southern Africa, and is expected to produce an average of c 50koz gold per annum over its remaining 11-year mine life.

Underground production at Evander decreased by 29.8% to 19,173oz (cf 27,312oz in H122) despite an increase in processed tonnes of 6.0% to 73,946t (cf 69,790t). While slightly larger than anticipated, the decrease resulted from:

At the same time, unit working costs reduced by almost a third in rands per tonne processed terms relative to H222, to ZAR4,460/t. In part this reduction was achieved as a result of lower production bonuses, but it also arose as a consequence of a number of energy efficiency and management initiatives in FY22, including high efficiency motors and compressors, and pumps, geysers and motors replaced with power-saving models. Similarly, the recycling of underground water continues to reduce the amount of energy consumed. The reduction in costs was also helped by the capitalisation of salaries, mining and processing and electricity costs related to 24 Level development. As a result, adjusted EBITDA increased 50.5% relative to H222 (despite a US$149/oz lower gold price) to a level that was its third highest on record for a six-month period since Evander was acquired by Pan African in February 2013.

As per its mine plan, the 8 Shaft pillar now has a remaining life of approximately six months, during which it is expected to produce c 22koz gold. Mining at 24 Level will then extend 8 Shaft’s production profile, post cessation of the 8 Shaft pillar mining, for an additional two and a half years from FY23, as the current pillar mining reaches completion, after which the board has also now approved the development capital for Evander’s 25 & 26 Level project, which is expected to increase the 8 Shaft’s mine life to 13 years at an expected annual production rate of approximately c 65,000oz.

For the moment, the 24 Level project remains in its construction phase, with all development and infrastructure placement for mining progressing according to plan, with the equipping of the existing vent shaft from 17 to 24 Level to enable hoisting via the vertical shaft currently underway. The construction of Phase 1 of the underground refrigeration plant on 24 Level is complete and has been commissioned, and will be expanded to provide cooling on 24 Level for steady-state production (Phase 2) in Q423. Phase 1 will allow mining of both the 24 Level F raise line stopes and 24 Level B, C and D raise lines. Phase 2 will allow for additional mining crews to be placed on 24 Level as well as mining on 25 Level in subsequent years. Thereafter, the board has approved the continued mining of the down-dip extent of this orebody on 25 and 26 Levels, using the 24 Level infrastructure. Development leading from the existing 24 Level footwall infrastructure will allow access to both 25 and 26 Levels, with an on-reef decline layout. The mining of 25 and 26 Levels will thereby extend Evander Mines’ 8 Shaft production, post extraction of the 8 Shaft pillar and 24 Level, at an annual production rate of approximately 65,000oz pa. Access development on 25 and 26 Levels is reported to be on schedule. Dewatering on 25 Level is in progress and blasting of development ends will commence this year, with mining of the first stope planned for FY25.

In the meantime, preliminary work has commenced on the Egoli project, where dewatering of the Number 3 Decline started in June 2022. This decline is anticipated to be dewatered to below 19 Level in Q323, after which reserve delineation drilling will commence to accurately define the Egoli pay-shoot for early mining.

Capex for the 24 and 25 & 26 Level projects at 8 Shaft and equipping costs for Evander Mines’ 7 Shaft infrastructure is estimated at c US$50m, including steel work and development costs, which will be funded from existing cash flows.

In the wake of H123 results, we continue to forecast that group production at Pan African will reach 253.9koz in FY26 (from a guided level of 195–205koz in FY23) and 272.8koz in FY29, and remain at approximately this level until at least FY33 (with production from Egoli still pending):

Following completion of its transaction to buy Mintails’ assets in October, Pan African has at least two immediate organic growth projects plus one further corporate growth project (Blyvoor tailings) in prospect for development in the future. Beyond these, it also has at least the Fairview sub-vertical shaft, Rolspruit, Poplar and Evander South assets available for potential development.

On 6 November 2020, Pan African announced it had entered into a conditional agreement with the liquidator of the Mintails group for the purchase of the total share capital and associated loans of Mogale Gold and Mintails SA Soweto Cluster (MSC), comprising a number of TSFs to the west of Johannesburg, for ZAR50.0m (c US$2.9m at prevailing forex rates at the time) and the assumption of a closure environmental liability of c ZAR120m. As part of its due diligence process, on 30 June 2022, Pan African announced that it had successfully completed a definitive feasibility study (DFS) on the Mogale portion of Mintails’ assets. The study demonstrated compelling economics and the potential to significantly increase group gold production by c 25% over an initial mine life of 13 years and this was the subject of our note, Building steam, published on 7 July 2022. On 6 October, Pan African confirmed that it had successfully closed this transaction and, as such, Mogale is now fully incorporated into our valuation of Pan African (below). However, the MSC assets are not.

Although Pan African does not currently include MSC mineral resources in the Mogale mine schedule, a conceptual production schedule for this project was applied, based on available information, entailing the processing of reserves of the combined Mogale and MSC TSFs and demonstrated a more robust recovered ounce profile and an extended mine life for the project in excess of 20 years, as shown below:

Confirmation of the feasibility of including the MSC dumps in the Mogale mine schedule will require further technical studies to be completed. In the meantime, however, we have attempted to quantify what MSC’s valuation could be to Pan African. In formulating this valuation, we have made a number of assumptions, which are summarised below:

On the basis of the above assumptions, we have calculated the following valuation and financial parameters with respect to MSC:

In the meantime, readers should note that our US$20.1m valuation of MSC as a development asset reconciles tolerably closely with our valuation of it of US$11.7m (or 0.61c per share) as an in-situ resource, based on the average value of in-situ gold resources listed in London of US$9.88/oz calculated in our report Gold stars and black holes, published in January 2019.

On 15 December 2021, Pan African announced that it had entered into a conditional agreement to acquire the entire issued share capital of Blyvoor Gold Operations from Blyvoor Gold (Pty) Ltd, subject to due diligence, for a cash consideration of ZAR110m (currently c US$6.1m cf US$6.4m previously). The principal assets of Blyvoor Gold Operations are six historical TSFs with a total mineral resource of 1.4Moz gold at a grade of 0.31g/t and a mineral reserve (as at 1 December 2020) of 0.8Moz gold at a grade of 0.30g/t. A recent (2020) technical study completed to pre-feasibility standards indicated the potential to process c 6Mt of tailings annually by hydro-mining (ie similar to Elikhulu) to produce c 25–30koz gold annually over a life of 15 years (extendable to 25 years) at an expected carbon-in-leach metallurgical recovery of c 54%.

Having concluded an initial ‘fatal flaw’ analysis, Pan African, together with its independent consultants, has embarked on a full fatal flaw assessment and gap analysis as part of its due diligence process and has extended the period for completion of the transaction to coincide with the completion of a DFS. In the meantime, by way of comparison, investors should note that Blyvoor’s resource of 1.4Moz is similar to Elikhulu’s original resource of 1.7Moz, while its initial reserve of 0.8Moz is approximately half the size of Elikulu’s 1.5Moz, albeit at a fractionally higher grade of 0.30g/t (cf Elikhulu’s 0.29g/t). Pan African announced the results of an independent DFS on Elikhulu on 5 December 2016, which demonstrated an NPV9 of US$75.9m (or, then, 5.0c/share, or US$40.95 per resource ounce) at a gold price of US$1,180/oz and a forex rate of ZAR14.50/US$. At the time, we estimated Elikhulu to be worth US$69.9m (or 4.6c/share) at a 10% discount rate and to be capable of adding 1.33p to EPS in the first eight years of its operation (albeit there are now 27% more shares in issue). Now, however, with capex having been expended and associated debt repaid, we estimate a valuation for Elikhulu of c US$81.32 per initial resource ounce or US$106.83 per remaining resource ounce. With suitable caveats therefore, Pan African could be on the cusp of acquiring for US$4.36/oz an asset that should be worth US$9.88/oz as an in-situ resource (see Gold stars and black holes, published in January 2019) and may eventually be worth up to a peak of US$129.36 per remaining ounce (or US$81.32 per initial ounce), at steady-state production after debt repayment.

Royal Sheba is a world-class orogenic greenstone gold deposit, where historical mining has enabled high-resolution modelling of the orebody to be completed and a resource of over 1Moz Au to be defined at an average grade of c 2g/t over mineralised widths averaging 10m delineated by drilling to 150m below surface over a strike extent in excess of 850m.

Historically, Royal Sheba material was treated at Barberton’s Sheba metallurgical plant and existing Barberton milling capacities (especially at the BTRP) are sufficient to cater for a throughput of c 40ktpm of run-of-mine production from Royal Sheba, while grade control drilling results have confirmed expected recoveries. The down-dip extent of the ore body has been proven up to 650m below surface and may be accessed from the 23 Level development at Sheba Mine’s ZK Shaft, but is open beyond that.

Recent development at Royal Sheba commenced in May 2021 via an already established surface adit located approximately 1.2km to the east of the existing Sheba metallurgical plant. The decline and associated cross-cut have provided access for the extraction of a 10,000t bulk sample from historically unmined areas, located 26m below surface, between 6 and 7 Levels, which has now been completed. An average feed grade of 1.22g/t and metallurgical recovery of 84% were achieved (cf 0.5g/t and 85% planned, respectively). If fully approved by the board, first ore from Royal Sheba could provide feed to the BTRP this year, following the installation of a run-of-mine crushing circuit, which will increase the latter’s life by an approximate 18 years. To date, the development has progressed through the historically mined voids, filling them with waste rock followed by capping with steel beams and sets, while aerated cement has been used to stabilise workings. The development plan is set to target the extraction of 40,000tpm from the project at an average head grade of 3g/t over its mine life, which will be achieved by implementing long hole open stoping mining methods from a decline system through the use of trackless mining machinery and automation, requiring a minimal labour complement.

In the meantime, work on the Dibanisa project, which is designed to combine the Fairview and Sheba Mine infrastructures to optimise costs and efficiency, is well advanced. Project Dibanisa aims to connect the underground tramming and hoisting infrastructure of Fairview Mine 38 Level with Sheba Mine 23 Level, allowing underground production below 23 Level from Sheba Mine to be transported to surface using the existing Fairview Mine 2 Decline infrastructure. The hoisted ore will then be processed at Fairview’s metallurgical plant, which will create capacity at Sheba’s metallurgical plant, which will initially be used for the treatment of Royal Sheba ore, thereby reducing the initial capital requirements for the Royal Sheba project. All rails and haulages on both the Fairview project and Sheba Mine’s respective sections have been rehabilitated and a series of three ore passes between the 23 Level Sheba haulage and the 38 Level Fairview haulage established.

In recognition of the recent moves in the price of gold, we have adjusted our short-term gold price forecasts from US$1,749/oz in H223 to US$1,850/oz (note this implicitly assumes that the gold price will remain at US$1,835/oz for the remainder of Pan African’s financial year). Thereafter, we assume that it will decline in real terms to bottom out at US$1,524/oz (real) in CY27 (unchanged).

At the same time, we have adjusted our foreign exchange rates:

In the light of our refinements (as well as revised external factors such as the gold price and forex rates, above), our absolute valuation of Pan African (based on its existing four producing assets plus the 25 and 26 Level project and Mogale) is 32.59c (cf 31.30c previously), albeit excluding any contribution from Egoli. We are valuing Egoli separately, for the moment, as a standalone project at 13.36c/share, on the basis of the present value of our estimated maximum potential stream of dividends payable to shareholders over the life of its mining operations (applying a 10% discount rate):

Stated alternatively, based on our long-term dividend forecasts, we calculate that an investment in Pan African’s shares at a price of 14.60p offers investors an internal rate of return of 20.4% per annum in US dollar terms to at least the end of FY39.

Including its other growth projects and assets, our updated total valuation of Pan African as a whole is as follows:

Exhibit 14 below depicts Pan African’s average share price in each of its financial years from FY10 to FY22 and compares this with HEPS in the same year. For FY23 and FY24, the current share price (14.60p) is compared with our forecast normalised HEPS for FY23 to FY24. As is apparent from the graph, Pan African’s price to normalised HEPS ratios of 4.4x and 4.2x for FY23 and FY24 respectively (based on our forecasts, see Exhibit 19) are very close to the bottom of the range of recent historical P/E ratios of 4.1–14.8x for the period FY10–22:

If Pan African’s average year one price to normalised EPS ratio of 8.6x for the period FY10–22 is applied to our normalised earnings forecasts, it implies a share price for Pan African of c 29.53p in FY23 followed by 30.49p in FY24. Stated alternatively, Pan African’s current share price of 14.60p, at prevailing forex rates, appears to be discounting FY23 and/or FY24 normalised HEPS falling to 2.13c/share (cf 4.44c reported in FY22 and 4.17c and 4.31c forecast in FY23 and FY24, respectively).

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

Alternatively, applying Pan African’s peers’ average year one P/E ratio of 10.7x to our forecast normalised HEPS forecast of 4.17c/share for FY23 implies a share price for the company of 36.8p at prevailing forex rates. Applying its peers’ average year two P/E ratio of 9.4x to our forecast normalised HEPS forecast of 4.31c/share implies a share price of 33.3p.

According to our estimates, Pan African will have the 11th highest dividend yield of any precious metals mining company in the world in FY23. To broaden its strategy to return value to shareholders and given the quality and profitability of its existing operations and growth projects, on 1 April 2022, Pan African announced the initiation of phase one of a share buyback programme to purchase up to ZAR50m (then c £2.6m) of ordinary shares of the company over the course of the month, starting on 1 April on the London Stock Exchange (LSE) and the Johannesburg Stock Exchange (JSE) in approximately equal amounts. Subsequently, on 12 May 2022, Pan African announced that it had completed Phase 1 of its share buyback programme, repurchasing a total of 11.8m shares for a total consideration of ZAR50.3m (c £2.55m), of which a total of 7.6m were repurchased on the LSE at a volume weighted average price of 21.67p and a total of 4.3m were repurchased on the JSE at a volume weighted average price of 418.21 South African cents per share. All shares purchased under the programme were subsequently cancelled, such that the company now has 2,222,862,046 ordinary shares in issue, of which 306,358,058 ordinary shares are held in treasury to result in a post-consolidation figure for shares outstanding of 1,916,503,988 shares.

Although small in initial scale (0.5% of shares in issue prior to the announcement), this initiative nevertheless demonstrates that the company is prepared to consider share buybacks as a means of returning capital to shareholders as and when it is appropriate to do so.

Pan African reported net debt of US$52.8m on its balance sheet as at end-December 2022 (cf US$12.0m as at end-June 2022), which equated to a gearing ratio (net debt/equity) of just 18.1% and a leverage ratio (net debt/[net debt+equity]) of just 15.3%, after cash flow from operating activities of US$31.6m in the six-month period (before dividends). However, this is 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). At the same time, we forecast that the company will continue to generate cash from operations at or above the US$100m per annum level into the foreseeable future, such that net debt peaks at end-FY24 at US$107.0m (equating to a gearing ratio of 26.1% and a leverage ratio of 20.7%), before being eliminated in FY25 when we assume that capex will reduce once again to merely sustaining levels.

Pan African reports that it received a number of financing offers from financial institutions and third-party financiers with respect to the funding of the Mogale project. Following due consideration however, it has agreed a credit-approved and underwritten term sheet with RMB for US$80.0m of senior debt, for part funding of the project’s construction. In the meantime, it reports that it is in the process of evaluating a number of further funding options for the balance of its capital requirement, with the intent of having the funding package finalised by March 2023.

Note that, including all other components, total net debt as at end-December 2022 amounted to US$53.7m, as shown below:

Readers are reminded that Pan African’s liability to Redink Rentals relates to its funding of the solar photovoltaic renewable energy plant located at Evander Mines and, as such, is included in long-term and short-term borrowings in Exhibit 19, below, as are leases. Otherwise, the US$0.9m difference between net debt, as apparent on Pan African’s group balance sheet of US$52.8m and its net debt of US$53.7m as per Exhibit 17 is accounted for in terms of the US$0.8m in ‘other’ items in Exhibit 17 plus rounding.

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