Value Investors Club / DRDGOLD LTD (DRD)

Description

DRD Gold takeover imminent

In July 2018 DRD acquired a number of gold dumps and metallurgical plants from

Sibanye-Stillwater for 265m DRD shares (equivalent to 26.5m ADR’s). Among these

assets was the high grade Driefontein 5 dump, which has since been brought into

production, producing 60k ozs p.a. at a cash cost of $700/oz with a capex cost of a mere

$23.3m.

As part of the deal, Sibanye was also granted an option to increase its shareholding in

DRD from 38.1% to 50.1% at a 10% discount to the 30-day VWAP at any time up

to/prior to July 31, 2020. That option was exercised this week at a cost of $76.3m

equivalent to $4.54 per ADR.

We now expect Sibanye to launch a bid for the remaining 49.9% of the company’s

shares. In the event of a full bid, minorities will benefit from the fact that DRD is

domiciled in South Africa, where appraisal rights are extremely powerful, swift, and

cheap to enforce.

The current rating is undemanding at a TEV of 4.4 x our forecast EBITDA to June and

3.7 x forward. The valuation doesn’t discount any potential production growth from the

other Driefontein, Kloof, Libanon & Venterspost dumps. Given the remarkably short

payback period on the current DP2 Plant, it should be fairly easy to roll out a second

modular production line at the second existing, mothballed Driefontein plant.

Investors can therefore look forward to an Interim dividend of 30c or more per ADR to

be declared in the next 3 weeks. A possible reduction of capital of 88.3c (tax-free) may

be announced by March. Interim results will be released on February 12.

Why Sibanye is likely to buy out the DRD minorities

At the time that Sibanye sold its dumps to DRD in 2018, the group’s balance sheet was

under severe strain after the all-cash acquisition of Stillwater. The transaction with DRD

converted dormant assets on the balance sheet into a liquid marked-to-market asset.

Since then, Sibanye has benefited from its exposure on its palladium and rhodium side,

while it shut several loss-making gold shafts. This has structurally improved the metrics

of the balance sheet, but at the same time has left it significantly underweight gold.

DRD represents a lower risk exposure to the gold cycle than Sibanye’s labor intensive,

deep level mines and will improve the average cost of production of the gold division.

DRD also has significant untapped ore reserves and resources that can be brought on

stream at affordable capex, and in short turn around times, should the bull market in gold

be sustained.

Having exercised the subscription option, Sibanye will likely seek to remedy its financial

and tax inefficiencies.

DRD clearly has no use for the ~$110m in net cash, while its dump operations are

earning $8m of EBITDA per month and has no material capex requirements. It’s also

illogical for DRD to hold large positive cash balances while Sibanye is servicing

significant high interest-bearing loans. With the recent reduction in Sibanye’s debt

covenant ratios, the group could do worse than to acquire cash, and high-quality earnings

for an issue of shares.

While the compartmentalizing of the Driefontein dumps under DRD was a shrewd

exercise to monetize dormant assets in 2018 and to finance the capex to turn the dumps to

account, the structure itself is tax inefficient.

The status quo means that the Driefontein dumps are being taxed at full company rates

inside DRD, while Sibanye’s contiguous Driefontein underground shafts have unutilized

tax credits as a result of unredeemed capital expenditure.

DRD also has industry leading expertise in dumps, while Sibanye has significant

remaining gold dumps in the Free State province, as well as platinum and chrome dumps

near Rustenburg, and at Stillwater in Montana. By applying DRD’s skills, these dumps

can add high quality ounces to the group, thus improving the viability of these potential

operations.

Why the offer for DRD is imminent

Sibanye-Stillwater CEO, Neal Froneman is a seasoned campaigner, with a very keen

sense of timing. Sibanye’s stock has re-rated massively on the back of the palladium rally

– from ~$2 in August 2018 to its current price of ~$10. It is therefore an opportune

moment to strengthen the balance sheet by acquiring debt-free, quality assets.

Sibanye’s year-end is December. By announcing the acquisition in the next few weeks,

Froneman will be able to present the annual results with pro-forma figures inclusive of

DRD.

DRD Management Incentive Scheme

DRD shareholders approved a new “Long-Term” Management Incentive Scheme at the

DRD AGM in December last year. (see Notice of AGM, p.26).

In summary the scheme is to provide DRD management with options that vest

immediately and fully in the event of a take-over of the company. It is a virtual carbon

copy of the Management Incentive Scheme implemented at Lonmin PLC in early 2019,

just before Sibanye acquired the company under a grossly undervalued Scheme of

Arrangement.

One can therefore safely assume that a full take-over is not only likely, but imminent. As

with Lonmin, Sibanye will be able to rely on DRD’s Board and Management to be vocal

in their support of the excellent merits of their offer.

Appraisal Rights in South Africa

DRD is a South African domiciled company and dissenting shareholders are therefore

able to invoke their appraisal rights, which is a channel to allow aggrieved minorities to

defend their interests without significant costs.

Section 164 of the new Companies Act of 2008 contains clear, and powerful rights for

dissenting shareholders. These rights have been further strengthened by the positive

judgments in three successive court cases, the most notable of which was Cilliers vs La

Concorde Holdings Ltd., in which the judge ruled that that the courts will seek to provide

“effective recourse” to “smaller investors” to ensure that the Constitutional “principles of

equality and fairness … and access to information” shall be adhered to, hereby protecting

the interests of smaller investors.

What makes the system so valuable is the simplicity of the process, clear cut timetables

and low costs. The Act and the judgments have created a framework in which dissenters

have an upside-only scenario, with the outcome of the process typically determined in 2-8

months, depending on whether the bidding company plays hard ball or not.

Investors can therefore rest assured that a low-ball bid for DRD will not result in their

expropriation, as happened in the case of Sibanye’s scheme of arrangement acquisition of

the UK-domiciled Lonmin PLC last year.

Background

DRD Gold transitioned from an operator of marginal underground gold mines to being

the largest pure play producer of gold from mine dumps in the world. The latter occurred

in two steps. The first step was the acquisition of Crown, that was previously operated by

Rand Mines, and the recommissioning of Ergo, that was previously operated by

Anglogold.

The second step was the 2018 transaction with Sibanye.

The business model is economically robust, and fulfills a vital social function by cleaning

up dozens of small, environmentally problematic historic dumps, and consolidating the

fresh residue into a single, large compliant dump. This results in a marked improvement

in the quality of life and health of the surrounding communities, and allows the

previously occupied land to be redeveloped as industrial real estate.

As the last man standing in the greater Johannesburg area, DRD also has the benefit of

being the only buyer able to effectively extract value from derelict dumps.

DRD’s Ore Reserve inventory of 5.77m ozs (June 2019) of owned dumps therefore

doesn’t do justice to its de facto access to a much larger list of dumps that are still extant

in this prolific gold province. This is especially relevant in a gold bull market, or during

times of weakness in the Rand (local currency) exchange rate to the US Dollar.

Recent results

DRD released strong production figures for the 6 months to December. The company

produced 97,643 ozs during this period. The guidance for the year to June 2020 is only

190,000 ozs, which we expect DRD to exceed.

Production in the September quarter was 48,001 ozs, rising to 49,642 ozs in the

December quarter. The latest quarterly improvement was achieved despite the following

3 factors;

1. The traditional seasonal weakness during the December quarter, when operations

are affected by heavy rains and electric storms that force temporary safety

stoppages on the exposed dumps

2. The cessation of production at Ergo’s Fine Grind Circuit during the quarter, to

determine if this high cost plant is cost effective or not, and lastly

3. The significant load shedding by Eskom (South African national electricity public

utility) during the latest quarter.

We are particularly bullish about the Fine Grind Circuit being taken off-line. This plant is

both capex and opex intensive and has never delivered on its designed unlock of occluded

gold in the pyrite encrusted particles in the ore. We believe that Ergo’s costs can be

reduced by as much as 10% per ounce by the cessation of fine grinding.

If our thesis is correct, then the Interim results that will be announced on February 12,

will not only show the benefit of the sharp reduction of costs at Ergo, but should contain

a materially positive production surprise from the low-cost Driefontein plant. In other

words, DRD’s Interim earnings could surprise significantly to the upside.

Looking forward

In the attached model, the impact of the new Driefontein plant as well as the stronger

gold price is clearly visible in the transformation of DRD’s fortunes.

In line with the discussion above, we forecast production to continue improving to beat

guidance of 190,000 ozs this financial year by approximately 8,000 ozs. This should be

well within reach, based on the strong December quarter.

On that basis we forecast EBITDA of $95m for F2020 and $112m for the year to June

2021. These forecasts make no allowance for any cost benefits from the possible

termination of Ergo’s Fine Grind Circuit or for the impact of Driefontein production

running at the upper end of the plant’s capacity.

DRD Gold
				Forecast
12m to June	2017	2018	2019	2020	2021
Tons treated (m)	25,0	24,3	25,2	30,0	31,0
Recovered grade (g/t)	0,171	0,193	0,197	0,205	0,215
Gold produced (kg)	4 268	4 679	4 977	6 150	6 665
Gold produced (ozs)	137 114	150 423	160 014	197 729	214 286
Price received ($/oz)	1 254	1 300	1 267	1 475	1 500
Cash Cost ($/oz)	1 122	1 118	1 096	960	940

	$m	$m	$m	$m	$m
Turnover	173,2	175,9	196,3	291,6	321,4
Less : Operating Cost	-160,5	-175,2	-178,2	-196,8	-209,1
Adjusted Ebitda	12,7	0,7	18,1	94,8	112,3
PAT	1,0	0,5	5,6	73,9	80,8
HEPS per ADR ($)	0,02	0,01	0,08	0,85	0,94
Dividend per ADR ($)	0,04	0,04	0,17	0,80	0,90
Div Yield (%)	1%	1%	5%	13%	15%

Shares Out (ADR's) (m)	43,1	43,1	69,6	86,5	86,5
Stock price June 30	3,15	2,54	3,05	6,06	6,06
Market Cap ($m)	135,9	109,6	212,4	523,9	523,9
Net Debt / (Cash) ($m)	-17,8	-20,6	-18,7	-111,3	-111,3
TEV ($m)	118,1	88,9	193,7	412,6	412,6
TEV / Ebitda (times)	9,3	123,0	10,7	4,4	3,7

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Catalysts

Significant dividend declared in the next 4 weeks

Positive results surprise announced on February 12

Reduction of Capital

Sibanye launches full bid for DRD

DRD acquires additional dump operations

show sort by

			2020	2021
Price:	6.06	EPS	0	0
Shares Out. (in M):	865	P/E	0	0
Market Cap (in $M):	524	P/FCF	0	0
Net Debt (in $M):	-111	EBIT	0	0
TEV (in $M):	413	TEV/EBIT	0	0