Pan African Resources — Dividend yield trending higher than P/E ratio

On 7 August, PAF announced its production for FY23, which, to a large extent, bore out its estimates of 26 May and are compared in the table below in addition to Edison’s calculation of the production thereby implied for H223:

At the same time, PAF also indicated an 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. It also reported net senior debt of US$18.9m as at end-June, which compared with an estimate of US$25–35m at the time of its 26 May announcement and US$49.9m as at end-December 2022.

From PAF’s announcement, we would conclude the following:

In light of these changes, we have revised our operating assumptions for each of PAF’s underlying operating mines to those shown in the table below (note that our assumptions for surface operations at Evander are not shown, owing to both the fact that it is the smallest of PAF’s operations and also space constraints; however, these may be taken to be the difference between the sum of the four operations shown and the ‘Total’ column):

In addition, we have altered our treatment of depreciation to better reflect run-of-mine (ROM) tonnes mined, given that it is formally calculated relative to its life-of-mine reserve base – hence if ROM production is lower, the charge is commensurately lower.

Finally, with respect to our H223 forecasts, we have also adjusted our forex rates to those shown below for the six-month period January to June 2023 (cf those previously assumed at the time of our last note on 30 May):

Of note is the fact that, contrary to the more orthodox pattern of forex movements, the period from 30 May to 30 June was characterised by strong sterling and a weak dollar with the rand in between.

Taken in aggregate, the consequence of all these changes is to adjust our financial forecasts for H223 to those shown in Exhibit 3, below:

Our final estimate for normalised headline earnings per share (HEPS) of 1.79c in H223 and 3.50c in FY23 compares with the market consensus as follows:

Readers should note the apparent anomaly between the estimate for the year calculated by adding the actual H123 outcome and (apparent) second half forecasts with the full year estimates (ie columns 4 and 5 of the above table). Among other things, this could be taken to suggest that the analysts that forecast annual numbers are not the same as those forecasting on a semi-annual basis (with the possible exception of the analyst at the high end of the market range) or that they are using different financial models. Note that, on balance, we would suggest that it is probably the H223e forecasts shown in the above table that are obsolete.

Shortly before releasing its production numbers for FY23, on 1 August, PAF announced that all conditions precedent to its ZAR1.3bn (c US$69.9m at prevailing forex rates) senior debt facility, designated for the funding of 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$43.0m) in December 2022, completion of a ZAR400m (c US$21.5m) derivative funding structure with RMB in March and the closure of the senior debt facility, the full upfront capital of ZAR2.5bn (c US$134.4m) 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, 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. In this context, steady-state production for Mintails 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 the life of the project, with the orebody still open at depth. 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 Barberton Tailings Retreatment Project (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 annum in 2026 and push normalised HEPS to around 6.00c per share.

In addition to changes to our immediate output assumptions, we have adjusted our long-term foreign exchange rates (in real terms), to reflect the recent strength of the rand, in particular, and also, albeit to a lesser extent, sterling against the US dollar:

In the light of these changes, our absolute valuation of PAF (based on its existing four producing assets plus the 25 and 26 Level project and Mogale) remains virtually unchanged at 34.24c (cf 34.17c 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).

Stated alternatively, based on our long-term dividend forecasts, we calculate that an investment in PAF’s shares at a price of 12.80p offers investors an internal rate of return of 25.6% per annum in US dollar terms to at least the end of FY39.

A summary of the changes to both Edison’s valuation and our FY23 earnings forecasts according to each factor considered in our analysis is as follows:

Including its other growth projects and assets, our updated total valuation of PAF as a whole is provided in Exhibit 8, below:

Exhibit 9 below depicts PAF’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 (12.80p) is compared with our forecast normalised HEPS for those years. As is apparent from the graph, PAF’s price to normalised HEPS ratios of 4.7x and 3.4x for FY23 and FY24, respectively, (based on our forecasts, see Exhibits 3 and 11) remains (in the case of the former) far towards the bottom of the range of recent historical P/E ratios of 4.1–14.8x for the period FY10–22 and (in the case of the latter) below the bottom of that range:

If PAF’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 PAF of 23.51p in FY23 (cf 26.56p previously) followed by one of 32.69p in FY24. Stated alternatively, PAF’s current share price of 12.80p, at prevailing forex rates, appears to be discounting FY23 and/or FY24 normalised HEPS falling to 1.90c per share (cf 4.44c reported in FY22 and 3.50c and 4.86c forecast in FY23 and FY24, respectively).

In the meantime, it may be seen that PAF remains cheaper than its London- and South Africanlisted gold mining peers on at least 86% of comparable common valuation measures (31 out of 36 individual measures in the table below) if Edison forecasts are used or 77% if consensus forecasts are used (28 out of 36 individual measures).

Alternatively, applying PAF’s peers’ average year one P/E ratio of 10.4x to our normalised HEPS forecast of 3.50c per share for FY23 implies a share price for the company of 28.47p at prevailing forex rates. Applying its peers’ average year two P/E ratio of 8.5x to our normalised HEPS forecast of 4.86c per share implies a share price of 32.30p.

Readers’ attention is also drawn to the decline evident in the market’s year two 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.