Lonmin positive metal price outlook tempered by local concerns and debt LMI

Falling metal prices and tough domestic conditions have led shares in South African platinum miner Lonmin (LON:LMI) to plummet from 183p to 60p this year. Lonmin’s cash levels and global metal prices may be moving in the right direction, but last month’s horrible set of results swung the focus back on the firm’s highly clouded future.

In its half-year results Lonmin worried markets by revealing that there now exists an uncertainty around its ability to survive as a going concern. It has long been hit by weak metal prices in the platinum metals group as well as rocky macroeconomic conditions and inflationary cost pressures within the South African mining industry.

In response to these concerns, Lonmin launched an operational review in August, which aimed at cutting costs and increasing cash by selling off assets and reviewing future capital requirements. But after seeing shares creep to as much as 106p in September and October, Lonmin’s problems returned last month following the release of its Q4 results. Its shares immediately dropped by more than 30pc.

Despite increasing its cash reserves to $103m, up from $86m at the end of June, the results saw Lonmin shed a fifth of its value, returning to around 60p, after it revealed that it would be delaying the publication of its accounts. It said it is at risk of breaking one of the banking covenants on its $150m debt facility, which demands that its tangible net worth does not fall below $1.1bn.

Despite getting these covenants temporarily waived last month, Lonmin’s tangible net worth is currently sitting worryingly close to this figure due to an ongoing financial impairment. As a result, the company said it cannot publish its accounts because ongoing discussions with lenders could result in a change to its status as a going concern. This issue has captured ‘management’s undivided attention’, we are assured.

Considering that in August, when Lonmin’s tangible net assets sat at $1.434m, we warned that this may be a little close for comfort for some investors, this further deterioration seems even more worrying.

While undoubtedly troubling, Lonmin is hopefully taking the right steps to address its issues – indeed, it said it has received ‘encouraging’ third party interest in its assets and is cutting jobs to reduce overheads. But the results also revealed a number of other disturbing signs, which essentially boil down to factors outside the company’s immediate control.

As a result of an 8pc increase in labour costs, Lonmin’s unit cost per ounce of metal rose to R11,701 in 2017, up from R10,748 in 2016. With average prices for its metals sitting below this figure at R11,266/oz for the year- a figure which is itself down 3.4pc from 2016 due to weak metal prices – the company’s production costs do seem to be causing the company to struggle.

What’s more, unit costs are set to rise even further to between R12,000 and R12,500 a month in the 2018 financial year. The impact of high inflation in South Africa can also be seen, with the value of the rand against the dollar falling 9.5pc from R14.77 in 2016 to R13.37 in 2017. If this trend continues, then Lonmin could well face additional disquiet among its labour force, for local conditions that are completely out of its control.

Factoring in the company’s debt and it is understandable why the market has taken the axe to Lonmin’s share price.

What’s next?

Provided Lonmin is able to get its house in order and prove that it is not at risk of running out of cash, the macro price environment has in fact begun to favour the company in recent months.

After falling spectacularly from $1017.20/oz to $915.40/oz over September, the price of Platinum has slowly picked up ever since, currently sitting at $939.80/oz. Palladium prices, meanwhile, have played an absolute blinder this year, rising from $685.80/oz to $1014.40/oz year-to-date.

With platinum forming roughly 51pc of Lonmin’s total refined platinum group metals and palladium forming around 23pc, based on production figures in its latest result, these movements bode well.

From a technical analysis viewpoint, Lonmin is showing tentative signs of forming a new base. Prior to the warning of a possible covenant breach, the share price was showing signs of recovery, posting higher highs and higher lows.

But since the 31% drop after November’s results, an attempt to consolidate around 67p support has failed. The share price now looks to be regrouping at its next support level at around 58p.

Should the share close below 58p, a further move south to around 50p is likely. A subsequent strong bounce from here
could yield an initial target of around 84p. This makes Lonmin very much a binary play based on the reality of its circumstances and news could move the price beyond local resistance and support levels in the blink of an eye.

South African headwinds

As positive as the macro price environment appears to be for Lonmin, it is vitally important to play close attention to the geo-political risk facing the company. Unfortunately, troubled local operating appear to be growing ever more desperate.

Earlier this month, Lonmin’s labour union said it had overwhelming support for a strike at the platinum mining firm motivated by its perception of the way employees are treated. Then, last week, the Mining Forum of South Africa called on the country’s mineral resources minister Mosebenzi Zwane to suspend or cancel the firm’s operations, arguing that it had failed to comply with social and labour plans.

This really is not an issue that should be ignored. In 2012 10 people were killed in what is now known as the Marikana massacre. The catalyst for this tragedy was a wildcat strike at Lonmin’s Marikana mine. Two years later and the 2014 South African platinum strike, South Africa’s longest and most expensive strike, completely shut down the company’s operations. Even the hint of a repeat of anything approaching either of these events could send Lonmin’s share price tumbling.

However, Lonmin chief executive Ben Magara has sought to reassure investors that all was well in its Q4 results, boasting of reduced capital expenditure and a 9.3pc jump in total metals mined over the three months. Lonmin’s high-level of cash flow generation relative to the company’s market cap is certainly appealing, but this is only part of a much more complex story. The clouds cast by Lonmin’s troubled legacy, signs of possible looming difficulties in the South African economy and the very real threat of bondholders calling time post-covenant breach, all make a purchase at the stock’s current price a significant gamble.

Continued strength in precious metal markets could entice equity investors back in, but if this happens be prepared to be nimble, taking profit aggressively.

 

Disclosure

The author of this piece does not hold shares in the company written about above.

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