Description

All values are given in USD unless otherwise stated.

This is a company which is dependent on Russia for about 60% of it’s EBITDA. The major source of its technological advantage is also based in Russia.
While I have a very small position in this company, there are obvious uncertainties here. I hope this writeup could open a discussion and give other points of view on this company.

Why Polymetal then?

The company is trading at a PE around 1, the EV/EBITDA is less than 2 and the company spots a dividend yield of more than 40% at current prices.

Add to this, the operating statistics of this company are absolutely TIER 1. With ROE’s of between 15 en 50% over the whole life of the company, EBITDA margins in a range of between 40 and 60%, and more than tripling reserves over a period of 10 years while entering the TOP 10 largest gold miners in the world. This in a period when most global gold miners have struggled to maintain reserves. Polymetal even managed to produce a sizable amount of FCF almost every year, making it possible that they can pay out a pretty sizeable dividend over the years (more than 2.6 billion to be precise, with another quarter billion still to come in H1 2022 if the world won’t come to an end by then). So while they are not the highest margin gold miner, they do manage the elusive quest in mining of growing production AND having FCF for a sizeable dividend in most years (last year was one of the few exceptions when capex was higher than cashflow from operations).

Even the more yippie people amongst us should be happy to invest in this company. This company was never suspended during the first Ukrainian crisis and the Crimea annexation (even condemned the current invasion in the last conference call). They rank first for ESG on a list of emerging market mining companies and even rank higher than many gold mining majors like Newmont or Agnico Eagle. Their development projects, which they have about 1 major project every year, have come on production often before the deadline and on cost guidance.

Mining and most of the natural resources sector are absolutely terrible investments. When the cashflow is plentiful, the attractive investment opportunities are scarce. Management is very aware of this with a quote from the CEO that says just this: “Never say never, but during an upcycle in gold prices, it never makes sense to buy a producing mine because the valuations have gotten out of hand very quickly”

What do they do different then?

There are 2 things.

Firstly, they are just good operators with a focus on the right things like FCF, returns, etc.. (even the capex on “green projects” have return hurdles).

This is made clear with the acquisition of 2 mines, namely the Kapan and Kyzyl mines.

In 2016 Polymetal acquired the Kapan mine in Armenia from Dundee Precious metals, itself a pretty decent operator of mines. Kapan is an Armenian Gold, Silver, Zinc and Copper mine. It was a pretty bad operation for Dundee, loosing money since 2013 and taking a pretty big impairment charge. Polymetal saw some potential here and acquired the mine in 2016 for 25 million, a royalty to Dundee and a few contingency payments. They managed to double throughput and turned a loss making operation in a basically flat gold price environment (2014-2018) into an operation which makes a 14 million operating profit (EBITDA went from 5 million at the time of acquisition to 20 million in a flat gold price and a negative to flat silver price). In 2018 they decided to sell this operation since more meaningful projects came in their crosshairs (Kyzyl for example) which had much larger reserves and production and a lower cost profile. In the end, they booked a somewhat disappointing 3 million profit on the sale of the asset.

The most important acquisition was in 2014 with the Kyzyl mine for a little over 600 million dollars (formerly called Bakyrchik or sometimes Bolshevik, a mine with a checkered history). Because of the high grade (around 7 grams per tonne Life of Mine), there were many attempts by former owners to try to make this mine economical. There were however 2 problems, a relatively unstable subsurface and a large portion of the ore was refractory. Refractory ore is more difficult to process since the gold is very fine and doesn’t normally bind to the standard recovery methods (cyanide and carbon absorption).

Polymetal took a step back and simplified everything. The unstable underground mining conditions were dealt with by constructing a large, high strip ratio open pit mine. The refractory ore was dealt with by just producing a concentrate on site and shipping it to roasters (a process which can release gold from the refractory ore) in China. This freed them from large capital outlays on roasters and lowered the processing risk. Management is cognizant that roasting is environmentally worse for the environment due to the large amount of sulfur that is released in this process and developed the IP and facilities to treat their own refractory concentrate.

Now this mine produces around 400-500 million in annual EBITDA on an initial investment in the region of 950 million (acquisition plus development capex).

They are also very hands on in my opinion. There is an anecdote that when they build their first POX plant (Pressure Oxidation - a way to treat refractory ore using heat and pressure) the project faced delays due to the unavailability of some crucial parts. Management’s solution was to take with them pieces of pipes and linkages made from exotic alloys in personal luggage from business trips to Australia and Canada.

The experience they gained mining Albazino (one of their earliest refractory ore mines which they acquired in 2006) and Kyzyl gave management more confidence to tackle refractory ores, which is where their second competitive advantage comes from. And this is a reason why they stayed in FSU countries. Russia’s gold reserves consist for 80% of refractory ores according to some sources. Another reason is also economical. Even though they are somewhat jurisdiction agnostic (see their Armenia and Kazakhstan acquisitions) they prefer FSU countries given the higher bang for the proverbial exploration buck. Many FSU countries have seen 1/10th the amount of exploration compared to even many African countries. This crisis then can be a catalyst to slowly branch out and invest some of their FCF into other regions of the world to gain more jurisdictional diversification (and should be favorable for the long run for the company).

Commodity diversification is again something management is not agnostic about. The company came to the market mostly on the back of a large silver mining project, namely Dukat (which is nearing the end of it’s mine life and will be replaced in the future by another high margin silver project they have in the pipeline – Prognoz). They mine some copper with Varvana in Kazakhstan and are trying to expand more into copper and PGM’s (with the Viskha project in Russia as well).

Some of the reason that they focus on these refractory ores are the higher grades of these deposits. This is why some of their mines are amongst the highest grade mines in the world, both in open-pit and underground mines. And higher grades, even with these higher treatments costs, translate into higher margins.

Russia risk somewhat hedged

While this is a Cyprus headquartered, mostly Russian mining company, there are some points which should shield Polymetal at least somewhat from the current Russia crisis.

Their largest, highest margin, longest life (and highest FCF) mine Kyzyl is located in Kazakhstan. This mine alone with a reserve life until 2050 produces around 350,000 ounces a year and 400-500 million in EBITDA. Their product is sold almost completely to China, however with plans to divert this production to their POX-2 processing plant scheduled for completion in 2023. Should this crisis not be resolved by then, I expect them to keep exporting their concentrate to China.

Varvara, another mine they own in Kazakhstan has it’s own processing plant and produces both gold and copper, has a mine life until about 2036 and a decent AISC profile (around 1100-1200 USD per ounce). There are some opportunities with a satellite deposit which has a higher grade and should lower the operating costs starting in 2025.

Together, these Kazakhstan mines generated almost 1 billion in revenues in 2020 and 2021, more than 600 million in EBITDA and over half a million ounces in both years. These 2 mines alone should more than cover the current EV of under 3 billion. That equates to an EV/EBITDA of less than 5. This is less than the 6.4 times that was paid for KAZ Minerals about a year ago (KAZ minerals was mostly a copper miner, but it gives some indication).

The Ruble depreciation should also be favorable to the company. Their operating costs for Russian mines are for a large part priced in Rubles (except of course some materials and diesel).

In the past, they sold much of their concentrate in China, or sold their gold to Russian banks. The gold (and some silver) which is produced and sold in Russia is mostly sold to local banks. The company is concerned about counterparty risk and even before the first Ukraine crisis they only sold gold to financially strong banks. Here again, the current crisis has increased the demand in Russia for gold, which is again positive for the company.

Some more points about gold and Russia

Even during the cold war, Russia was able to export gold to the rest of the world. And with a large gold demand from neighbour and "ally" China, I see no real issues here in the medium term.

Since the sale of their gold in Russia is mostly to local banks, it is not unreasonable that the higher demand ensures them to get a fair price.

The Central Bank of Russia purchased a majority of the locally produced gold during the last crisis a few years ago.

Did I look at other Russian companies?

This is a question which is inescapable given the writeup of a Russian company. I did look at a few but all came with bigger problems than Polymetal.

Polyus has better mines (they have bigger reserves and larger margins) but there is more political and operational risk here. All their mines are located in Russia and the majority owner (Suleyman Kerimov) is on the banned billionaires list (trading in the shares has also been suspended).

The other Russian gold mining company on the LSE (Petropavlovsk) has a pretty big debt package (for them at least) coming due this year, only has operations in Russia and is less profitable.

Russian banks, no thanks. That sounds short, but there are so many things that can go wrong with banks in my opinion. A long economic crisis in Russia is bad for asset prices, financing and assets freezing can kill a bank, bank runs are very much possible, etc…

Russian steel companies: most got suspended, have quite some debt (Evraz for example) and operations are almost entirely in Russia.

So to conclude, Polymetal is one of the very few companies which have quite extensive (although Kazakhstan had its own issues, I agree) foreign operations, is run by a good management team, is active in a sector which could actually be favorably impacted by this conflict (lower ruble lowers costs and USD revenue source, more demand in an uncertain environment) and let’s not forget, the bargain valuation.

Catalyst

The only catalyst here would be a favourable outcome in the long run of the Russia conflict or a possible acquisition of a non Russian mine.

Spinning of the Kazakh mines is a possibility, but I do not think this is likely outcome judging managements attitude towards this scenario.