Fixed Income Analysis /
Russia

Petropavlovsk: Growing stronger with gold prices; reiterate Buy

  • Strong FY 19 results, significantly increasing gold sales after a successful commissioning of the POX Hub

  • Gold prices and higher volumes will boost 2020 revenues

  • We reiterate our Buy recommendation on the back of improving fundamentals and supportive technicals

Tellimer Research
29 May 2020
Published byTellimer Research

Reiterate Buy. Petropavlovsk reported strong FY 19 results, significantly increasing gold sales after a successful commissioning of the POX Hub. Revenues increased 48% yoy to US$742mn, EBITDA was up 45% yoy at US$265mn and net leverage decreased to an unconcerning level of 2.1x. We expect 2020 to be another year of strong performance when increasing revenues and EBITDA will promote further deleveraging and make a strong case for an early liability management transaction to refinance the US$500mn 8.125% notes due 2022. POGLN 22s are indicated at mid-price of 104 and YTM of 6.15% offering one of the highest returns among Russian non-financial corporates, with the closest peers yielding below 4%. We reiterate our Buy recommendation on the back of improving fundamentals and supportive technicals.

POX Hub becomes the main revenue driver right away. In 2019, Petropavlovsk increased gold production by 22% to 517koz, of which about one-third was treated at the recently launched POX Hub. The pressure oxidation facility (POX) has addressed and resolved the problem of refractory ore treatment, which represents 70% of the company’s 8.5Moz 2P reserves. As the POX Hub can process more concentrate than the company can currently produce, Petropavlovsk has been buying third-party concentrates, which accounted for 9% of gold output in 2019. By the end of 2020, the company expects to complete a new floatation facility at Pioneer, which will double its refractory concentrate capacity to 7.2mt. In 2019, revenues increased 48% yoy to US$742mn on the back of higher gold sales and average realised prices (Table 1 on page 3 in full report). However, as the rally in gold prices started to gain momentum only in H2 19, the main effect on revenues is yet to be seen.

Gold prices and higher volumes will boost 2020 revenues. The bullion trades at levels not seen since 2012. In Jan-May 2020, the average price was US$1,629/oz, 17% higher than the average price in 2019. Combining the price effect with management’s production guidance of 620-720koz (430-460koz from own ore), one can expect Petropavlovsk to generate over US$1bn in revenues in 2020. Unlike 2019, when the company could not fully participate in the gold price rally constrained by forward contracts fixed at a relatively low price, the new hedging strategy will help to keep prices in the range of US$1,600-US$1,832/oz on 3.5koz a month or 42koz a year, giving some protection on the downside, but allowing the company to benefit from rising prices.

Profitability to increase on high gold prices and RUB depreciation. In 2019, the company reported US$265mn in EBITDA posting a 45% yoy growth after restatement. A re-classification of deferred stripping of costs to mining assets increased depreciation and EBITDA and reduced total cash costs (TCC) in 2018. Accounting changes had no effect on cash flows. In 2019, the TCC increased 10% yoy to US$749/oz and the all-in sustaining costs (AISC) were at US$1,020/oz. Management guidance suggests that the TCC will remain in the range of US$700-800/oz in 2020. With gold prices up c20% yoy, Petropavlovsk is likely to see significantly higher profit margins particularly in light of RUB depreciation (13% ytd), which will help to keep production costs in check.

Deleveraging to continue. In 2019, Petropavlovsk achieved several important milestones on the debt front. The loan of its associate IRC (Petropavlovsk is a guarantor) was refinanced and its repayment schedule better matched with the borrower’s cash flows, reducing the likelihood of Petropavlovsk having to step in. Also, the company refinanced US$100mn convertible bonds on a new US$125mn convertible issue due 2024. Gross debt remained roughly unchanged at US$609mn, but net leverage reduced to 2.1x (from 4.0x in 2018) on the back of higher EBITDA. A positive outlook on earnings suggests that deleveraging is likely to continue in 2020. We believe improving credit fundamentals could encourage management to look at early refinancing options for the US$500mn notes due 2022. A liability management transaction in the form of a tender offer conditional on issuance of new notes could help extend maturity and lower interest rate. The company reached a preliminary agreement to sell most of its stake in IRC. The disposal is not expected to generate significant proceeds, but may release it from a guarantee on the IRC loan to Gazprombank, of which US$219mn remained outstanding in Q1 20.

More liquidity available now. On the operating level, high gold prices are set to convert into higher free cash flows amid reducing capex requirements of US$70mn-US$80mn in 2020. However, working capital, which is likely to increase from higher prices and expected increase of third-party concentrate purchases, could absorb the operating surplus. Petropavlovsk uses gold prepayment contracts to finance its working capital requirements. According to management, there was cUS$120mn outstanding under the prepayment facilities as of May, but there are more available. Gazprombank, the counterparty under the contracts, has recently increased the limit to c392koz or RUB33.9bn (US$485mn at current exchange rate). Other potential outflows could come from dividends and acquisition.