Eskom may sink Gold Fields' rerating plans

Allan Seccombe | Thu, 29 Oct 2009 16:21
[miningmx.com] -- GOLD Fields reckons it has it within its capacity to narrow the ratings gap between its shares and those of its North American peers, a long-time bugbear for the South African gold industry, but moves by Eskom to hike rates by 200% over three years could scupper those ambitions.

In an enormously complex matter of weighing North American gold firms up against those in South Africa it depends largely on what metric you use to draw that comparison. Some use price to net present value, others use price to earnings or price to cash flow or even price per resource ounce. Even volatility of the respective shares could be a measure of the way the companies are viewed, with South African stocks traded more actively than their peers.

In some, it’s easy to see South African gold shares trading at a discount, with recent price to net present value showing a roughly 30% discount to their North American peers, with the interesting development being Harmony trading at a reduced discount compared to Gold Fields and AngloGold Ashanti, which have far less South African exposure.

This could be an indication that AngloGold and Gold Fields were miss-priced relative to Barrick and Newmont, the world’s two largest gold companies, and could be due for a re-rating, meaning increased share prices.

On a price: earnings ratio (p:e), Gold Fields has, based on Thursday’s quarterly results, an annualised p:e of 29 times, Newmont 13 and Barrick 17 times. “Gold Fields is attracting a very good rating or it could simply be way too expensive,” an analyst said.

Gold Fields chief executive Nick Holland looked at the market capitalisation of a North American company, which has output of 400,000 oz a year and reserves of 13 million ounces against Gold Field’s targeted output this year of 3.7 million ounces this year and reserves of 80 million ounces.

“Yet our market caps are similar. You ask yourself how can this be. What the hell is going on?” Holland said.

The company has over the past 18 months looked closely at the matter. It found investors looked at declining grades and increasing depth at South African gold mines over the last decade, safety stoppages, falling production, an incorrect perception costs were rising more vigorously in South Africa and concerns about the operating environment, lending a political discount, legislative requirements and concerns about rising power costs and supply consistency.

“All of these issues have tended to escalate the gap between the South African producers and the rest of the gold sector,” Holland said.

“If you go back... you’ll find there were times when that gap had narrowed to zero. With proper management of these issues there’s no reason to suggest this will continue forever,” he said, arguing a significant re-rating – read price increase -- of South African gold shares could be in the offing.

“When I look at the valuations of some of the other majors offshore, it’s crazy. We can do something about it. It’s not going to be solved in one quarter, but the way we are trending right now we are moving in the right direction,” he said.

Analysts said this was not new because South African gold companies had been pushing this line for years, but what was going to make it more difficult for them to sweeten offshore investor sentiment was Eskom’s proposed price hike, which will be decided on in coming months.

Eskom, which has already hiked tariffs by a third this year, wants annual increases of 45% over the next three years towards funding an aggressive capacity expansion programme.

Holland estimated that if the increase is approved by the regulatory body, the cumulative impact on group operating costs will be 17% at the very least before the knock-on effects are felt by suppliers and fed into Gold Fields.

DRDGOLD has warned if the price increase goes ahead it will be forced to shut its only operating underground mine.

The tariff increase will result in the more rapid closure of marginal mines resulting in large job losses and the mining industry is urging the government and Eskom to re-think their financing model.

“It will put unusual cost pressures on the South African gold miners relative to the rest of the world. It puts Harmony at a bigger disadvantage than AngloGold and Gold Fields,” said an analyst, adding it would certainly push the ratings between South African stocks and their peers further apart.

Holland said he was sure a sound solution could be found for Eskom’s funding crisis.

If Gold Fields could continue to stabilise production and grades and grow production in South Africa, which it is doing with the South Deep mine, and operate more safely, reducing the number of safety stoppages, there should be a re-rating of the share price, he said.

Gold Fields, which has just acquired AIM-traded Glencar, with its exploration assets in Mali, is looking inwards for growth, particularly from three advanced exploration projects in Chile, Mali and Kyrgyzstan, rather than buying other gold firms which have risen strongly with the high dollar gold price.