Reiterate Hold. With refractory reserves unlocked by the up and running POX Hub facilities and immediate liquidity concerns lifted after the refinancing of the IRC loan, Petropavlovsk’s credit story has approached a turning point. However, the company’s FY results, management guidance and comments about processing of third-party concentrate suggest to us that Petropavlovsk will continue to rely on advance gold sale agreements to bankroll its operations in 2019. We do not expect the company to deleverage in 2019, but acknowledge that positive operating and liquidity developments are likely to support bond prices in the short term.
A pile of bills paid. Gold production came to 422,000oz (- 4% yoy) in 2018 and gold sales fell to 370,000oz (-16% yoy) as the company accumulated concentrate to be processed at POX Hub. With the average gold selling price flat yoy, lower sales volumes hit revenue, causing the top line to decline by 15% to US$500mn. EBITDA was down by 27% yoy, coming in at US$143mn due to lower volumes and higher unit costs. With high demand put on weak cash flow, the company had to utilise US$163mn under the advance gold sale agreements to fund US$134mn of capex (20-30% above prior management guidance), US$60mn interest, a US$57mn bridge loan to IRC and inventory build-up ahead of POX commissioning (Table 1).
Liquidity requirements to remain high in 2019. Management expects gold production to reach 450,000-500,000oz in 2019, including c52,100oz high-grade concentrate stockpiles accumulated in 2018. Total cash cost (TCC) is expected to increase by 8-20% yoy to US$850-950/oz and capex is budgeted at US$45mn-55mn. Based on mid-range guidance and the YTD gold price, we estimate the company’s free cash flow at US$46mn in 2019 (Table 2). This is still only a narrow safety margin given high leverage (4x in 2018) and significant working capital requirements to purchase third-party concentrate, which is not yet part of management guidance.
Advance gold sale agreements provide liquidity cushion. US$163mn owed by Petropavlovsk to the banks under the advance sale agreements will be settled by physical delivery in 2019-20. The company confirmed that the revolving facilities remain available to the maximum amount of 175,000oz. Access to working capital funding will be essential for the company if c100,000-oz equivalent of the third-party concentrate is to be processed at POX. An additional 100,000oz of production by POX Hub could generate cUS$128mn revenue at current prices. Costs, however, will also be affected. The working capital required to purchase concentrate will depend on the discount on the gold price negotiated with suppliers.
What could reduce free cash flow? The gold price could decline (200,000oz hedged at US$1,252 at end-18); the capex to expand the Malomir flotation capacity to 5.4mtpa might be brought forward to 2019; IRC could fail to meet its 2019 debt repayments; unexpected mining costs; RUB/USD below 66.
What could increase free cash flow? Sale of 31% in IRC; processing of third-party concentrate at a profit; the gold price rising above US$1,300; RUB/USD above 66.