Fitch downgrades Harmony

André Janse van Vuuren | Fri, 12 Nov 2010 16:16

[miningmx.com] -- FITCH Ratings on Friday lowered its assessment of Harmony Gold while maintaining a negative outlook for future re-ratings, stating it is concerned over the gold producer’s cash holdings.

The ratings agency downgraded Harmony’s long-term foreign currency issuer default rating to “BB-” and its national long-term rating to “BB-(zaf)”.

“The ratings downgrade primarily reflects Fitch’s concern about company-specific issues following the erosion of Harmony’s cash buffer in FY2010,” Fitch said in a statement.

According to Harmony’s 2010 annual report, the group’s cash holdings decreased from R1.95bn (on June 30 2009) to R770m a year later. Over the same period, borrowings (both current and non-current) shot up from R362m to R1.19bn.

“The agency had previously noted that this (Harmony’s cash holdings) was a key supporting factor for its previous ‘BB’ ratings, given the rising operating cost pressures that are expected of the next three to five years.

“Harmony’s ratings were already constrained by its high marginal producer status, compared with its global peers.”

Fitch was, however, complimentary about Harmony’s mine portfolio restructuring actions. “This includes rebalancing the group’s production base to better grade operations and the potential ramping-up of production to 2 million ounces by 2013.”

Harmony produced 1.4 million oz of gold during its 2010 financial year, and its revised target for 2011 is around 1.65 million oz. It has in recent years embarked on a process to transform itself into a lower-cost, high-margin gold producer with a significant production pipeline. In the process, it closed some of its Virginia and Evander shafts which were low-margin operations.

However, the extent to which Harmony’s continuing marginal operations remained a drag on its growth projects was evident in the group’s quarterly results to end-September. A 6,200 oz total output rise at Harmony’s growth projects - Doornkop, Kusasalethu, Phakisa as well as Hidden Valley – was more than discounted by falling production at other assets, resulting in a 2.9% overall quarterly output drop.

Fitch said it believed Harmony’s management will continue to have some flexibility to restructure its operations, even in a potentially weaker gold price environment.

The agency also said it will keep a close eye on rising operating costs, fuelled by above-inflation electricity price hikes, labour costs and water tariffs.

Fitch forecast that Harmony’s total funds from operations would be more than R6bn from 2011 to 2015, while capital expenditure would be R10.5bn. The assumed costs per ounce is between $700/oz and $773/oz. At an average gold price of $1,100/oz in 2011 and lower thereafter, it said Harmony’s ratings would be pressured, and it expects the company to raise additional equity or debt to finance expansions.

This is in stark contrast to Harmony's stated objective of funding growth projects through the cash generation ability of its South African operations.

“Future negative rating action could arise from a step-change in Harmony’s gross leverage profile and a material weakening in the liquidity position,” said Fitch.

“Operating cost inflation ahead of expectation and material operational delays would also negatively affect the current ratings.”