Interactive Investor

Stockwatch: time to upgrade this mid-cap share 

A new chief executive is honing this £1 billion miner as gold prices strengthen. 

18th May 2021 11:04

Edmond Jackson from interactive investor

A new chief executive is honing this £1 billion miner as gold prices strengthen. 

The gold price is currently at a three-month high at around £1,315 ($1,869) an ounce, with traders citing a fall in US treasury yields and worries about higher Covid-19 cases in some Asian countries.  

I suspect another key reason is incipient inflation: can you trust the US Federal Reserve’s reassurances that inflation will pass, or is the inflationary fire being stoked with ongoing massive stimulus programmes - despite the US economy turning up? 

It doesn’t take a huge number of investors to decide they want a portfolio hedge for gold to keep rising. It may also benefit from cracks emerging in the speculative edifice of cryptocurrencies, which has been seen as competing with gold in the “alternative assets” spectrum. A second week of Israeli-Palestinian clashes also raises the fear quotient of Middle East unrest.  

So, after gold had fallen from £1,430 in early January to £1,220 in early March, there are reasons to believe in a new bull trend. Gold mining equities may lag this as investors want to see if it has legs. But I would tend to favour miners’ operational gearing over exchange-traded funds (ETFs) as a means to capitalise on higher commodity prices. 

Those I have covered in the past are mid to large cap such as Petropavlovsk (LSE:POG), Centamin (LSE:CEY) and FTSE 100 listed Polymetal International (LSE:POLY). Mind that all three operate in areas of higher political risk: respectively, Russia, Egypt, and Russia/Kazakhstan/Armenia. This does however reflect geographic priorities of the modern industry, and you can assess a profits stream versus speculative small caps.  

Timely to re-consider Petropavlovsk under a new CEO 

Its stock is relatively low in the historic range and has not kept pace with gold’s rise, although the market was unimpressed by Petropavlovsk’s first-quarter 2021 update on 20 April, citing mixed production.   

This partly reflected inherent variability of mining, although it is disappointing to see third-party gold production had slumped to 13,200 ounces from 84.2k like-for-like, even if due to “expected” lower volumes of ore concentrate available and lower grades supplied. This was in context of 95.6k overall which had halved, like-for-like. The new CEO blames turmoil before he took over, including delaying contracts. 

When I set out a ‘buy’ case at 16p in March 2020, a key plank was a high-capacity Pressure Oxidation “POX” hub being a game-changer; Russia having substantial quantities of refractory ore with fine particles throughout, that is resistant to standard extraction. They also constitute around 60% of Petropavlovsk’s resource base. 

As if in recognition, two Russian gold industry operators had bought into the stock and last summer one ousted the company’s founders, installing a new CEO. He says the POX hub should be running at full capacity by the end of this year, and “I feel that the turbulence for the company is over”. 

Shares firming after the results 

I tempered my stance to ‘hold’ at 25.5p last July, when the boardroom battle was underway. Otherwise, fundamentals appeared to be evolving pretty well, if mixed. The 2019 results had shown a 22% rise in gold production, but financial measures contrasted radically. 

Interestingly, and despite a mixed financial profile continuing, the stock tested 40p later in July 2020 when gold hit £1,570 an ounce – when the tide in gold rises definitively, it can raise all boats. If gold merits exposure, waiting for a company in your sights to prove said potential, comes at a price.  

Mind how along with the wider market, Petropavlovsk had slumped back to 26p last November, then the Covid vaccine rally prompted a recovery to 33p. By March this year it had drifted briefly below 24p.  

Yesterday, in response to results, the shares were mixed, initially up about 1p to 26p only to drift back to 25.3p, then strengthen later on to 25.8p. This appeared to reflect afternoon strength in gold but, with firm buying up to 26.4p in the first hour today – near twice the number of trades initiated as buys than sales – it appears the results are being digested quite well. 

Mixed release albeit an underlying growth dynamic 

“There is much to be addressed to drive improvement across the business in 2021 and beyond,” writes the new CEO. It is encouraging that he’s identified issues and formulated action, but he hints at financial numbers being compromised for a while yet. 

Own gold production fell 18% in 2020 to 386k ounces, while that from third-party concentrates soared 256% to 163k ounces, the net effect being a modest 6% advance in total gold produced and sold. The average realised gold price rose 30% to £1,232, so a continuation of the bull trend should help expectations for 2021. 

Otherwise, the numbers continue to be mixed, if reflecting an underlying growth dynamic helped by higher gold. Revenue is up 33%, underlying EBITDA up 32%, and cash from operations before working capital adjustments up 31%. Yet there was a $49 million net loss, mainly due to a non-cash $43 million loss on fair value re-measurement because the stock had risen, and also some asset impairment. Excluding such non-cash items, net profit rose from $26 million to over $76 million, albeit swollen by a $27 million deferred tax credit. 

Petropavlovsk   - financial summary
year end 31 Dec 2014 2015 2016 2017 2018 2019 2020
Turnover ($ million) 865 600 541 587 500 742 989
Operating margin (%) 6.0 -13.4 14.2 17.1 30.0 20.2 15.0
Operating profit ($m) 51.7 -80.1 77.0 100 127 150 148
Net profit ($m) -261 -239 33.7 37.0 25.9 25.7 -48.9
Reported earnings/share ($) -0.34 -0.07 0.01 0.01 0.01 0.01 -0.01
Normalised earnings/share ($) -0.30 -0.06 0.01 -0.01 0.01 0.01 -0.01
Operating cashflow/share ($) 0.31 0.03 0.01 0.04 0.07 0.02 0.04
Capex/share ($) 0.36 0.03 0.01 0.03 0.04 0.02 0.03
Free cashflow/share ($) -0.05 0.00 0.00 0.01 0.03 0.00 0.01
Cash ($m) 48.1 28.2 12.6 11.4 26.2 48.2 35.4
Net debt ($m) 930 610 599 585 568 561 501
Net asset value ($m) 549 493 554 556 601 635 672
Net assets per share ($) 1.00 0.15 0.17 0.18 0.18 0.19 0.17
Source: historic Company REFS   and company accounts      

Significant cash from operations

Generating $329 million of cash from operations is encouraging for medium-term debt repayment and preparing a base to restore dividends (paid from 2007 to 2012). Interest-bearing gold prepays (advances received from customers under prepayment arrangements) were cut 66% to $64 million, but there is a way to go on bank debt where the balance sheet shows a year-end reduction of 12% to $536 million (all longer-term). The income statement however shows the interest expense down only 2% to $59 million, which swallowed 40% of operating profit. 

They say debt reduction is a key priority, as is a restructuring around better terms to cut this expense. 

While the April update cited cash-at-bank down from $35.4 million at end-2020 to just $7.5 million at end-March, this is due to a portion of March gold proceeds being received in early April. 

Norway’s sovereign wealth fund raises stake

“Norges Bank” as it is known in RNS Holdings announcements, is a capable institution taking a long-term view, so it is encouraging how it has recently increased its stake in Petropavlovsk from sub-2% to 3.7%. Otherwise, the main shareholders appear to be sitting firm. 

My sense is that they are satisfied with the change of top management and scope to drive better progress, especially in an environment where the risks surrounding gold look to favour upside.  

The group’s ability to process its own ore is targeted to double in the second quarter, with extra plant commissioned, then further capacity coming on stream in the third quarter.   

A new medium-term development strategy is to be delivered by the third quarter, and the proposal of a dividend policy. That would underline a break with a troubled history of soaring debt and the previous CEO facing embezzlement charges. 

Despite the complexity of mining and the country risk Russia represents, I concur with Norges about how Petropavlovsk is becoming a more attractive play on stronger gold. At 26.2p currently, I upgrade to Buy

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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