IMPUF - African Rainbow Minerals' Full-Year Results: Turning Point Or Further Misery?

2023-09-06 15:49:25 ET

Summary

• African Rainbow Minerals Limited's full-year earnings softened as many anticipated.
• A trying time for commodity prices coupled with regional systemic risk dented African Rainbow Minerals' progress.
• However, most of its ex-post headwinds have likely been priced, and a turning point is possible.
• Although short-term commodity prices will likely stay depressed, the longer-term trajectory might differ and accommodate an aggressive CapEx cycle.
• Key metrics suggest the stock is undervalued and presents a lucrative dividend.

African Rainbow Minerals Limited ( AFBOF ) released its 2023 full-year earnings on Monday, revealing disappointing figures, primarily stemming from systemic risk factors such as sluggish commodity prices and logistical concerns.

With the South African miner's 2023 in arrears, the question becomes, is African Rainbow Minerals' American Depositary Receipts investable at approximately $10 per unit?

Let's delve into the company's results and a brief outlook to address today's central question.

Results

African Rainbow Minerals' group earnings depreciated in 2023. The company reported a 21% slump in earnings, with its bottom line settling at R8.9 billion (approximately $170 million) from the R11.338 (approximately $218) it achieved in 2022.

The group's segmental earnings performance is shown in the following diagram; however, I ran through a few sales and production numbers beneath the diagram to make sense of the firm's earnings.

Iron ore production and sales slumped by 14% and 12% apiece during the year owing to lower demand-side factors and logistical issues pertaining to on-mine maintenance and issues with Transnet's functionality.

Further, although prices influenced the segment, Manganese ore and alloy supply functions settled higher than in 2022. The prior experienced a 9% increase in production, while the latter achieved a 15% increase.

Platinum Group Metals' ("PGM") production volumes decreased by 3% due to weaker industry demand and the lower grades at the Two Rivers mine.

Lastly, domestically supplied coal sales increased by 3% while export coal decreased by 5%. The prior primarily stemmed from a shortage of local energy coal, whereas the latter suffered from a weaker-than-anticipated Northern winter and supply adjustments in the global energy mix after elevated coal demand in 2022's energy crisis set the bar high.

Below are the absolute numbers.

Source: African Rainbow Minerals.

Note that the Manganese alloys relate to smelter production from the firm's Cato Ridge and Sakura midstream facilities.

Our Take

In our view, African Rainbow Minerals did not deliver substantial structural surprises, as most of its results reflected lower commodity prices and regional supply issues.

Prices and Remaining Mark-To-Market Settlements

For the time being, it is unlikely that commodity prices will receive support. I base this claim on the circumstances of the economic cycle, which is embodied by disinflation, lagging manufacturing numbers, and high interest rates in net importing nations such as the U.S., EU, and UK.

However, with that being said, commodity prices are priced in advance as they typically sell under forward contracts. Thus, the aforementioned factors might already be priced.

Another factor to consider is the mark-to-market values on some of the firm's PGM contracts. As shown in the following diagram, the company marked some of its forward contracts to market in 2023 and suffered damage on both realized and unrealized losses.

The unrealized contracts could play a significant role in the firm's income statement. If we contrast our earlier outlook and say that PGM prices will rise in the coming quarters, the unrealized gains will be reversed, and an incremental gain will be recorded. Moreover, the contracts could receive additional support if an earlier-than-anticipated interest rate pivot were to occur.

Overlooked Operational Factors

Much is anticipated from African Rainbow Minerals' current CapEx cycle, with expansion in Manganese and PGM mining being central to its investment thesis.

Black Rock Prospects

As mentioned in our previous coverage of African Rainbow Minerals, the company is on an expansion route within the manganese space via its Black Rock mine. Moreover, African Rainbow Minerals partially owns the Cato Ridge and Sakura midstream facilities.

The Kalahari basin (where Black Rock is situated) possesses approximately 80% of the world's proven manganese reserves, with Black Rock catering to the steel deoxidization market, providing African Rainbow minerals with synergies to its iron ore business.

Black Rock's construction was completed in September 2022 after an R7.4 billion (approximately $380) cost outlay. The mine is anticipated to reach 4.6 million tonnes per annum, with the asset's life expectancy set at 30 years.

In our view, Black Rock and related procedures are overlooked by many. The Kalahari presents infrastructure challenges as it is an area facing water scarcity, undeveloped terrain, and ESG challenges. However, we believe the feasibility of the resources in the region will lend African Rainbow Minerals the necessary latitude to invest in suitable railway systems, water access, and energy supply.

Two Rivers Expansion

The Two Rivers mine, which is partially owned by Impala Platinum ( IMPUY ), is a six-element PGM asset. The mine has been operational for numerous years; however, African Rainbow Minerals is investing aggressively as it believes the mine would allow it to compete with regional PGM powerhouses.

Two Rivers' latest expansion has been commissioned, and African Rainbow Minerals is in the process of ramping up the mil by an additional 40,000 tonnes of capacity per month.

Valuation and Dividends

Investors tend to consider a mining stock's price-to-book ratio as a mining firm is asset-heavy; mining stocks also tend to be mean-reverting due to their cyclical attributes.

We believe African Rainbow Minerals' price-to-book ratio of 0.69 is in sound territory, especially as a pending South African interest rate pivot might adjust African Rainbow Minerals' mine NPVs higher. However, further commodity price declines could lead to impairment losses, which is a risk investors must consider.

Source: Seeking Alpha.

Many might be aware that African Rainbow Minerals pays an astronomical dividend, yielding 19.06%. Additionally, the stock's 3-year average dividend yield-on-cost of 15.61% substantiates the claim.

Risks pertaining to the stock's dividend include the fact that it is a cyclical asset, and its dividend distributions fluctuate accordingly. On top of that, foreign investors might suffer from tax disadvantages, meaning the asset is likely constrained to tax-deferred or tax-free accounts, limiting the application of the stock in a non-South African investment portfolio.

Other Risks To Consider

A major concern to African Rainbow Minerals' stock is its primary operating terrain, which is South Africa. The nation's country risk premium is on the higher end of the BRICS nation scale amid electricity grid issues, fears of nationalization, and an unpredictable 2024 national election outcome.

Although these factors can improve in time, they overshadow African Rainbow Minerals' strengths for the time being.

Further, African Rainbow Minerals is taking on an expansion project at the Bokoni mine, which was acquired from Anglo American Platinum ( ANGPY ) in late 2021. The Bokoni mine was rather inefficient under Amplats, meaning African Rainbow Minerals is risking quite a bit of shareholder capital on a doubtful project.

Final Word

African Rainbow Minerals' full-year results disappointed to some extent. However, a uniform decrease in commodity prices coupled with wavering demand and local supply chain issues meant that investors anticipated softer results.

Although we do not believe a short-term uptick in commodity prices is likely, we hold the view that African Rainbow Minerals possesses lucrative secular prospects for long-term orientated investors to take advantage of.

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