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Amplats, it’s tough out there

February 4, 2013 in Uncategorized

“And production this year is expected to be around where it was last year, 2012, between 2.1 and 2.3 million ounces. Cash costs per ounce back in the year 2002 was 3599 ZAR. That is around 4.5 times higher now than it was back then. Sadly, back in 2002 total PGM production was 3.947 million ounces. Now. The pattern emerging here is exactly the same between Harmony Gold and Amplats. Lower production, higher costs.”

To market, to market to buy a fat pig. Whilst the jobs number in the US was more a meet (and greet), it was enough to see the “bluest” blue chip index, the Dow Industrials reach 14 thousand for the first time since October of 2007. Back then people were starting to get anxious about subprime mortgages and the general state of the housing market in the US. Cracks were starting to appear. And all these cracks were exposed as too much leverage, too much risk taking and not enough oversight coupled with perhaps an overly friendly central bank in the US. Back then most sectors were overvalued relative to today, check out figure 18 from this long piece: Earnings, Revenues, & Valuation: S&P 500 Sectors. Industrials (scroll to page 17 at the top) are trading at under 14 times forward earnings, back then as the S&P 500 topped out at 1560 (there and there abouts), industrials were trading at closer to 17 times forward earnings. Which was more expensive than the long time mean. Take a look at how cheap tech stocks are, perhaps collectively as cheap as anyone can remember. Healthcare looks cheap, financials not that much.

On a relative basis however, if you scroll down to page 18, longer term “cheapness” is laid bare. Not too sure that I would stake any meaningful allocations towards the financial sector, but that being said there are probably only two stocks that should catch a rebound in the housing market, JP Morgan and Wells Fargo. But know for the record that Vestact as a house is not in favour of complicated financial services companies as “safe” investments, if there is such a thing. If you need a single graph to show you what I mean, scroll forward to page 20, the page titled: S&P 500 Sectors Forward Earnings. Find the financials graph and then immediately below it see healthcare. Which one looks “safer”? Add to that mix that the powers that be in Washington DC are more bent on making the banks more utility like in the long run, and perhaps the heydays of the middle part of the last decade might be a thing of the past.

So, what am I trying to say in a convoluted way? The markets, at the same sort of levels as they were all those years back in October ’07, are cheaper on a forward basis now. All we have seen over the last few months, leading into the fiscal cliff and beyond is multiple expansion. Meaning that ordinary investors are willing to pay more for the market now than they were six months ago. Normally you should be keen as beans to get a discount, and not the other way around. I suspect that the sunny outlook does flow into an improved confidence, confidence that politicians can get the job done, hiring can begin and generally trade can start to expand again. That is all that we have seen, folks are willing to pay more for the same thing.

Jozi, Jozi 26o 12′ 16″ S, 28o 2′ 44″ E OK, this morning there is a set of quarterly numbers from Harmony Gold. And this is also for the first half of their financial year, we will focus on these. Why should we, here at Vestact and specifically me, care much for these numbers? We do not hold any of the shares at all. We do not encourage our clients to own any gold companies. Well, I guess sometimes you need to look at the numbers in order to crystallize why we are not invested in single commodity stocks and specifically gold companies. The issues around higher costs, a seemingly unhelpful government and militant labour unions does not exactly add up to a pleasant investment outlook. Cash operating costs for the six months increased by 15 percent, to breach 300 thousand Rands per kg for the first time that I can remember. Excluding Kusasalethu, cash costs improved on the quarter. That tells you why the mine is being shut. Ten years ago, if you were approaching 100 thousand Rand per kilogram you were in trouble. So, in short, cash operating costs have more than tripled in a decade. In fact, I checked, just to be sure that Mr. Memory was not too fuzzy.

It is sadly a lot more, for the same quarter a decade ago, cash operating costs were 68,302 Rands per kg, cash costs have increased four times over. Back then, for the half to end 2002, ounces produced, 1.57 million, the yields were 3.5 grams per ton, the gold price was 103,362 Rands per kg with a very weak Rand at that point, assumptions were for 10 ZAR to the USD. Presently, fast forward (DeLorean DMC-12 style) to these numbers, ounces produced for the half were 613 thousand ounces. WOW, that puts “things” into perspective. If you annualize that lost production you get to roughly 1.9 million ounces of gold no more. I guess that part is all you need to know about the declining gold production picture in South Africa. The ounces produced however are of higher quality I guess, underground recovered grades improved in the quarter to 4.77 grams per ton. Now listen in closely, the gold price received for the half is 460,244 Rands per kg. The Rand gold price is nearly four and a half times more than it was a decade ago. But, cash costs are about four and a half times more than they were a decade ago. And as you know, production is wildly lower than it used to be.

The share price is up over six percent this morning to top 60 Rands, but that is only half the story. The ADR price in New York over ten years is down nearly 58 percent. Ten years. Down 58 percent. As they say in the classics, that is all you need to know. And what about Wafi-Golpu? Out in the middle of nowhere, environmental issues, social issues, grades are average, I am not too sure if this is the saviour for now. I don’t know what to say other than we continue to avoid the stock, the company is stuck in a difficult downward spiral.

A company with problems of their own, not too dissimilar to the ones mentioned above is Anglo American Platinum Limited. The opening lines are unfortunately the long and the short of what was a year to forget: “In a year that was marred by illegal and violent industrial action across the mining industry, and where continued high levels of inflation and a subdued macroeconomic environment, particularly in Europe, led to severe margin contraction, Anglo American Platinum today reported an operating loss of R6,334 million for the year ended 31 December 2012. This represents a 180% reduction, from a profit of R7,965 million in 2011.” This notion that mining companies have billions of Rands, perhaps someone should send those two short lines to the powers that be.

The reason why the company continues to point to Europe is that motor vehicle demand has been awful. See the latest: Declining January car sales sink European upturn hopes. Sadly. So in the short term, a combination of austerity, short term policy uncertainty and tax compliance issues in Europe have seen lower consumption of Amplats core product. This major issue is lost on many people locally, including politicians and Joe Public.

I wanted to do a similar thing, as I did above with Amplats now versus ten years ago, and highlight how their costs have risen and their production is much lower, just so that many people can see all the issues that are facing South African mining companies. So let us start with the numbers today, production in a troubled year was 2.22 million ounces, down 8 percent from the year prior. Let us use the cash costs projection: “between R16,000 and R 16,500 per equivalent refined platinum ounce” And production this year is expected to be around where it was last year, 2012, between 2.1 and 2.3 million ounces. Cash costs per ounce back in the year 2002 was 3599 ZAR. That is around 4.5 times higher now than it was back then. Sadly, back in 2002 total PGM production was 3.947 million ounces. Now. The pattern emerging here is exactly the same between Harmony Gold and Amplats. Lower production, higher costs and no doubt much smaller work force has been the order of the day. Lower capex going forward also means that fewer jobs are/can be created. I have not seen a detailed costs breakdown over the last decade, but I suspect the usual suspects. And now Eskom want further increases.

I saw this morning an interview with the Chamber of Mines (involving Chris Yelland, and Brian Kantor from Investec) in which the Chamber guy said Eskom would have all the excess they needed in 2018 at the current escalation rate, implying that mines aplenty would be closed. I have always said that if government want to lend a helping hand, this is a possibility here. If you want to know why South African mines and industrial South Africa in general is under pressure, search no further than this table: Average price increases. Wow. And I guess that is all to say about that.

Sad face. Business cannot go along absorbing the costs all the time, if government want them to maintain full employment. It is pretty well known that Eskom employees are pretty well remunerated relative to the other SOE’s. Which themselves are comfortably above the private sector. This has been the mainstream line: Eskom hike for salary increases – report. Average salary over at Megawatt Park currently (average!!) 633 thousand ZAR per annum. I am not too sure what you think about that, but I would rather this amount offset the outstanding debt, after all, what major risks are these employees taking? And where is the competition? Exactly.

    Byron beats the streets. This morning we had a very interesting announcement from Aspen which has put them under cautionary.

    “Shareholders are advised that Aspen is currently engaged in discussions with MSD (known as Merck in the United States and Canada) in respect of a possible transaction comprising the acquisition of an active pharmaceutical ingredient facility situated primarily in the Netherlands and a related portfolio of pharmaceutical finished dose form products.”

    Now remember that Aspen already have a fantastic relationship with GlaxoSmithKline, a global healthcare company based in the UK. Glaxo own 18.6% of Aspen which they acquired in a deal which allowed Aspen to supply their products in SA. A second deal was struck which allowed Aspen to supply GSK products in Australia. This was bought for cash though.

    Although the details of the Merck deal are not given one would expect that something similar is being struck. Merck have some great products but like Glaxo their focus may not be on Africa, South America or Australia. You see Aspen take the responsibility for marketing and selling these goods in return for either shares or cash. You’d probably find that since they became larger they would prefer to pay using cash and debt as opposed to equity. Although when you lock in a client with equity your interests do become aligned so we could see a bit of both.

    Another interesting observation is that the acquisition is taking place in Europe. This could be Aspens entrance into a new continent. Why Europe you may ask? Well they entered Australia to gain access to Asia so this may be another gateway to gain access to the products and bring them to the developing regions where Aspen operate. At the same time Europe has an aging population, cheap debt and big growing populations to the east.

    This time around they are looking to buy a production facility. When these deals were first struck they would not have been able to afford a facility. But again this may have been forced upon them by Merck. It is also interesting to see Merck divesting from Europe. Do they see Europe as a place to get out of? I wouldn’t take that as a negative for Aspen, they strive on underappreciated, noncore assets. There are still lots of unanswered questions which I am sure we will get the answers to soon. As always we back what is often considered the best management team in the country to make the right acquisitions. If history is anything to go by, this will be an exciting development.

Crow’s nest. We are higher here again to begin with. Another record high. Although we are slipping.

Sasha Naryshkine and Byron Lotter

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