The Dire State of the Platinum-Palladium Miners

During the third week of May each year, representatives of the platinum industry gather in London, for an event that has become known as ‘Platinum Week’. Platinum Week centers on an industry dinner sponsored by the London Platinum and Palladium Market (LPPM) which marks the anniversary of the inauguration of the London Platinum Quotation (the forerunner of the present London Fixings) in 1973.

This event is attended by platinum group metals (PGM) producers, refiners, fabricators and traders. The first major event of the week is the publication of Johnson Matthey’s annual review of supply and demand for the PGM markets.

According to Johnson Matthey, the platinum market was in deficit by 375,000 ounces in 2012, close to their forecast made last November. The palladium market was also undersupplied but by a much larger margin of more than 1 million ounces.

For platinum and palladium, this was a reversal of the position a year earlier when both were in surplus. Gross demand for these metals continues to recover from the slump in 2008. Overall, gross demand for platinum fell by only 50,000 ounces year-over-year to 8.045 million ounces, a stronger performance than might have been expected.

The automotive market has been a major focus of attention and we believe that many observers will be surprised that demand from this sector grew from 3.185 million ounces in 2011 to 3.24 million ounces last year.

In Europe, auto catalyst demand fell from 1.505 million ounces to 1.33 million ounces as the car industry continued to slow. The surprise growth in demand comes from the Chinese jewelry market, where demand grew strongly to 1.95 million ounces. According to Mitsui, in net terms Chinese jewelry demand was larger than gross automotive demand for platinum in Europe for only the second year ever. The launch of a platinum ETF in South Africa is also positive for demand this year. The ABSA fund has already purchased 283,000 ounces of platinum as of the 17th of May. Overall we view the demand statistics from 2012 as very bullish for platinum and palladium in 2013.

While demand is expected to remain solid for 2013, the bull case for the PGM story is on the supply side. As we analyze the state of the miners, their situation is getting progressively worse, even more so than we expected.

Investors in platinum stocks have dumped their shares in a panic over the last six weeks, fearing that the platinum sector is in terminal decline. Since April the sector has fallen by 20%, bringing the cumulative decline for the year to 30%. What has caused this exodus? The results coming in from the PGM miners have been awful. Take Impala Platinum, the world’s second-biggest producer of the metal, which said that more of its shafts are producing at a loss as prices decline and costs rise. “These units are being monitored on a continuous basis to determine their ongoing viability.”

According to ‘Implats’, average extraction costs increased 23% to 15,957 rand ($1,766) an ounce for the nine months through March from a year earlier.1 This implies that at today’s platinum price, Implats is losing close to $300 per ounce produced.

For a longer-term view of the industry, we were intrigued by an article by David Holland and Brian Kantor entitled: “Thinking in the same old way will not rescue the platinum industry”. The analysis highlights why we have had such a negative view on the miners. For this study the authors aggregated the historical financial statements of the five largest South African platinum miners (Anglo American Platinum, Impala, Lonmin, Northam and Royal Bafokeng) and calculated the inflation-adjusted cash flow return on operating assets (“CFROI”), which is the real measure of return on capital for the industry.

The glory days for platinum mining were between the years 1999 to 2002 and provided the first wave of extraordinary fortune for platinum miners. The real return on capital exceeded 20%, making it one of the most profitable industries in the world at that time (the average CFROI for global industrial and service companies is 6%).

The second wave of fortune occurred during the global commodities "super cycle" from 2006 to 2008. Again, platinum mining became one of the most profitable businesses in the world. The good times ended abruptly at the end of 2008, when platinum miners saw their real return on capital drop to 1% — much less than their cost of capital.

In 2012, the CFROI in the platinum sector of South Africa’s economy was a miserable -0.6%, the lowest return on capital since 1992. Suffice to say, platinum miners are not producing sufficient returns to satisfy shareholders, or to support their operations. This has resulted in unavoidable cost-cutting, lay-offs and scaling back of capital expenditure plans.

And what does the future hold? The authors took analysts’ expectations for this year and next and estimated the real return on capital at a value destructive level of 0% for this year and a depressed 3.4% until 2017. There is no hint of a return to superior profitability in the share prices of platinum miners. In a nutshell, South Africa’s platinum miners are destroying value and are expected to continue to do so. They are in a dire state.2

Adding to this ‘perfect storm’ for platinum miners are the wage negotiations with the largest union of mineworkers. The South Africa National Union of Mineworkers in two weeks' time will present a demand for a wage increase of "no less than 10%" and up to 60% for its industry members to take effect from July, union spokesman Lesiba Seshoka said Monday.3 Given the financial state of the largest platinum miners these new demands will be difficult, if not impossible to meet. This aggressive stance has rattled mining investors after wildcat strikes last year at platinum and gold mines killed 50 people and cost billions in lost output.

Investors are not sticking around to find out what happens next with the miners and are taking positions in the metal itself, which we believe will be rewarding in the long term. As reported by Bloomberg, holdings of all platinum ETFs have increased by 30% since the beginning of this year and palladium holdings have increased by 16%. Both are healthy increases over a short period of time, highlighting investors’ preference for the metal over the miners. Given the data and opinions provided at Platinum Week, we continue to believe in a bright future for these two precious metals.

www.sprottgroup.com/thoughts 

1Implats Assessing Shafts’ Viability as More Become Unprofitable. Retrieved on May 22, 2013 from: http://www.bloomberg.com/news/2013-05-02/implats-assessing-shafts-viability-as-more-become-unprofitable.html

2Thinking in the same old way will not rescue the platinum industry. Retrieved on May 22, 2013 from: http://www.bdlive.co.za/opinion/2013/05/14/thinking-in-the-same-old-way-will-not-rescue-the-platinum-industry

3South Africa Union to Seek 'Double-Digit' Wage Rise. Retrieved on May 22, 2013 from: http://online.wsj.com/article/SB10001424127887324482504578454603754058118.html

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