Description

Harmony Short

Harmony Gold (Harmony) is structurally overvalued thanks to ongoing purchases by passive managers. The company is at an inflection point where at least two of its mines will close down in the next 18 months, and one more could follow. At the same time all the other mines and dump operations are moving into a heavy capex phase. Complicating the picture is the desperate power shortage due to rolling blackouts at Eskom, the national electricity monopoly.

We expect Harmony’s complex problems to play out against a background of a retracement in the gold price, caused by forced sales from Russia, sustained high interest rates and a drop in retail jewelry demand.

Mine closures

As mines approach the end of their reserve lives, they often close suddenly and sooner than expected. This is what happened first at Unisel, then at Bambanani, one of Harmony’s cash cows. The mine produced between 20% - 25% of Harmony’s free cash flow, but closed suddenly last year, after encountering an increase in seismicity (rock bursts). This was followed by the Surface Rock Dumps, with Kusasalethu and Masimong to follow in the next18 months.

Harmony is an agglomeration of late stage assets, acquired in well on a dozen sets of acquisitions, earning it the moniker of the dustbin of the gold industry. While the group has some skill in traditional narrow reef gold mining, it seems to lack the expertise to optimize assets that don’t fit the standard recipe. A prime example of this is Target 1, which is in a full blown crisis. The forecast turnaround has instead become a rout, with both grade and tonnage imploding in the 6 months to December last year. That pushed the AISC to a catastrophic $3127/oz.

Target’s lack of tonnage appears to be linked to the strange decision to change the mining method, and the collapse in on-reef development meters from 368m to 55m between F2021 and F2022. (33m in the half –year to December).This is especially stark when compared to total development meters, which only declined from 2,211m to 1,544m. In old parlance, this represents a drop in the payable development percentage from 16.6% to 3.6% - a feature often seen in the dying days of a mine.

The mine differs from all the other mines in the group that have labor intensive narrow reef ore bodies of less than 6 feet in width. Target mines the Dreyerskuil Reefs that attain widths of up to 400 feet, won through massive mechanized mining. The plan to abandon paste fill in an effort to save costs looks like a last-ditch attempt by a management team that’s run out of options. The mine was originally opened by Anglovaal in 2002 and has never really performed to expectation under Harmony’s ownership. Target was originally expected to close in 2026, but the current run rate of 44,000 ozs pa simply can’t sustain a capital intensive mine that’s 9000 feet deep. (Also see the discussion on the electricity crisis below).

Rehabilitation Liabilities

The previous owners of Harmony’s mines understood precisely how the environmental liabilities would snowball over time, especially in a country where the government is setting ever more stringent standards for mine rehabilitation, while failing to police illegal miners and informal businesses.

The example of Sibanye’s Cooke Division appears to be the model that is likely to play out industry wide. Cooke’s care and maintenance costs for 2022 amounted to $41.7m, a figure that could eventually apply to each of Harmony’s mines. What is so troubling is that these costs were incurred while Cooke is in breach of its Water Use License conditions. In other words, they could increase significantly if Sibanye was forced to comply with the full letter of the law.

Cooke cites in mitigation “unachievable license limits” for the water it releases into the Vaal River catchment area. (Sibanye Integrated Report 2022, p.203). The report mentions the exceedance of sulfate and metal loading limits in the semi-treated water Cooke releases, in part due to “acutely toxic manganese and ammonia from upstream water users.” However, it’s far from clear how Cooke’s sulphate levels could be impacted by manganese and ammonia from upstream releases. The costs of remediation are therefore likely to increase by a significant quantum. Cooke’s security costs are also likely to increase. In 2022, the mine recorded the death of one of their security guards in a skirmish between mine security and an armed gang of copper thieves, looking to strip the mine’s electric infrastructure.

A Capex Extravaganza

Harmony’s cycle of mine closures coincides with a gargantuan capex program at eight of the group’s mines and projects, amounting to at least the market cap of $3bn. The capex budget for the Financial Year to June 2023 is $500m and a further $530m for F2024. The Capex budgets are split roughly 50/50 between growth and sustaining capex, leaving only room for $250m per year for the growth projects. The $3bn - $4bn of growth capex is therefore totally unaffordable. The company never publishes feasibility studies, except when the JV partners such as Newcrest do so. It also doesn’t provide capex estimates on a per project basis, except in a haphazard way as a throwaway figure in a press release.

List of capex projects;

Zaaiplaats (Moab Ultra Deeps) : ~$350m

Mponeng Ultra Deeps : TBD (Our est. $400m)

Kareerand Tailings Storage Facility : $230m

Solar electricity in 3 Stages totalling 223MW : ~$200m

Eva Copper (Australia) : $170m purchase + $30m +$30m + $350m (2018) upfront Capex

Hidden Valley Stage 8 pushback (Papua New Guinea) : $90m

Wafi Golpu (50% JV with Newcrest in PNG) : $1.4bn (2018) : (half share)

Doornkop Expansion : TBD

Savuka Shaft Pillar : TBD

Tau Tona Shaft Pillar : TBD

Kerimenge Heap Leach Project (PNG)  : TBD

Kalgold Expansion : TBD

Savuka Tailings Project : TBD

Eskom rolling Black-outs

South Africa has suffered rolling black-outs on an almost uninterrupted basis for the past ~250 days. The severity of the cuts has reached a point where the electricity supply is sometimes interrupted on a 4 hour on 4 hour off basis. (So-called “Phase 6”).

This situation is caused by unchecked levels of corruption at the national energy monopoly, called Eskom. With the southern hemisphere winter imminent, it is likely that these power cuts could intensify, to a point that would make it impossible for Harmony to conduct even reduced mining activities, without compromising the pumping of water from the mines.

We believe that this likelihood is not reflected in Harmony’s rating. To add insult to injury, electricity tariffs have risen by double the rate of PPI over the past 15 years and now amount to 18% of Harmony’s operating costs. The tariffs increased by a further 18.65% with effect from April 1 this year, with the usual winter surcharge levied from June to August.

We therefore expect the September quarterlies to be an absolute shocker.

Productivity

Harmony’s mines are among the least productive we have ever analyzed. The average employee produces less than 3 ounces of gold per month or less than $6,000 per head. It’s impossible to understand how the Board of Directors can continue to vote new capital for mines where the likelihood of an economic return is based on hope, rather than fact.

Conclusion

Harmony’s de facto strip of options on the gold price appears to be running out of road, with a vast capex bill required to sustain the magic. We therefore don’t expect the company to be able to raise the capital at anywhere approaching the current price. Sell.

Catalyst

• Premature closure of Target 1 mine.
• Production curtailment due to worsening rolling blackouts