Sylvania Platinum — Lower rhodium prices overshadow strong production

The rhodium price has collapsed during Q423; it has dropped by 50% since the beginning of April 2023, with a 41% decline since the beginning of June 2023 alone. Sylvania is very sensitive to the level of the rhodium price as the company has up to 12% of the metal in its prill split. We had already reduced our near-term forecasts for rhodium in our 4 May update note by 18% for FY23 and 20% for FY24 and highlighted the sensitivity of our valuation of 11.5% for every 10% reduction in the rhodium price. At that stage, we did not revise our long-term rhodium price forecasts of US$17,595/oz from FY27. However, the subsequent decline in rhodium spot prices to around US$4,100/oz has necessitated further forecast adjustments, including a sharp moderation to our long-term forecasts.

Rhodium is used mainly in emissions control in catalytic converters or autocatalysts for cars, light- duty trucks and heavy-duty trucks. China is the largest car market in the world where demand has collapsed because of its COVID-19 shutdowns. This has resulted in a build-up of unsold China 6A emissions-compliant car stocks, which are being sold before 6B-compliant cars are brought in for sale. Furthermore, Chinese and Western fibreglass manufacturers have thrifted their rhodium content in the dyes used in the manufacture of fibreglass and this thrifted metal is now available for use by the autocatalyst-makers. As a result, supply has increased and demand for rhodium reduced.

The deadline for sales of 6A-compliant cars in China has been extended to December 2023 and, as a result, we think that current levels of rhodium prices will persist at least until then, and possibly into 2024. By 2025, however, Euro 7 and Tier 4 (US) legislated emission limits will come into force and heavy-duty emissions legislation in these and other jurisdictions around the world will see higher demand and better prices beyond 2025.

Despite the current price being US$4,100/oz, it is still at a level higher than it was in May 2019, which was the point at which the rhodium price began its substantial rise (see Exhibit 3).

Given the prevailing rhodium spot price weakness and the uncertain near-term outlook, we have again reduced our near- and long-term rhodium and palladium price forecasts (Exhibit 1), which follows the prior reductions in our price assumptions made in May.

This compares to our previous forecasts as shown in Exhibit 2.

The rhodium market, at around a 1Moz pa demand, is small compared to the 10Moz pa palladium market, the 8Moz pa platinum market and the gold market at 130Moz pa. Volatility in the rhodium market is high because it is a less transparent market and, when significant supply suddenly comes from a previously unconventional source, like the glass industry, fluctuations in its price can be significant. When demand returns, the rhodium price could recover swiftly.

Our PGM price forecasts assume an increase in FY25 because of expected higher vehicle sales combined with higher demand as Euro 7 legislation for light vehicles comes into force and Tier 4 standards come into play in the United States and North America, possibly followed by China 7 emissions regulations (though the date of implementation is not yet certain).

A rhodium price chart over the last five years (Exhibit 3) shows its volatility compared to other PGM prices. Our adjusted rhodium forecast profile now allows for a recovery to US$10,000/oz by FY30, supported by increased vehicle sales and supply constraints, followed by a stable price thereafter, which is 43% lower than our previous long-term forecast levels. We consider this a prudent level in the current environment, with the potential for future revisions as market visibility improves. Please refer to the Sensitivity section below, which highlights such revision potential from our downgraded valuation.

Q423 saw a 22% increase in plant feed versus Q323, which was 4.5% higher than our expectation. PGM plant feed increased by 11.6%, 12.6% higher than our estimate, with a 5.7pp decline in feed grade from Q323. 4E PGM and 6E production were 6.4% and 6.6% ahead of Q323 (5.1% and 3.7% ahead of our expectation, respectively).

Achieved basket price was 18.2% down on Q323 and 26.2% lower than our expectation, mainly because of the lower rhodium price, resulting in 4E revenues 28.0% lower than expected and total revenue (allowing for sales adjustment) 26.9% lower than our expectation.

Total South African rand operating costs were 10.6% lower than we had forecast due to our anticipated higher cost increases than Sylvania achieved. Total US dollar operating costs were 15.4% lower because of a 5% fall in the rand against the US dollar.

On the back of a lower PGM basket price, Q423 group EBITDA was down 20.2% and was 45.7% below our forecast.

Cash balance decreased to US$125m from US$144.2m on the back of the company’s interim dividend of 3p per share, capex of US$6.2m and rand depreciation affecting South African cash balances in US dollar terms, as well as US$13m in taxes (dividend withholding tax, provisional income tax and mineral royalty tax). The increased capex (US$6.2m) in Q4 was spent on work on tailings dams at various plants and the MF2 plant at Lannex.

Exhibit 4 shows the quarterly results and the variance between our forecasts and Q423 financials.

We have revised our valuation for producing assets downwards because of our updated rhodium forecasts, which has reduced our EPS and long-term cash flow forecasts. We have maintained the value of the exploration assets at book value at 13.8p per share, resulting in a total valuation for Sylvania of 118.2p per share, down from our previous valuation of 173.7p per share.

Edison values operating mining resources companies at a 10% real discount rate based on the dividend discount model (DDM), allowing for a constant currency approach to forecasts.

Our longer-term forecasts used in our DDM allow for maximum supportable dividends towards the end of our explicit forecast period (FY40), which results in a 100% payout ratio in FY40 and implied thereafter. Prior to FY40, and given the high current cash balances on Sylvania’s balance sheet, we allow for a gradual cash drawdown via higher payout ratios (ie dividend payouts somewhat higher than the net cash generated by the business), resulting in a US$50m cash balance at the end of FY40 compared to the FY23 ending cash position of US$125m.

As a result of the meaningful reduction in our near-term rhodium and palladium forecasts and the moderation of our long-term rhodium forecasts, our valuation for Sylvania’s producing assets has been reduced by 34.8% to 104.4p per share from 159.9p per share. This adjusted valuation allows for some moderating effects relating to long-term cost inflation and cash payout assumptions, where we have reduced our levels of conservatism relative to prior valuations (weaker South African rand moderating US dollar costs and reduction in cash balance to US$50m by FY40).

We continue to conservatively value Sylvania’s exploration assets at its book value of US$46m or 13.8p per share. We had previously flagged upside potential in this valuation of up to 59.1p per share because of Volspruit but, in the light of our rhodium forecast downgrades, this upside potential is under review. We will reassess this upside, as well as the upside from the Far North Limb and Volspruit South Body projects, once Joint Ore Reserve Committee (JORC)-compliant mineral resource estimates are published by the company.

The key risks (both upside and downside) to our valuation relates to PGM prices, with cost increases at the operations in rand terms and the currency impacts of the rand to the US dollar also playing a role. Because of the importance of rhodium to Sylvania’s valuation, we have given sensitivities of its value to the rhodium price in most of the reports that we have published.

In our May update note, we showed in Exhibit 5 that the base case value of 160p per share (operating asset value) reduces to 123p per share, or a 23% drop in value, with a 20% decline in the rhodium price. With the adjustment of our long-term rhodium price forecasts, the actual reduction in our producing-asset valuation was also higher at 34.8%, albeit allowing for some offsetting factors (long-term US dollar cost inflation and higher cash payout assumptions), this results in our base case value of 104.4p per share (Exhibit 5).

We show the sensitivity of our downgraded Sylvania producing asset valuation of 104.4p per share in Exhibit 5 to lower and higher rhodium prices, eg a 30% drop in the basket price from current levels would result in Edison valuing Sylvania’s operating assets at 70p per share or a 32.8% decline on our current value. A 30% rise in our long-term rhodium price assumption would result in an increase in our producing asset valuation to 139p per share and our combined valuation to 153p per share.

End-June (Q423) cash was US$125m, having declined from US$144.2m at the end of Q3 because of the company’s interim dividend of 3p per share (US$9.9m), dividend withholding tax (US$1.3m), mineral royalty tax (US$2.5m), provisional income tax (US$9.9m), share buy-backs (US$3.6m) and increased capex (US$6.2m) in Q4 spent on the work on tailings dams at various plants and the MF2 plant at Lannex.

Exhibit 6 shows our forecasts to FY25. We see a decline in EBITDA to US$39m in FY24e due to our lower forecast PGM prices and anticipated cost increases. The new MF2 circuits installed at each of the SDOs, bar Lannex (due to be installed in H124), will further improve metal recoveries.

We estimate that costs will rise by 6.3% in FY24 due to continued inflation and the possibility that ESKOM (South African power utility) power cuts will become significantly worse from FY24 onwards. As a result, power costs are likely to add to total costs.

As our PGM price forecasts rise in FY25, we see a rebound in EBITDA from US$39m in FY24 to US$46m in FY25. Our EPS forecasts for the next three years show declining headline EPS (HEPS), from 20.4c per share in FY22 to 18.3c per share in FY23, falling further to 9.0c per share in FY24 (when we see the rhodium price averaging US$6,000/oz) and rising to 11.2c per share in FY25, in line with our PGM price forecasts and cost increases that we anticipate because of the factors mentioned above.

We expect ordinary dividends to reduce in FY23 to 5.8p per share, from 8.0p per share in FY22, and to 3p per share in FY24, before rising to 4.0p per share in FY25.

We expect Sylvania to continue to be cash generative with little or no debt over the next few years. Because of this ability to generate cash, we forecast cash levels in FY24 to increase to US$135m (currently US$125m) and US$152m in FY25.

Sylvania paid out its first interim dividend of 3p per share in April this year, in line with its new dividend policy which is to pay out a minimum of 40% of adjusted free cash flow for the financial year.

While our forecasts from FY26 onwards (not shown in Exhibit 6 below) have also been negatively affected by reduced PGM forecasts (rhodium in particular), the impact has been less pronounced due to a forecast improvement in PGM prices (with our FY30 rhodium price forecast of US$10,000/oz representing a more modest downgrade). In addition, our longer-term US dollar cost levels have been moderated due to the benefits of a weaker rand.

As a result, while our gross margin is forecast to decline to 35% by 2025, compared to 42% in our previous set of forecasts, it steadily improves thereafter to above 45% in subsequent years as PGM prices are expected to recover and expense efficiencies are anticipated.