Russia recently joined the World Trade Organisation. This is significant as the Kremlin now has to lower import and export duties and grant more freedom to its foreign trading partners. Corporate governance should also improve, pushing up domestic asset prices as the country becomes more accessible and perceived as being less of a ‘wild west’ frontier.
This is good news for Petropavlovsk, a gold miner in the Russian far east. Output at its four producing assets was 630,000 oz last year, and this is set to rise 13% to 700,000 oz in 2012. Yet in August its shares fell sharply after the group’s first-half earnings were hammered by higher costs as new facilities came on stream. Worse still, net borrowing ticked up to $1.12bn to fund expansion.
However, this bad news is more than factored into the depressed price. Assuming the gold price doesn’t drop significantly, gearing should drop to around twice earnings before interest, tax, depreciation and amortisation (EBITDA) by December. Encouragingly, average selling prices rose 13% to $1,639/oz, compared to a 6% jump in underlying production costs to $697/oz – a better result than most of its peers and partly down to a weaker rouble.
Petropavlovsk (LSE: POG)
Chairman Peter Hambro defended the group’s decision to take on more debt and said its borrowings would peak next year and fall in 2014 as cash flow generated by higher gold production enabled loans to be repaid. He argues that, at a time when the cost of money is cheap and the price of gold is high, miners should be investing. Consequently, a fair chunk of planned spending has been brought forward.
In a sign of his confidence, the 5p interim dividend was maintained (that’s a prospective yield 3.6%), with output expected to rise to 415,000 oz in the second half (versus 286,100oz in the first half) as production ramps up at its Albyn and Pioneer mines. The stock trades on a forward p/e of 5.5 (around half the sector average), which looks far too cheap.
Petropavlovsk may be suffering the same price inflation on chemicals and equipment that’s hitting the industry worldwide, but it is not suffering the wage pressures being encountered elsewhere. It also owns rights to large unmined reserves.
So overall I would rate the stock on an adjusted EBITDA multiple of seven, which suggests an intrinsic value of around 600p per share. Joint House broker Canaccord Genuity has a price target of 820p, and the next trading update is scheduled for 16 October.
Rating: SPECULATIVE BUY at 368p (market cap £670m)