Posts Tagged ‘Gold Fields’

Feb

PITY THE SOUTH AFRICAN GOLD MINER

Posted by: Mr. Gold in Uncategorized

Earlier this week, ANC’s Youth League issued a policy statement, warning the mining industry of “nationalization [which] may involve expropriation with or without compensation”.

Pity the South African miner. Every day he walks into a dark cage which drops him with a screech some 10 thousand feet (3250m) underground. He then takes a little yellow train which will rattle him and his comrades far away from the shaft. When the train arrives he will walk on in dim light, occasionally plunging his muddy boots into puddles of black water. It is over 40 degrees Celsius (100F) and the humidity rarely drops below 80%. Before reaching the workout, he may need to trudge up a narrow, cramped corridor, slipping on unrelenting scree. It is dark, dusty and dangerous. Packs of explosives lie around, live wires occasionally hang from the walls and many of his comrades are HIV-positive. Worse, several others may have perished in recurrent fall of ground accidents (euphemistically referred to as ‘FOGs’). When he finally reaches the mine face, he will stoop to wield a heavy, yet shaky drill, poking it into the hard, hot rock.

It is a relief to see the sunlight back on the surface. And yet, there has not been much of a relief for South African mining industry. Its safety record has been slow to improve. Attempts to mechanize the older mines have only led to very marginal improvements. And then, there is the lingering threat that the genuine efforts of these brave men (and some women) may again be annihilated by the country’s politics. When in May 2002 the first draft of a new black empowerment regulation was leaked to the press, within several days Johannesburg Stock Exchange index lost nearly 9% of its value. Plans to combine South African giants with their North American counterparts had to be shelved. Averting much more damaging upheaval, the industry leaders engaged in a tortuous process of negotiations which led to the introduction of a new legislation and opened equity pools to business groups led by historically disadvantaged South Africans. Only slowly in this process did the government activists understand that the high profile mining executives do not actually “own” the corporations they managed.

There is no denying that even today the leftist activism retains attractiveness among South Africa’s idealistic youth. South African museums extol the bravery of local Communist heroes in the 1960s and 1970s. Not surprisingly, many ambitious firebrands perceive the legacy industry – mining – as the target of the self-styled “distributive justice” and the State as the main tool to implement such a process. Unfortunately, the experiences of nationalized mining in Africa – from Zambia to Congo – are pitiful. Former mining regions are littered with crumbled installations, devoured by rust, long abandoned by the supposedly salutary hand of the State. If the enrichment of Black Empowerment group in post-2002 South Africa has quite not led to improved conditions in the townships, further ‘nationalization’ threats to the mining industry are not a panacea either.

Where does it leave the South African gold stocks? Since early December, the Johannesburg Gold Stock Index has lost 21% of its value and is now at the level where it was two years ago (February 2007), despite the fact that gold itself – denominated in South African Rand – has since appreciated 74%. Something is clearly wrong.

When South African mining industry ruled the global gold market, its companies were viewed first and foremost as value investments. Deep level shafts required heavy upfront capex and investors demanded a payout from day one. Not surprisingly, the dividend payout ratio was high. The model was jeopardized by the success of North American growth stocks in the 1980s, many of which benefited from the heap leach revolution. These US and Canadian stocks offered no dividends, but reinvested earnings into further acquisitions, promising ‘jam’ tomorrow. For as long as the sheer scale of South African towered over the competition, it did not seem to matter. But the days when one South African company accounted for over 50% of global gold production are now long gone.

South African stocks remain cheap. At current gold prices, and unusually for gold equities, Gold Fields and Harmony have leading P/CF ratios in single digits. AngloGold Ashanti is valued slightly higher – probably due to its portfolio’s lower exposure to South Africa. Some of this discount certainly reflects the higher-than-average cash costs of these producers, at the current ZAR/USD exchange rate.

Although the US dollar has been strengthening recently, the Rand has proved rather resistant. More importantly, later this year the South African mining is facing two step changes which will negatively affect its cost base. First, as of April 1, ESKOM will further hike its power tariffs, an event which has to be taken in the context of overall mining inflation. Then, in May, a new royalty regime will be introduced. The formula is structured in a way that even a loss-making company would have to pay a minimum 0.5% royalty. On average, a profitable enterprise is expected to pay around 3%.

The market expectations are low. The onus will be on the delivery by the management – Harmony is expected to reduce its overreliance on South African risk by proving that it can successfully manage its operations in Papua New Guinea and possibly acquire other assets overseas. Gold Fields – probably the biggest disappointment of the recent years – has to come to grips with the damaging seismic events on its mines. AngloGold Ashanti is expected to advance the turnaround of the former Ashanti assets in Ghana and Tanzania and accelerate the hedge book reduction. The success – or failure of these initiatives is what the investors should watch out for, not the politically marginal posturing by youthful, over-excited demagogues. Unless, of course, ANC bigwigs have used the Youth League upstarts to sound out broader opinion. This time at least, the market didn’t seem to be bothered.