Pan African Resources — Quietly getting the job done in South Africa

Pan African announced its H121 financial results within the context of known production results, which were released to the market on 19 January. Overall, production in H122 was 9,699oz (9.9%) higher than H121 and 4,694oz (4.5%) higher than in H221. Together with our production forecasts for H222, this result in H122 also implies that Pan African will exceed its (updated and upgraded) production guidance for the year by c 4,042oz (2.0%):

In general, Pan African’s outperformance in the first half could once again be attributed to operations at Evander underground, which reported its largest single adjusted EBITDA in a six-month period under Pan African stewardship and contributed more to the group than any other single business division, despite (for example) production being little more than half its level in H213:

Elsewhere, gold production at Barberton was in line with the mine plan. Production from Elikhulu decreased by 3.6% relative to the prior year period, primarily as a result of above average rainfall and lightning storms in November and December 2021, which prevented increasing throughput from mitigating a reduction in plant recoveries due to higher than average concentrations of carbonaceous material in the lower benches of the Kinross dam.

Exhibit 3 presents our updated expectations for H222 both in light of Pan African’s H122 results and recent historical results. In general, both earnings and headline earnings were consistent with our prior FY22 forecasts. Two notable features were a decline in the depreciation charge relative to H221 as a result of the extension of the projected life of Evander’s underground operations with the sanctioning of the 24 Level project (given that Pan African depreciates on a ‘units of production’ basis) and the continuation of ‘other expenses’ at relatively high historical levels owing to growth in business development expenditure (albeit this is anticipated to abate in the future). Elsewhere, the tax charge decreased to US$15.6m, or an effective tax rate of 25.3%, owing to the reversal of temporary deferred tax differences relating to the settlement of certain long-term incentive share schemes.

Once again, deferred taxes accounted for the majority (75%) of the total tax charge for the six-month period. Cash taxes paid amounted to only 23% of the total tax charge.

Barberton continued to reap the benefits of increased mining flexibility in H122 with the establishment of four platforms from which to cycle high-grade production at the Main Reef Complex (MRC) orebody. Notwithstanding being in line with Barberton’s mine plan, gold production was nevertheless 6% lower than in both H121 and H221 as a result of:

As a result, although adjusted EBITDA at Barberton decreased relative to H121, the decrease was relative to a record high and it nevertheless more than covered capex of ZAR183.3m. In addition, the improved flexibility resulting from accelerated underground development programmes has now increased the face length available for mining to over 200m (cf 130m at end-FY20) while, at the 257 platform, geological mapping and reserve delineation drilling have identified mineralised widths in excess of 15m (cf the usual 7m ordinarily encountered on the upper platforms).

Although the increase in Barberton’s unit working costs of 8.2% (in ZAR/t terms) was above average group, it should be seen within the context of the following company-wide increases in costs:

The PC Shaft Level 42 project at Barberton’s New Consort operation contributed significantly to production in the prior year period. Following this performance, a cemented backfill grout plant was commissioned at New Consort to assist in supporting the poor ground conditions associated with the highly altered (but high grade) schistose orebody and also volume extraction. Secondary support on the strike and down-dip extensions of the orebody is being installed, while the final cuts of the 42 Level block are extracted, albeit at a slower rate owing to unfavourable ground conditions. It is envisaged that the down-dip extension of the orebody will then be accessed during the fourth quarter of FY22. Further high-grade mineralisation has also been identified on the PC Shaft’s 20 Level, where exploration and establishment activities are underway.

In the meantime, mining of the high-grade Thomas and Verster orebodies at Sheba has assisted in maintaining the mine’s production profile over the past two reporting periods. Development on the 37 Level haulage in the ZK orebody has intersected high-grade cross-fractures, which are currently being explored and also prepared for mining activities. Elsewhere, Project Dibanisa (which effectively connects the underground workings of the Fairview and Sheba mines), is progressing on schedule. This project is aimed at decreasing the operational cost of the Sheba operation by hoisting the ore from Sheba Mine’s MRC Shaft, utilising Fairview Mine’s infrastructure above 2 decline and is scheduled for completion by the end of FY22, with the first Sheba ore expected to be hoisted at Fairview in FY23. It will also create further capacity at Sheba Mine’s ZK Shaft for the hoisting of Royal Sheba ore from 23 Level, when the 23 Level development intersects the Royal Sheba lowers, which will significantly reduce Royal Sheba’s capital requirements.

In the period under review, Barberton Mines conducted 5,003m of near-mine and exploration drilling (cf 3,502m in H121) in order to delineate and de-risk the near-term mine schedule. Plans for the next six months at Barberton Mines include an increase in near-mine and broader-scale exploration drilling, with exploration targets including the Hope Reef, MRC, Consort Contact Reef and Main Muiden Reef. Desktop studies are also being conducted on various other known but unmined lower-grade resource blocks.

Gold production at Elikhulu increased by 5.3% in H122 cf H221 as a result of a 16.8% increase in the grade in the material mined and despite a 13.2% decline in plant recoveries as a result of higher than expected concentrations of historically processed fine carbon in the lower benches of the Kinross tailings storage facility (TSF), which adversely affected metallurgical recoveries, compounded by the mining of the coarser but high-grade outer wall of the Kinross TSF, which also acted to reduce recoveries. In addition, operations were disrupted by above average rainfall and associated thunder storms in November and December.

As a result, whereas we calculated that Elikhulu accounted for 47% of group-wide H120 adjusted EBITDA, 91% of H220 adjusted EBITDA and 68% of FY20 adjusted EBITDA, since then we estimate that it accounted for 39% of H121 adjusted EBITDA, 27% of H221 adjusted EBITDA, 33% of FY21 adjusted EBITDA and 29% of H122 adjusted EBITDA. Nevertheless, while adjusted EBITDA at Elikhulu was comparable in magnitude to that of both Barberton and Evander (see Exhibit 2), its capex was still an order of magnitude lower (eg ZAR28.9m cf c ZAR160m), such that it almost certainly remained the largest contributor to the group’s operational cash flow.

Elikhulu’s AISC increased by 27.1% to US$937/oz relative to the prior year period, mainly owing to an increase in salary costs as a result of a change in the incentive structure, an increase in headcount and a decrease in recoveries and production.

Capex at Elikhulu will continue to increase in FY22 as it transitions from Phase 1 of its operations (the re-mining of Kinross tailings) to Phase 2 (the re-mining of Leslie and Bracken tailings), necessitating the installation of approximately 6km of piping and a pump station between the plant and the areas to be mined. Thereafter, it is expected to produce approximately 60,000oz gold pa until FY26. For the final seven years of operation, as re-mining transitions to the Winkelhaak tailings storage facility (TSF), Elikhulu is expected to produce c 50,000oz gold pa (excluding c 102,000oz inferred mineral resources delineated in the soil material beneath the existing TSFs).

In the current year, we expect Elikhulu to produce 51,500oz gold (see Exhibit 1), with improved throughput and higher recoveries from the planned re-mining of areas on the upper benches of the number three Kinross TSF dam (in line with its mine plan from the start of production).

Relative to prior periods, underground operations at Evander in H221 recorded a vastly improved performance, with both tonnes processed and grades increasing materially at the same time that unit costs (measured in ZAR/t) decreased materially, to result in a near seven-fold increase in adjusted EBITDA (cf H121) to a level that is a record for underground operations at Evander since they came under Pan African ownership and management in H213.

The increase in unit working costs at Evander could be attributed to:

Gold production from the 8 Shaft pillar is expected to reduce in H222 as mining progresses to areas with lower estimated grades. As per its mine plan, the 8 Shaft pillar now has a remaining life of approximately one and a half years, during which time it is expected to produce c 60,000oz gold at a rate of c 40,000oz pa. 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 and maintain annual production at c 34,000oz pa. Mining from this level is anticipated to commence in FY23, as the current pillar mining reaches completion, after which the board has also now approved the development capital for Evander’s 25 and 26 Level project, which is expected to increase the 8 Shaft’s life of mine to 13 years at an expected annual production rate of approximately 65,000oz.

Pan African has at least two immediate organic growth projects plus two further corporate growth projects in prospect for development over the course of the next four years. Further into the future, it also has at least the Fairview sub-vertical shaft, Rolspruit, Poplar and Evander South assets available for potential development.

One of the assets with the most immediate optionality in the company’s portfolio is Mintails/Mogale, which could yet prove very similar in nature to Elikhulu, and into which Pan African is currently conducting a due diligence exercise with a view to acquisition.

On 6 November 2020, Pan African announced it had entered into a conditional agreement with the liquidator of Mintails’ assets for the purchase of the total share capital and associated loans of Mogale Gold and Mintails SA Soweto Cluster. Due diligence has been extended until 31 August 2022. In the meantime, Pan African has successfully concluded both a fatal flaw analysis and a high-level financial evaluation of the project (which would be similar in nature to Pan African’s flagship Elikhulu project). In July, it subsequently completed a pre-feasibility study (PFS) on the Mogale Gold assets. Key outcomes of the PFS (cf the financial evaluation) are as follows:

While not explicitly reported in the results of the PFS, metallurgical recoveries were estimated to be c 53% in the initial financial evaluation (cf Elikhulu’s 48%). In the meantime, by way of comparison, investors should note that Mintails’ and Mogale’s aggregate resource of 2.36Moz compares favourably to Elikhulu’s original resource of 1.7Moz and its initial reserve of 1.5Moz, but at a fractionally higher grade of 0.30g/t (cf Elikhulu’s 0.29g/t). Pan African announced the results of an independent definitive feasibility study (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 28.0% more shares in issue). Now, however, with capex having been expended (albeit with not all associated debt having quite been repaid), we estimate a valuation for Elikhulu of c US$139.25 per initial resource ounce or US$182.92 per remaining resource ounce. As such, and albeit with suitable caveats such as the Mintails/Mogale assets developing in a similar fashion to Elikhulu, Pan African could acquire for US$1.31/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), could be worth US$23.98/oz (pre-development) and may be worth up to US$206.60 per remaining ounce (or US$124.48 per initial ounce), post-initial capex and debt repayment.

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, subject to due diligence, for a cash consideration of ZAR110m (currently US$7.6m). 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’ due diligence process, Pan African is now proceeding with a DFS until December 2022. 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, its initial reserve of 0.8Moz is approximately half the size of Elikulu’s of 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 28.0% more shares in issue). Now, however, with capex having been expended (albeit with not all associated debt having quite been repaid), we estimate a valuation for Elikhulu of c US$139.25 per initial resource ounce or US$182.92 per remaining resource ounce. As with Mintails/Mogale (above), and albeit with suitable caveats, Pan African could therefore be on the cusp of acquiring for US$5.40/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 be worth up to a peak of US$206.60 per remaining ounce (or US$124.48 per initial ounce), at steady-state production after initial capex and debt repayment.

After previously sanctioning the development of Phase 1 of the number 2 decline on 24 Level at 8 Shaft, Pan African’s board has also now approved the capital required for the development of the 25 and 26 Level project.

An integral component of the Phase 1 study was the identification of pre-May 2018 problems at Evander underground and appropriate mitigation of the major challenges encountered during the mining of the Kinross orebody. These included:

Development leading from the existing 24 Level footwall infrastructure will then allow access to both the 25 and 26 Levels, with an on-reef decline layout. The mining of 25 and 26 Levels will extend 8 Shaft’s production profile for an additional eight years after the completion of the 24 Level project at an annual production rate of c 65,000oz pa. A summary of the salient features of the 25 and 26 Level project is as follows:

The existing 24 Level footwall infrastructure will intersect the reef horizon on 25 Level. The project development plan is then to access the higher-grade ore extending deeper and to the northwest of the current 24 Level mining area via a twin-barrel, on-reef decline system. Owing to the shallower dip in the area, sub-levels will be introduced to limit mining back-lengths to around 150m. In the meantime, the mining method employed at 25 and 26 Levels will be a hybrid of conventional breast mining and mechanised trackless on-reef development. Stope faces will be drilled using traditional handheld pneumatically driven air leg-assisted rock drills. Blasted ore will be cleaned by means of a series of scraper winches from the face into strike and centre gullies. Ore will be collected in ore loading bays at the bottom of the raise and then loaded with diesel-driven load haul drivers and tipped onto strike conveyors running along the sublevel strike drives. The strike conveyors will deposit the ore onto the decline dip conveyor, which will tip the ore into ore silos between 24 and 25 Levels. Ore will then be drawn on 25 Level and transferred by diesel locomotive to the existing 2 decline conveyor on 25 Level. As a result of the on-reef development layout, limited waste from 25 and 26 Levels will be blended with the ore stream prior to processing at the Kinross metallurgical plant.

Among other things, the development of the Evander mine’s 24, 25 and 26 Levels from existing 8 Shaft infrastructure is expected to result in a materially reduced capital outlay for Egoli when compared to its earlier standalone development plan. As a consequence, Egoli will now be developed in a phased approach, with dewatering expected to start before the end of the current financial year, followed by mineral reserve delineation drilling to accurately define the pay-shoot prior to mining.

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 delineated at an average grade of c 2g/t over mineralised widths averaging 10m 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 will provide access for the extraction of a 10,000t bulk sample in 2022. 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 was used to stabilise workings. The ore extracted from the bulk sample area will be treated at the New Consort and Sheba metallurgical plants. If fully approved by the board, first ore from Royal Sheba could be produced as early as FY23.

The 24 Level project at Evander underground has been included in our forecasts since the time of our last note (see Everything falling into place, published on 28 October 2021). In the light of the announcement of the board’s recent approval of the project however, for the purposes of our financial forecasting, we have also included production and costs from the 25 and 26 Level project now as well, as follows:

Offsetting this to some extent however, we have now removed the Egoli project from our forecasts, not because we do not believe that it will be developed but owing to the uncertainty surrounding the timing of its development. As noted previously, Pan African will implement a phased approach to the development of Egoli. Whereas we had previously assumed that capex for Egoil would be expended in FY21–23 with production beginning in FY23, we are now assuming that Pan African will develop and mine the 24 Level project in FY22–26 and will then phase in the 25 and 26 Level project in FY22–25, before embarking on Egoli, albeit this later timing will allow it to be funded from 24 Level and 25 and 26 Level project cash flows, rather than requiring third-party debt finance. In the event that the 25 and 26 Level project is developed however, there will be scope to significantly reduce the upfront capital expenditure uniquely associated with Egoli, though to date, this remains unquantified. In addition, the prior development of the 24 Level and 25 and 26 Level projects will allow Egoli access to both ‘white areas’ and inferred resources that will be mined during the dovetailing of the three projects.

As a result of the above changes to our assumptions (particularly the deferral of the development of Egoli), whereas we had forecast that group production at Pan African would reach 214.0koz in FY26 previously, we now forecast that it will reach 235.8koz (with production from Egoli still pending):

In the light of Pan African’s H122 results and reprioritised development plans (and fractionally revised external factors such as the gold price and forex rates), our absolute value of the company (based on its existing four producing assets including the 24 Level and 25 and 26 Level projects) has decreased by 8c from 41.79c/share to 33.79c (albeit excluding any contribution from Egoli, which are we now valuing separately, for the moment, as a standalone project at 10.40c/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):

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

Exhibit 12 below depicts Pan African’s average share price in each of its financial years from FY10 to FY21 and compares this with normalised headline earnings per share (HEPS) in the same year. For FY22 and FY23, the current share price (22.80p) is compared with our forecast normalised HEPS for FY22 to FY23. As is apparent from the graph, Pan African’s price to normalised HEPS ratios of 5.8x and 6.1x for FY22 and FY23, respectively (based on our forecasts, see Exhibit 18) are close to the bottom of its recent historical range of 4.1–14.8x for the period FY10–21:

Stated alternatively, if Pan African’s average year 1 price to normalised EPS ratio of 8.9x for FY10–21 is applied to our normalised earnings forecasts, then it implies a share price for Pan African of c 34.83p in FY22 followed by 33.00p in FY23.

In the meantime, it may be seen that Pan African remains cheaper than its South Africa- and London-listed gold mining peers on 75% of comparable common valuation measures (27 out of 36 individual measures in the table below) if our forecasts are applied or 69% (25 out of 36 individual measures) if consensus forecasts are applied.

Alternatively, applying Pan African’s peers’ average year 1 P/E ratio of 11.0x to our forecast normalised HEPS forecast of 5.18c/share for FY22 implies a share price for the company of 43.3p at prevailing forex rates. Applying its peers’ average year 2 P/E ratio of 9.6x to our forecast normalised HEPS forecast of 4.91c/share implies a share price of 36.0p.

In order 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, Pan African announced the initiation of phase one of a share buyback programme to purchase up to ZAR50m (c £2.6m) of ordinary shares of the company over the course of the month, starting on 1 April 2022. The shares will be repurchased at a price (excluding expenses) that does not exceed the last independent trade or the highest current independent bid on the relevant trading platform and will be cancelled as soon as practicable thereafter. It is the company’s intention that the repurchases will occur on the LSE and the JSE in approximately equal aggregate amounts. Since its announcement, Pan African has repurchased two tranches of shares:

These two transactions have now been included in our financial forecasts in Exhibit 18, below.

Although small in initial scale (c 11.4m shares, or 0.5% of those in issue prior to the announcement), this initiative nevertheless signals the company’s preparedness to consider share buybacks as a means of retuning capital to shareholders as and when it is appropriate to do so.

Pan African reported net debt to financial institutions of only US$13.3m at end-December 2021 (see Exhibit 16), which equates to a gearing ratio (net debt/equity) of only 4.9% and a leverage ratio (net debt/[net debt+equity]) of just 4.6%. Notwithstanding its capex, share buyback and dividend commitments over the course of the next two years, we are continuing to forecast the company will be, to all intents and purposes, free of net debt to financial institutions by the end of FY22 and will remain so by the end of FY24:

Including all other components, total net debt amounted to US$28.2m, made up of the following components:

This US$28.2m (cf US$39.0m previously) level of net debt equates to a gearing ratio (net debt/equity) of 10.3% (cf 13.8% previously) and a leverage ratio (net debt/[net debt+equity]) of 9.3% (cf 12.1% previously).

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. For the purposes of our financial modelling, debts to non-financial institutions, such as lease liabilities, are included in ‘Other long-term liabilities’ in Exhibit 18, below.

In the meantime, the group remains very comfortably within its revolving credit facility debt covenants to the point at which they are now, to all intents and purposes, irrelevant: