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South Africa’s deep level gold mining industry will over the next 10 years almost entirely cease to exist (excluding Gold Fields’ South Deep mine).

This is according to Nedbank precious metals analysts LEON ESTERHUIZEN and ARNOLD VAN GRAAN.

And while this may be tragic news for the country it is not necessarily bad news not for the industry’s prominent role players should they successfully ramp up their efforts to build strong international portfolios, writes LAURA CORNISH.

This article first appeared in Mining Review Africa Issue 2, 2019

“The South African gold industry is rapidly declining,” Esterhuizen begins. “The production numbers confirm this. In the early 1980s the country was producing around 1 000 t of gold a year. Today this has dropped to around 100 t.”

Nedbank’s forecast moving forward suggests that this number will decline to around 50 t in the next five years as the industry continues to shut down non-profitable shafts.

“By 2029 we believe that Gold Fields’ South Deep mine could be the only deep level mine with meaningful production still producing in the country. There could be a few individual shafts here and there, including some in the Barberton area, but at much lower output levels.” Esterhuizen continues.

This is not entirely unexpected

The scenario the gold industry is facing is the result of a series of decisions taken two decades ago – driven by concerns that South Africa was going to become a more ‘politically difficult’ environment to operate in.

“The gold sector underwent significant consolidation in the late 1990s, primarily with the aim of better positioning themselves to evaluate blue sky opportunities off-shore. The potential for profit margins to decrease moving forward were high as political instability and uncertainty plagued the country,” Esterhuizen outlines.

As a result, almost no capital was injected into the development of the industry to build and prepare it for a long-term sustainable future.

In combination with rapidly escalating costs and socio-economic challenges (labour and electricity), the ore bodies were shrinking and the ability to compensate for low tonnages with higher grades at greater depth today is narrowing as most of the best high grade resources have or are being mined out already.

The cost associated with black economic empowerment and other legislative requirements add further cost pressure to the industry.

“The labour environment and other structural changes to the cost base are unfortunately hastening the speed of the industry’s demise,” Van Graan notes at this point.

The solution is a more efficient mining industry that is able to produce gold at a lower cost and at higher volumes.

“If we could find a way to achieve this we could extend our mine’s lives considerably.” “But we don’t have the ability to do that anymore because we have stopped spending capital on the asset base,” says Esterhuizen.

"To arrest the sector’s demise, a much higher gold price would help, supported by fresh capital allocation.

“Having said that, we are not certain this could reverse our current situation. Our asset base has been under-capitalised for at least six or seven years and we no longer have this amount of time to reverse the situation with the current capital being injected into the sector - even if the gold market climate changed today.”

When questioned about the potential for technology to ‘fix’ the problem, both analysts agree that even this option cannot save the industry. “A lot of technologies have already been tested and most have failed.

"We are trying to implement existing technologies and that is not enough. We need radical technological breakthroughs and again, time is not on our side,” Van Graan points out.

But, it’s not all bad news

“For now, South African gold shares represent excellent trading opportunities in our opinion, but therein lies a harsh reality – these are never long-term ‘value’ kind of investments.

"It demands an active trading approach (buying and selling regularly) to derive any pleasure from this space. So, we believe that this is not for the faint hearted and some investors do hold a small (less than 10%) position in the portfolio as insurance for that one in a million chance that the world’s financial markets do go into meltdown.”

Fortunately, long-term futures have been planned for and South Africa’s gold majors have taken many steps in the right direction – to invest and build portfolios outside of the country.

Today, AngloGold and Gold Fields’ South African gold output represents less than 15% of total company production. AngloGold is also considering taking its exit strategy one step further and is looking to leave South Africa entirely, moving its public listing from the Johannesburg Stock Exchange to the London Stock Exchange.

“This will unlikely deliver a re-rating for the company however. We don’t believe there is any necessity to move shareholder bases from South Africa, even if operating and growth pipeline portfolios don’t reside in the country in future,” Esterhuizen notes.

“Support for businesses that deliver returns on their investments remains a solid platform to build companies further from this local base. South Africa still understands gold mining.”

It is also likely that the gold majors may sell off some of their assets – so ownership change in the sector is predicted.

Esterhuizen and Van Graan’s recent investment theses looks at South Africa’s major deep level gold mining companies and reviews their investment value and international portfolio outlook.

AngloGold – Hold

"We believe the AngloGold story is good. However, the company has higher gearing and a more muted growth outlook compared to Gold Fields. We are also of the opinion that the new CEO may steer the company’s strategy in a slightly different direction."

The uncertainty associated with this as well as the continued challenges in the remaining South Africa base could weigh on the valuation, in our view.

"Recent market anticipation of a potential London listing and divestment of its South African exposure will do little, in our view, to improve free cash flow and as such, will be unlikely to lead to any significant improvement in market valuation."

"The risk to our forecast and recommendation is primarily a big change in the gold price. The operational and political risk in South Africa remains a big risk, in our view. Political and regulatory risk in the DRC and Tanzania also remains elevated in our view."

Gold Fields – Buy

"Gold Fields remains our most preferred stock, despite yet another most recent setback at South Deep. Even if it never gets South Deep right, it is not big enough to sink the balance sheet.

"A resolution (fix or sell) on South Deep could see the stock re-rate. Gold Fields generates strong cash flow from the international base (US$200 – 300 million per annum), which would far outweigh any losses from South Deep.

"We continue to hold the view that the rest of the asset base is in good shape and that the market places too much emphasis on the failings at South Deep.

"In our view, the international asset base has been delivering good, strong cash flow, providing a sound dividend and, most importantly, providing potential good internally funded growth over the next two years.

"We believe the stock should start to re-rate as investment capex starts winding down and before free cash flow starts coming through (given delivery on that growth in 2020, we believe Gold Fields should start to react in 2019, particularly given the most recent significant sell-down).

There is good growth coming through from the international base with Gruyere, Asanko and the Damang pit coming through in 2019, while project capex should start coming down.

"Gold Fields, trading at such very low multiples, is naturally also an excellent target for any offshore producer at this stage, in our view.

"Other than a big change in the gold price, a major potential disappointment at South Deep is the only other possible risk to the business.

Harmony Gold – Buy

"Harmony’s operational performance has been very strong over the past year, in our view. Hidden Valley seems to be delivering on its latest promise, and the Moab deal could be transformative if the disappointing recent performance can be turned around.

"That is all very good, but we believe that Harmony faces a big decision when it comes to Golpu and its future growth. There is still a big question mark over its ability to fund Golpu, while many investors, including us, are concerned about the technical risks associated with Golpu.

"Harmony’s large South Africa exposure also remains a drawback, although it does make for solid rand gold price gearing, in our opinion.

"Taking all these factors into account, we see Harmony continuing to lag its larger South African gold peers, but we believe that its valuation is very undemanding, also allowing for a ‘get-in-low’ opportunity.

"Again, other than a change to the fold price, any major announcements of acquisitions or major new capital expenditure and significant operational disruptions could have a material impact on our estimates, given the geared nature of the company.

Pan African Resources – Hold

Pan African is still emerging from the setbacks it suffered in 2018 with the closure of Evander underground and the operational setbacks at Barberton. Although it seems as if the company is slowly getting back on track, especially with Elikhulu stating to deliver, we believe it could be some time before the market regains comfort with the Pan African investment case.

Down to only one asset and a dump operation, most investors that know this space and this team would be expecting new M&A announcements soon, and that compounds the current uncertainty.

Though the valuation multiple has contracted following the setbacks at Evander and Barberton, it is now back above the same for its South African peers. We do not believe the premium rating is warranted yet at this stage given the risks highlighted above.

An operational setback at Barberton or delays at Elikhulu could materially impact our valuation.

Sibanye Gold – Buy

"Our numbers have been pointing to significant upside in Sibanye for a number of months now. We believe that the Stillwater assets are of good quality and should be able to survive throughout the PGM cycle.

"Once Blitz has been completed (2020), the assets should see a steep change in free cash flow generation. The higher palladium price has significantly boosted the prospects of the Stillwater asset.

"The South African PGM operations have also performed better than we expected, with the stronger basket prices being a boon. This has gone a long way to offset some of the losses from the gold operations.

Given the very high debt levels, the negative SA socio-political overlay and the AMCU strike at its gold operations, downside risk remains high.

"We believe the Lonmin deal adds solid PGM basket price gearing – which should see Sibanye perform well if the PGM basket price continues to rise.

"However, there is also ongoing uncertainly around the Lonmin deal. We believe the deal should go through, but we also believe there is a risk of industrial action associated with this that could impact the company’s PGM operations.

However, with the conclusion of the steaming deal, and extension of its debt tenure and the addition of more headroom, the risk-reward ratio still looks compelling.

"We remain cognisant of the risk, but we see the very low valuation multiple as allowing enough of an offset to take the risk at this stage. The reward could be meaningful, especially once the gold wage issue with the AMCU is resolved, in our opinion.

"The risk to our forecast and recommendation is primarily a big change in the gold price and secondly, any major disappointment at the current gold assets that could cause a significant balance sheet deterioration (given the debt taken on to buy the PGM assets that are not yet strong cash generators). A potential strike on the gold assets could severely damage the balance sheet.

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