DRD - DRDGold: Bullish On Easing Cost Pressures Into Gold Momentum

Summary

• DRDGOLD is trading at a 9-month high, rallying alongside the price of gold.
• While 2022 results were impacted by inflationary cost pressures, we see margins improving going forward as a tailwind for earnings.
• We like DRD for its unhedged production profile and compelling 4% dividend yield.

DRDGOLD Limited ( DRD ) is a leader in gold tailings retreatment which is the process of recovering precious metals from traditional mining waste. The model is recognized as environmentally conscious with attractive economics generating consistent profitability.

We last covered the stock early last year, taking a decisively bullish view citing strength in the price of gold ( GLD ) at the time, and what we believed to be compelling value relative to sector peers. For what it's worth, DRD has delivered a positive return over the period, even as most of 2022 was defined by extreme volatility with earnings hit through inflationary cost pressures.

Fast forward, our update today highlights a new wave of momentum in gold while many of those same cost challenges have reversed amid declining energy and logistics expenses setting up a boost to mining margins going forward. In our view, DRD remains a top-tier gold play with a generous dividend yield above 4% standing out as a compelling income idea in the sector. Macro tailwinds supporting further upside in gold prices can send DRD higher in 2023.

DRD Key Metrics

DRD released its fiscal 2022 year-end report back in August for the period ending June 30th. As a South Africa-based company, financials are only disclosed on a semi-annual basis. Last year, the revenue of R$5.1 billion "Rand" decreased by 3% year over year. This considers nearly flat gold production at 5,720kg, or 183k ounces, while the average price received was 3% lower.

Total volumes processed for the year were slightly lower given disruptions from a heavy rainfall event at the "Ergo Mining" facility. This was balanced by a tick higher in the group-wide yield to 0.207 grams per ton compared to 0.20 g/t in the first half.

Going through the financials, the bigger story last year was a drop in the gross profit, down -27% y/y largely reflecting higher mining costs, particularly against a tough comparison period in 2021. The total all-in-sustaining cost ((AISC)) climbed 5% for the year with the margin at 19.4% declining from a materially larger 31.8% in 2021.

Again, key operational inputs from consumables, materials, labor, and electricity played a role through higher prices. The cost of diesel was cited as driving the total cash operating cost at the "Ergo Mining" facility to $1470/oz compared to $1,272 in 2021. Separately, administrative expenses were also higher last year with some spending towards IT upgrades within operating charges.

Nevertheless, the takeaway here is that DRD remained profitable with a net income of R$1.1 billion for the year, translating to approximately $650 million at the current exchange rate. For 2022, DRD generated R$871 million in free cash flow or $51 million in dollars. From that amount, the company distributed approximately 60% of free cash flow as a dividend on common shares with the last payout of $0.20 per share for ADR holders distributed in September. Notably, this was the 20th consecutive year of regular distribution.

The latest update from the company came in October with a quarterly operational summary. Metrics like production, yield, and gold sold were nearly flat from the prior quarter. For the rest of 2023, several capital spending projects are planned including infrastructure updates and the expansion of a solar power source at Ergo. Still, management confirmed that with an ongoing "favorable position", a cash dividend will be considered around February in line with its complete interim financial results.

In terms of guidance, the target we have is for 2023 gold production between 160k and 180k ounces. If confirmed, the high-end rate is nearly flat compared to 183k in 2022 between the Far West Gold Recoveries ((FWGR)) operation and Ergo.

What's Next For DRD?

The bullish case for DRD beyond higher gold prices comes down to the tailwind of declining cost pressures. Going back to that graphic as the breakdown of operating costs, the setup here is a materially more favorable operating environment for key components between materials and electricity "energy" into 2023 compared to conditions last year defined by global supply chain disruptions and even the energy crisis.

In other words, key financial and operating benchmarks including metrics like the AISC and cash costs can trend lower which can be directly positive for earnings. Better than expected margins, incremental to the top-line momentum as the rally in gold accelerates can be a very strong tailwind for shares of DRD.

On that point, it's encouraging that gold has climbed above a key technical level of ~$1,825 which has bounced around as support and resistance over the past two years. Up more than 16% off the lows in November, we're watching an emerging breakout higher.

The setup here is supported by macro trends including a weaker U.S. Dollar that has coincided with signs inflation has peaked worldwide, opening a door for the Fed to ease off its aggressively hawkish monetary policy stance. Risks assets benefit, with gold reacting to the shift in real interest rates as long-term Treasury yields pullback. We believe this trend can continue.

As it relates to DRD, what we like about the stock is its high-quality earnings profile while offering one of the highest dividend yields in the sector above 4%. The company is also recognized as having an "unhedged" gold production which means it directly participates in the rally in commodity prices.

Compared to a global mining benchmark like Newmont Corp. ( NEM ) which has a similar dividend yield, or Barrick Gold Corp. ( GOLD ), the attraction in DRD would be its discounted valuation as a sales multiple given its operating model and South Africa jurisdiction. To the upside, we see room for this spread to narrow as part of the bullish case.

DRD Stock Price Forecast

We see shares retargeting the $13.00 level which it last traded at back in Q2 as a buy target for the year ahead. Assuming the price of gold accelerates further above $2,000 an ounce, DRD's all-time high near $18.00 could be back on the table as bullish sentiment returns to the sector supporting a measure of multiples expansion.

Covering risks, it will be important for the price of gold to remain above ~$1,750 to maintain the bullish momentum in related miners. A scenario where global economic conditions deteriorated sharply could precede a resurgence of the dollar, adding volatility to the sector and putting the price of gold under pressure. At the company level, weaker-than-expected results with an eye on gold production targets along with margin trends are the key monitoring points.

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