DRDGOLD LTD DRD
January 11, 2020 - 2:19pm EST by
Veritas500
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

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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 Sibanyes 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

 

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