Four turnaround mining stocks

[miningmx.com] — PICKING the right turnaround stock isn’t easy. You have to know when to buy and – arguably – the best time to buy is when the company is at its shoddiest, where corporate disciplines have slipped and fundamentals are faltering.

But that’s when most prudent investors are looking away in disgust and it’s hard to go against what might look like a sensible market view.

And, of course, there’s more than a degree of truth in the contention that investing in a well-run business rather than counting on a rebound in a “gone bad” business considerably lessens the chances of third degree wallet burns.

However, with the JSE displaying some signs of volatility (which frustratingly smears sentiment for good stocks), having a small portfolio of turnaround shares may be a lucrative little sideline in the months ahead.

Canvassing market participants on the merits of “turnaround stocks”, it’s apparent that not too many professional punters really regard them as a specific asset class. The lack of enthusiasm for turnaround stocks may be a function of an extended bull market, as well as robust business conditions where only a few companies have got into a tangle.

One well-known stockbroker notes: “I don’t really dabble in turnaround stocks. By the time I find out about turnaround situations it’s always too late…”

Another investment professional says: “But the market has been so good in recent years…are there really any lucrative turn-around opportunities available?” Miningmx sister publication, Finweek, thinks there are a few turnaround opportunities in the market for the braver investor and we’ve set out below four potential turnarounds in the mining space below.

HARMONY GOLD

FOR YEARS HARMONY was the golden child of Johannesburg’s mining industry, growing from a single lease-bound mine in the Free State in 1996 to a top 10 gold producer. Led by charismatic CEO Bernard Swanepoel, and ably supported by Ferdi Dippenaar, the two could do no wrong.

By 2004 the company had completed 26 corporate transactions, around three a year. Not even a historically low gold price of $255/oz (recorded in 2000) could strike discord into Harmony’s heart.

But by 2004, when Harmony embarked on its most ambitious corporate manoeuvre of all – a bid for Gold Fields – the seeds of its current crisis had been sown.

The mines on which Swanepoel had built the firm’s reputation were older and costlier and the company was larger and more difficult to manage. Key skills left the firm amid talk that Swanepoel had become trenchant.

Not even historic gold price highs could save Swanepoel his job when, in August, he suddenly quit amid a R653m loss for the June quarter.

Acting CEO Graham Briggs says there’s nothing wrong with Harmony’s assets; the only problem is the culture (which needs reinvention) and morale (which needs lifting). There’s also nothing wrong with the market, because gold had burst through a 28-year high at the time of writing.

Somebody once famously said that a mine is a hole in the ground with a liar at the top. Gold mines age and there’s nothing the most talented executive can do about it. So the single biggest obstacle to Harmony’s reinvention is that Briggs chases production over margin.

DRDGOLD

DRDGOLD’s best selling point has always been its imminent demise followed by miraculous recovery.

The company hasn’t paid a dividend in donkey’s years, nor much of a profit either (after capex). But that never mattered. Traders leapt gleefully into DRDGOLD – and its former incarnation, Durban Roodepoort Deep – whenever the gold price went up and quit the firm when it went down. They called it “The Roodepoort Rocket”.

But the company also hit the self-destruct button trying to replace its South African-based gold production with higher quality Australian gold. Though the strategy temporarily flickered, it became obvious DRDGOLD had forgotten what it was and then battled to produce sufficiently high quality gold ounces in Australasia.

The departure of Mark Wellesley-Wood, DRDGOLD’s seemingly indestructible CEO, in December 2006 spelled the end of the grand internationalisation period.

Swapping a mining engineer for a bean counter, DRDGOLD has installed John Sayers in the top job. Sayers by name, but not by nature: DRDGOLD’s new boss is taciturn and shy of words – a far cry from the immense marketing brio that was Wellesley-Wood.

However, Sayers has taken DRDGOLD back to its South African roots. Consequently, the sale of its Australasian mines has shored up the balance sheet with net cash of R840m ($120m).

But dangers abound for South Africa’s best-known corporate Lazarus. It continues to make grandiose promises concerning gold resources in underground mines it may never mine – and which could be difficult to manage and costly if it did. In addition, there are management succession doubts.

TRANS HEX

DURING DE BEERS’ long tenure on the JSE, Trans Hex was always viewed as a second line diamond stock, which befitted its reputation as a reliable (if a touch dowdy) producer of gems from alluvial concessions along the Orange River.

After De Beers’ delisting, Trans Hex enjoyed a few glory years before things started going awry.

First, the group had its push to be a major player in the marine diamond sector halted by retail tycoon Christo Wiese, who snatched control of Ocean Diamond Mining Holdings and sold the group off to Namco.

Then the longevity of Trans Hex’s traditional alluvial operations came into question. Trans Hex, with Remgro and Mvelaphanda Resources as major shareholders, has now pitched its tent in Angola.

Its operations there have looked promising enough in terms of production, although it would take a big hit in that country to convince punters that Trans Hex was back on a winning footing.

The general consensus is that there’s considerable risk in mining gems in Angola.

However, backers of Trans Hex – which holds a number of Angolan mining partnerships – say that if it strikes it big, it will be VERY big.

In the meantime the core Orange River alluvial concessions are cash generative. So far this has sustained Trans Hex’s policy of paying regular dividends.

SALLIES

IT WAS A GREAT IDEA in the late Nineties to transform the old SA Land & Exploration into a fluorspar player under the sexier Sallies guise.
By the time Sallies got itself ready to produce – after a bout of corporate upheaval that saw turnaround artists FRM brought in – fundamentals for fluorspar were fair to mild.

By 2005, fundamentals had improved considerably but the problem was that Sallies had locked itself into an onerous delivery contract with US-based Honeywell.

Sallies managed to extricate itself from that contract (which is still subject to a legal challenge) and also expand production capacity with the acquisition of a new mine. Unfortunately, things went wrong on the production side, which meant that costs weren’t covered by revenues and this year Sallies had to go cap in hand to shareholders for a(nother) rescue rights issue.

The group has pencilled in earnings of between 5c and 6c/share for its 2008 financial year, but the current market price of around 55c suggests there’s still much scepticism.

Fundamentals for fluorspar remain sound and the group has some influential backers – including retail tycoon Christo Wiese (who has twice pitched in new capital in just two years). The recent resignation of Izak Marais, Sallies CEO, is grounds for more doubts. Although he says he quit for ‘strategic reasons’, there’s lingering doubts Marais knows something investors don’t.

On paper, Sallies should be pumping profits. However, the operational setbacks of the past two years have raised uncomfortable questions concerning management’s ability to eke out meaningful rewards.