Dividends on agenda despite Harmony’s debt, capital ‘priorities’

Wafi Golpu

ONE of the painful lessons learned by the mining sector since the collapse of the commodity market has been the importance of using cash wisely, especially when times are good. So it will be interesting to see how Harmony Gold’s board approaches the issue of dividends, capital expenditure and its balance sheet after the June quarter.

To be speaking of dividends at Harmony Gold seems curious given that the company was fighting for its life just over six months ago. According to analysts, roughly 60% of its South African asset base was loss-making after capital expenditure during periods of last year.

But a heavy slide in the value of the rand against the dollar in December, which had the effect of taking the rand gold price to multi-year highs, and then a strengthening in the dollar price of gold in January made life for Peter Steenkamp, appointed CEO in January, vastly more comfortable than for his predecessor, Graham Briggs.

In an interview at the Johannesburg Country Club in Johannesburg, on a fresh winter morning, Steenkamp confirmed the question of whether to pay dividends was on the board’s agenda. He was reticent, however, to give anything away; demands on capital are strenuous and it’s no easy decision for Harmony.

“We’re obviously not against dividends. I can’t make a call on that now but when we get to the board meeting we’ll have a look at the situation at the time and make a recommendation. We obviously have this two-year window now which we wouldn’t have had originally which makes it more amicable for dividends,” he said.

There is also the issue of dealing with its debt which Steenkamp described as “our priority”.

At current rand gold prices, the company ought to be debt-free by the fourth quarter, or the second quarter of 2017 at the latest, which is fairly short work considering Harmony’s long-standing CFO, Frank Abbott, said in November last year it would take two years to rub out Harmony’s debt which was R2.7bn at the time.

We’re obviously not against dividends

Another potential call on cash is a requirement to “build a kitty” for Golpu, a copper/gold project Harmony shares with Australians Newcrest Mining in Papua New Guinea (PNG). It has been in Harmony’s portfolio since founding CEO, Bernard Swanepoel, ran the company, but it hasn’t been developed owing to the enormity of its cost.

Golpu is a giant undertaking.

Even if the current rand gold price were maintained, around R625,000 per kilogram, Harmony would only have built up cash of $132m by the time Golpu kicks off development, and that is assuming not much re-investment in Harmony’s South African assets, some of which are ageing.

The first phase of the project, in which some 3.6 million ounces of gold will be produced, is slated to cost about $2.6bn, equal to R40bn on an 100% basis. On an attributable basis, the project capital is still a meaty prospect matching perfectly Harmony’s market value at the time of writing.

Financing the project will put enormous pressure on Harmony’s balance sheet even though it’s unlikely to get the go-ahead until 2018. This is owing to regulatory delays in PNG, the government of which has yet to issue a development agreement.

Steenkamp said he won’t push the PNG for an agreement just yet, especially as it’s in an election year. “I’m not pursuing it any further because it’s right before the elections,” he said, adding that the regulatory process in the country is politically complex.

The existing government is actually a coalition: “There are a lot of factions supporting it, and some don’t support it, and I don’t think we should push it any further,” said Steenkamp.

CAPITAL PRESSURE

In addition, there’s also the question as to whether the PNG will take up its option of a 30% stake in the project. Analysts think it’s crucial to Harmony’s financial well-being that it do so as net debt becomes virtually ungovernable without it.

“At spot prices, we estimate Harmony would only be able to fund Golpu if the PNG government were to take up its full 30% allocation,” said RMB Morgan Stanley analysts Leroy Mnguni and Stefan Hansen in a jointly authored report earlier this year.

They calculated that net debt could increase to nearly $500m by 2023 without the government’s investment compared to net debt of only $130m with state involvement.

“This is too high for a company of Harmony’s value,” the authors said. They also highlight restrictions the PNG government may have in stumping up its contribution to the project.

According to reports in Australia, PNG’s cash flow crisis is so bad that politicians and public servants are not being paid on time while vital services are short on funds; government checks are also bouncing.

Harmony would only be able to fund Golpu if the PNG government were to take up its full 30% allocation

“Many people would argue that the state really should concentrate on its core functions of providing law and order, health, education, infrastructure maintenance and so on,” said Paul Barker, executive director of the PNG Institute of National Affairs in an interview with ABC, the Australian broadcaster.

There is also the risk of competing capital for Golpu. The PNG government has a stake in liquified natural gas (LNG) projects off its coastline, a multi-billion dollar business involving energy giants Total, ExxonMobil and Oil Search, the Australian firm in which the PNG government is invested.

Steenkamp believes the PNG government has enthusiasm for the project. “I think they are very keen. It’s obviously up to them to come to the party,” he said adding that the PNG government had the option of investing up to 30%.

“Maybe they won’t take the full amount, but we will have a look and see what happens there. The current prime minister is very keen on this development and to be part of it,” he said.

SA MINE CAPITAL LIMITED

As for funding the project, the aim is for it to be from cash. That’s certainly the expectation of Patrick Mann, an analyst for Deutsche Bank who commented in a report that “… Harmony should bank the cash flow [from the higher rand gold price]”. He added that this may result in limited investment in the South African mines.

Said Steenkamp: “At the moment, the plan is from cash flow [for Golpu], but we would find the right financial vehicle at the time. It depends obviously what the market is like, but at the moment if we can build a kitty we can fund from cash flow. Remember that the first few years is not a huge outflow of capital because you only sink into declines”.

Notwithstanding the pressure to finance Golpu, there is some investment locally. Steenkamp said Harmony had spent about R70m to R80m on re-equipping the infrastructure at Kusasalethu, Harmony’s west Rand mine, a task that resulted in 15 days of downtime at the mine over the Easter period.

There’s also a plan to put Phakisa and Tshepong together underground – a proposal that was current when Steenkamp was the company’s chief operating officer, several years ago.