SBYSF - African Rainbow Minerals: Maintaining Our Outlook

2023-03-17 18:09:11 ET

Summary

• African Rainbow Minerals Limited's near 30% year-to-date drawdown has presented a value gap.
• Inflection points are present as platinum group metals expansion and recovering iron ore prices are yet to be priced by stock market participants.
• Risks such as lower coal prices, a higher cost base, and a potential national shutdown in South Africa must be considered.
• However, factors, namely African Rainbow Minerals' potential operational pivot and its security's undervalued status, coupled with a dividend yield of above 15%, present us with optimism.
• We assign a strong buy rating to African Rainbow Minerals Limited with an indefinite horizon.

This report is a revision of our previous article about African Rainbow Minerals Limited (AFBOF), with the view of reiterating our strong buy rating. As explained throughout the text, various inflection points exist that may result in this undervalued American Depository Receipt receiving warranted traction. The asset has suffered a near 30% drawdown since the turn of the year amid segmented selloffs in the basic materials sector and higher country risk premiums assigned to South African miners. However, we believe investors have overreacted, resulting in unrecognized value within African Rainbow Minerals' ADRs.

Let's delve into a more detailed discussion.

Operational Update

African Rainbow Minerals Limited released its H1 interim results earlier this month, revealing a staggering 40% year-over-year increase in headline earnings, outpacing most of its peers, namely Sibanye Stillwater ( SBSW ), Impala Platinum ( IMPUY ), and Anglo American Platinum ( ANGPY ). Despite its robust operational performance, investors must note that the firm settled approximately $18 million in loans with Glencore ( GLCNF ) prior to the reporting period, contributing to much of the rise in earnings.

African Rainbow Minerals experienced a transition in revenue mix during H1 as its PGM (platinum group metals) gained ground due to relatively higher value than the company's ferrous and coal baskets.

Based on its corporate strategy and commodity price trajectories, we anticipate PGMs to form a larger part of African Rainbow Minerals' revenue mix due to continued benefits from a weaker South African Rand, potential Platinum price support stemming from its undervalued characteristics ( discussed here ), the inclusion of the Bokoni exploration project , and sustained expansion at the Two Rivers mine.

Furthermore, coal prices have fallen off a cliff since the turn of the year, as supply/demand for energy in the Eurozone has seemingly leveled. The Eurozone was in short supply post-pandemic lockdowns and amid the Russia-Ukraine war's inception; however, demand for steaming coal is fading, especially given the long-run political tilt toward renewable energy of developed nations.

As for ferrous metals, African Rainbow Minerals reported 4% higher net headline earnings in H1 than in the previous year. Manganese sales drove earnings higher; however, a 15% slump in iron ore export sales phased out much of the benefits. However, China's reopening and mean reversion have resulted in proliferating iron ore prices , lending a premise that the mining house's ferrous metals might outperform in the coming six months.

In a nutshell, African Rainbow Minerals is expanding its PGM footprint as indicated by its acquisition and development of the Bokoni open-cast platinum mine and its co-expansion of Two Rivers alongside Impala Platinum. Furthermore, African Rainbow Minerals' ferrous metals might rebound in the next half-year due to a price recovery; however, coal activities remain uncertain.

Value Remains Intact

African Rainbow Minerals is trading at a price-to-book ratio of merely 0.90 , which is 42.51% lower than its cyclical average. Moreover, resource investors usually emphasize price-to-book ratios as mining companies are asset-heavy and trade exchange quoted inventory. Therefore, African Rainbow Minerals is theoretically undervalued on a relative basis.

Furthermore, the depositary receipt pays a substantial dividend yielding 15.87%, presenting a case that the security's dividend will cover adverse price risk.

Risks To Consider

A newly surfaced risk for South African miners is the emergence of a national shutdown in a call for President Ramaphosa to resign amid the ongoing load-shedding crisis. Driven by the EFF (a regional Marxist political party), a national shutdown is becoming increasingly likely as our anecdotal observation is that matters have gained momentum on the ground. The EFF's presence among mineworkers is substantial, and it would not be surprising to see various operational disruptions in the coming weeks or even months.

Additionally, we expect the South African mining industry's average cost base to remain elevated due to the Eskom disruptions, and lower volumes are not out of the question.

African Rainbow Minerals' risks are primarily outwards, and unfortunately, it has little control over factors such as politically-driven operational disruptions and a higher country risk premium.

Final Word

Key metrics suggest that African Rainbow Minerals Limited is an undervalued security with a substantial dividend yield. More importantly, the company's portfolio possesses numerous inflection points with supportive iron ore prices and an expansionary PGM portfolio contributing to its prospects.

Risks, such as a national lockdown in South Africa, a higher cost base, and more realistic coal demand, must be considered. However, our net consensus remains the same as before: African Rainbow Minerals Limited stock is a strong buy.

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