Pan African Resources — Setting the scene for FY23 and beyond

Pan African announced its FY22 financial results within the context of known production results, which were released to the market on 14 July. Overall, production in H222 was 1,646oz (1.7%) higher than our prior expectations to result in production for the year that was 2.5% (or 5,668oz) in excess of the company’s formal guidance of 200,000oz:

As in H122, Pan African’s outperformance in H222 could once again be largely attributed to operations at Evander underground, which reported its third largest (implied) adjusted EBITDA in a six-month period under Pan African stewardship, continuing its post-H220 renaissance and cementing its position once again as a major contributor to Pan African’s profitability:

Readers should note that on this measure of adjusted EBITDA, Pan African’s performance in H222 was its third best on record, after H122 and H121, and only fractionally (3.8% or ZAR47.8m) below its record level of ZAR1,264.8m, which it achieved in H122.

PAF’s normalised HEPS in FY22 were 14.6% below our prior expectations, exclusively as a result of costs in H2 that stuck at higher levels than we had previously anticipated which, in this case, were left unrelieved by only a very modest depreciation of the value of the rand versus the US dollar (and appreciation against sterling):

Otherwise, revenue was slightly above and depreciation slightly below our forecasts – the latter as a consequence of the extension of Evander’s underground mine life as a result of the sanctioning of the 25 & 26 Level project (given that Pan African depreciates on a ‘units of production’ basis). While declining, ‘other expenses’ relating to business development expenditure also reduced further and faster than we had expected and are now expected to remain at lower levels into the foreseeable future.

Once again, deferred taxes accounted for the majority (79%) of the total tax charge for the year, with cash taxes paid amounting to only 21% of the total tax charge.

Full details of Barberton’s performance in FY22 and H222 are available in Pan African’s results announcement. In summary however, Barberton’s Fairview underground operation performed solidly during the second half of the year, mainly as a result of accelerated underground development programmes and a focus on optimising ore extraction and increased mining flexibility at the high grade MRC and Rossiter orebodies, where five large platforms (denoted 256, 257, 258, 259 and 358) are currently available for mining on the former and three on the latter. Nevertheless, in May, it still achieved two million fatality free shifts. Of particular note at Barberton during the second six-month period of the financial year was the close control of costs, with unit working costs declining by 3.9% in rand terms, to ZAR4,555.38/t in H222 cf H122, against a background of otherwise generally rising prices. As a result, adjusted EBITDA at Barberton increased by 16.3% in H222 relative to H121 and was the third highest on record, after H121 and H221 (see Exhibit 2).

A key focus for the year ahead will be the smaller underground operations at Barberton Mines to ensure that these high-grade assets perform to their full potential. In the meantime, management has initiated an exploration programme to define additional gold resources for mining at the Sheba and Consort mines. In the table below we summarise Barberton’s performance in H222 relative to our prior expectations and provide our forecasts for FY23.

H222 relative to H122 aggregate cash costs increased by 3.6%, while tonnes milled increased by 10.5% (leading to the decline in costs per tonne noted). Year-on-year, tonnes milled were almost identical in FY22 to FY21 (a change of just -0.9%), while costs increased by 7.8%, or US$7.1m. Nevertheless, this increase should be interpreted within the context of an increase of 8.4% in the group’s overall cost of production from US$208.8m to US$226.4m in FY22. Within this:

Barberton Mines is maintaining its exploration focus on the down-dip extensions of its existing orebodies in FY23. 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.

Production at Elikhulu was characterised by near-record throughput in H222, which recovered from preternaturally high levels of rainfall at the end of H122 and 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, 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 reverted to over 40% in H222 and easily covered capex of ZAR139.6m, despite the latter increasing sharply (as expected) to effect 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 at c ZAR405m 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).

A full analysis of Elikhulu’s performance in H222 relative to both previous half-year periods and our prior expectations is provided in the table below, including our expectations for FY23:

A new re-mining pump station and related infrastructure has been in place for mining to commence at Leslie/Bracken since September 2022, in consequence of which we have revised our immediate production outlook at Elikhulu to reflect the company’s production profile in its full-year results presentation, as shown below:

In addition, where before we had assumed that unit costs would revert to c ZAR40/t processed, we now assume that they will remain at a permanently higher level of c ZAR52/t in real terms to reflect inflationary pressure in the industry apparent in H222. At Elikhulu specifically in FY22, these included:

Excluding these cost increases, we estimate that unit working costs would have been ZAR45.73/t or 10.3% less than the actual ZAR51/t recorded in FY22.

Underground operations at Evander in FY22 recorded a vastly improved performance relative to earlier periods – largely on account of an elevated head grade and albeit slightly tempered by unit cash costs that remained at higher levels and declined to reduce in line with our prior expectations. Although production did decline in H222 cf H122 therefore, it declined by less than our expectations. Similarly, adjusted EBITDA declined in H222 cf H122, but still recorded its third highest level for a six-month period since Evander was acquired by Pan African in February 2013. Nevertheless, Evander Mines’ underground operations achieved a reportable injury free rate of zero during the period (cf 1.32 per million man hours in FY21), despite the increased number of crews deployed underground

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

Management implemented a number of energy efficiency and management initiatives at Evander during the year, including high efficiency motors & 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.

As per its mine plan, the 8 Shaft pillar now has a remaining life of approximately one year, during which it is expected to produce c 44,000oz 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 to progress according to plan. 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 in FY23, with mining of the first stope planned for FY25. As with Elikhulu, we have updated our mine plan for the 25 & 26 Level project – particularly in the earlier years – to reflect that anticipated by management in its results presentation, as follows:

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 US$50.6m, including steel work and development costs, which will be funded from existing cash flows.

As a result of the refinements discussed above (as well as inclusion of Mogale’s production profile into our group financial model), whereas we had forecast that group production at Pan African would reach 288.6koz in FY26 previously (from a guided level of 205koz in FY23), we now forecast that it will reach 253.9koz in FY26 and 272.8koz in FY29 and remain at approximately this level until FY33 (with production from Egoli still pending):

Following completion of its transaction to buy Mintails’ assets, 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 (US$2.9m at prevailing forex rates) 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. 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 life of mine 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 we summarise below:

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

A key sensitivity of our valuation is to the assumption of negligible initial capex. We calculate that the NPV of the project drops to zero in the event that initial capex exceeds US$132.8m, or approximately the same as the estimated initial capex estimate for Mogale (which we therefore think is unlikely).

In the meantime, readers should note that our US$18.2m 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$6.4m cf US$7.6m 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 a DFS scheduled for 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, 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, we estimate a valuation for Elikhulu of c US$77.97 per initial resource ounce or US$102.42 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$4.56/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$124.09 per remaining ounce (or US$78.00 per initial ounce), at steady-state production after initial 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, with an initial 5,000t of the 10,000t sample being processed at the Consort metallurgical plant. An average feed grade of 0.9g/t and metallurgical recoveries of 87% were achieved, relative to the planned 0.7g/t and 85% metallurgical recoveries and results from the remaining 5,000t remain pending. If fully approved by the board, first ore from Royal Sheba could provide feed to the BTRP in FY23, following the installation of a run-of-mine crushing circuit, which will increase its 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.

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 work currently underway includes the establishment of a series of three ore passes between the 23 Level Sheba haulage and the 38 Level Fairview haulage, which is expected to be completed by December 2022.

In recognition of the recent falls in the price of gold, we have adjusted our short-term gold price forecasts from US$1,819/oz in H2 CY22 to US$1,724/oz (note this implicitly assumes that the gold price will remain at US$1,763/oz for the remainder of the year). Thereafter, we assume that it will recover to US$1,749/oz in CY23 before declining 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), our absolute valuation of Pan African (based on its existing four producing assets plus the 25 & 26 Level project and Mogale) is 31.30c (albeit excluding any contribution from Egoli, which we are valuing separately, for the moment, as a standalone project at 13.03c/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):

In general, our forecasts for EPS and DPS have reduced relative to our last note to reflect a lower near-term gold price and higher assumed future costs. As a result, our valuation is lower than our valuation of 44.67c in July 2022. However, it is still approximately the same as our valuation of 33.79c in April 2022, with the major factors behind the change provided in the bridge chart below:

Even so, based on our long-term dividend forecasts, we calculate that an investment in Pan African’s shares at a price of 18.94p offers investors an internal rate of return of 18.2% 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 17 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 (18.94p) 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 5.9x and 5.5x for FY23 and FY24 respectively (based on our forecasts, see Exhibit 20) 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:

Stated alternatively, 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 27.69p in FY23 followed by 29.71p in FY24. Stated alternatively, Pan African’s current share price of 18.94p, at prevailing forex rates, appears to be discounting FY23 and/or FY24 normalised HEPS falling to 2.61c/share (cf 4.44c reported in FY22 and 3.82c forecast in FY23).

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 80% of comparable common valuation measures (29 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 10.4x to our forecast normalised HEPS forecast of 3.82c/share for FY23 implies a share price for the company of 33.7p at prevailing forex rates. Applying its peers’ average year two P/E ratio of 10.0x to our forecast normalised HEPS forecast of 4.10c/share implies a share price of 34.6p.

According to our estimates, Pan African will have the 16th 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 the company’s preparedness 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 only US$12.0m as at end-June 2022, which equated to a gearing ratio (net debt/equity) of just 4.1% and a leverage ratio (net debt/[net debt+equity]) of just 3.9%, after cash flow from operating activities in excess of US$100m in both FY21 and FY22. The company has provided detailed capex guidance of ZAR1.8bn in FY23, in addition to which we predict that it will also invest capital into its recently 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, such that net debt peaks at end-FY24 at US$120.3m (equating to a gearing ratio of 29.8% and a leverage ratio of 23.0%), before being repaid in FY25 when we assume that capex will reduce once again to merely ‘sustaining’ levels.

Pan African reports that it has 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, 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-June 2022 amounted to US$13.0m, 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 22, below, as are (now) leases. The US$1.0m difference in total net debt shown in Exhibit 20, above, compared to that shown in Exhibit 22, below, is accounted for by the ‘other’ entries in Exhibit 20, above, which comprise restricted cash, a refinancing modification adjustment, a facility arrangement fee and derivative financial assets.

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