Sibanye Stillwater – Unloved but Precious by Austin Crites, CFA
Commodity producing companies have been starved for capital for almost a decade leading to an attractive commodity price environment
Economic Moats in mining are derived from access to low-cost supply and wise capital allocation decisions
Sibanye Stillwater is our preferred choice in the mining industry due to their improving cost structure, strong corporate governance, and attractive valuation
Special thanks to my equity research interns for their contributions to this project: Fergus Washington-Smith and Lisa Cantú.
05/25/2022
Executive summary
I recently purchased shares of Sibanye-Stillwater (SBSW) for clients in our Core Equity, Concentrated Equity, and Equity Income portfolios. The stock trades at $12.32 as of market close 05/25/2022. Based on a valuation approach that projects and discounts future cash flows, I believe the stock is worth somewhere between $15 and $42.
In the bull run that followed the great financial crisis of 2008’-2009’, investors fell in love with capital light business models and generally shunned asset-heavy industries. Blame it on low interest rates, rapid innovation in software, ESG pressure, or any other contributing factor. Simply put, these businesses were starved for capital and for good reason. The 2000’s were the decade of rapid Chinese economic expansion hoovering up global commodities. Investors assumed the party would never end and encouraged extraction businesses such as oil producers and miners to grow production at all costs. This led to a massive supply glut that took a decade to unwind and created a new movement in extraction industries that prioritized minimal capital investment, cleaner balance sheets and maximum cash flow return to shareholders. As a result, investment in new capacity was, for the most part, a fraction of previous cycles and is a major culprit for the shortages of many commodities we see today.
Economic Moats in the mining industry come from access to low-cost supply and intelligent capital allocation decisions. Sibanye-Stillwater exhibits both qualities, which I will elaborate on further in this report. They are a miner of platinum group metals (PGMs) and gold with the majority of assets in Montana and South Africa. PGM mining is primarily limited to a handful of regions (Russia, South Africa, and North America) and the resources are mostly held by a handful of companies which leads to a favorable competitive dynamic. Russia produces roughly 40% of palladium globally which could lead to supply disruption and higher prices should the war in Ukraine drag on and/or spread to other countries. According to the US Geological Survey, South Africa has dominated total PGM mining production since the 1920’s and is expected to retain this position for the foreseeable future.
PGMs have other applications, but their main use is in the auto sector in catalytic converters to help internal combustion engines meet emissions standards. While the demand for catalytic converters will likely decline over the coming decades (due to electric vehicle adoption), I believe most of this will be replaced by demand in use cases such as hydrogen fuel cells, hydrolysis, dentistry, semiconductors, and other industrial uses. In particular, platinum has a bright future in the green economy due to hydrogen isolating properties. In the meantime, Sibanye pays an 8.4% dividend and is expected to repurchase 5% of shares annually while reinvesting excess cash flow in a green metals business to develop and process commodities like nickel, lithium, and uranium. The company trades for just 1.7 times cash flow which means investors expect current profits to vanish quickly. I politely disagree.
The company has an impressive history of creating value through mergers and acquisitions, is led by an industry veteran, and has a clear vision for returning capital to shareholders while reinvesting in the business. In summary, I like the business and am excited about the price we paid for it.
Macro
For the past several years, Wall Street has rewarded firms for pursuing capital light business models and shunning capital intensive “old industries”. For those companies with asset heavy business models, the message has been clear. “Operate for efficiency and pay maximal cash out to shareholders while neglecting the reinvestment needs of the business.” As a result, capital intensive businesses have been starved for capital owed to higher capital costs resulting in broken supply chains and high commodity prices. There is an old saying in commodity businesses, “Low prices are the cure for low prices”. Yes, Covid-19 and the Russia-Ukraine war have been singled out for the cause, but it simply exposed the root problem of underinvestment. Perhaps no industry has felt this pressure more than firms extracting natural resources. The graphs below show the deficient nature of capital expenditures within the platinum group metals since 2015 which has contributed to chronic undersupply and a price spike in the effected commodities.
The chart below shows the mix of global demand set against a supply mix from Sibanye Stillwater along with the primary source countries of South Africa, US/Canada, and Russia.
To take a step back, catalytic converters represent about half of global demand for platinum and roughly 80% for palladium and rhodium. These metals are essential for meeting increasingly stringent vehicle emission standards for light vehicles and heavy trucking. The onset of electric vehicles has led to the future for palladium (palladium is used in catalytic converters for gasoline engines) to be increasingly unclear, but the next several years should be extremely profitable due to ongoing shortages. Platinum has a much brighter future as it is used not only in heavy trucking (EV adoption is unclear, or at least slower) but for its role in hydrolysis and hydrogen fuel cells which may be the future propulsion technology for heavy trucking, marine transport, and even aviation. These metals are extremely rare and do have other uses, including dentistry, semiconductors, and jewelry. It should also be noted that while Russian palladium is not being sanctioned as of this writing, the country represents 40% of global supply and a prolonged war could lead to further supply disruptions.
It will come as no shock to readers that automotive manufacturing has been artificially suppressed in recent years due to a shortage in semiconductors and other supply chain bottlenecks. The chart below shows projections of global light vehicle production from IHS Markit. An eventual easing in semiconductor shortages should allow pent-up auto production to lead to an increase in demand for PGMs and provide a floor on commodity pricing and profits for associated miners.
Further, there is increasing concern over the availability of battery metals for EVs (especially nickel) as a speed-limit for adoption. While Sibanye is planning to reinvest a sizable portion of profits into battery metals projects such as lithium, the shortages of battery metals will likely lead to bumper profits for several years until Sibanye can transition the business towards the resources needed for the next generation of transportation and energy.
Resource intensive firms tend to follow the capital cycle. It can take over a decade for a greenfield mine to produce resources due to extensive permitting and feasibility study requirements, so the cycle tends to be long in duration. I believe we are at the beginning of the phase characterized by the box on the left in the chart below where supply is constrained leading to improved returns. I believe we have not yet entered the portion described by the box on the top because firms are not yet rewarded by shareholders for announcing new projects to increase supply. My conclusion is that chronic underinvestment into mining projects has led to an environment where companies controlling existing supply should experience significant economic profits for several years before additional supply can be brought to market. As discussed in the valuation section of this report, current stock prices do not reflect this reality.
Economic Moat – Can they Protect Profits?
Mining operations have limited-to-no opportunity for differentiation by product or brand, but they can build moats in other ways such as cost advantages. In the same way that Walmart built a moat around the lowest cost to supply everyday items to consumers, mining companies that can extract resources and deliver them to customers at a cheaper price can achieve profitability rates that significantly outpace their cost of capital over a full economic cycle.
The chart below shows Sibanye’s PGM assets in blue on the industry cost curve. Should PGM commodity prices decline, the assets to the right would be the first to generate losses and would face the threat of curtailment as companies look to protect their financial resources. Currently, Sibanye Stillwater’s assets are squarely in the middle. However, the company has been investing extensively in their Stillwater (Montana) operations, which should both significantly expand production, but also move the asset towards the left end of this chart in the next year or two.
In terms of competitive dynamics, the PGM industry is one of the more concentrated commodities in terms of both regional and corporate control of supply. The more entities controlling the supply, the more likely a commodity is to become oversupplied at some point due to exuberant producers irrationally expanding production. PGMs occur together, but in different proportions depending on location. Both Russia and North American supply are more heavily skewed towards palladium whereas platinum and rhodium are a much higher % of the production coming from South African and Zimbabwe. In both Russia and Canada, PGMs are a byproduct of copper and nickel mining. Most of these mineral resources are controlled by a handful of firms including Sibanye Stillwater, Norilsk Nickel, Anglo American Platinum, and Impala Platinum.
Another major moat source is a barrier to entry. In addition to the rare nature of the commodity and concentration of ownership in the reserves, the mining industry features barriers to entry of both time and money. Mining projects typically face more than a decade and hundreds of millions of dollars to complete due to the lengthy and expensive permitting and surveying process. This creates a long capital cycle where supply can be slow to respond to upticks in commodity prices creating a window where producers can earn economic profits. By contrast, should the industry become oversupplied it can lead to large losses as companies look to “right-size” their supply. The oligopolistic nature of the PGM industry offers some but not total protection against this risk.
Governance/Capital Allocation - Can we Trust Management?
Sibanye Stillwater has a strong capital allocation framework revolving around dividends, buybacks, and acquisitions. Their dividend policy is to return at least 25% to 35% of normalized earnings to shareholders, and historically they have targeted underappreciated assets to create an incredibly high ROI on acquisitions. In 2021, the company bought 5% (147.7 million shares at R8bn) of its issued share capital under the capital return program (announced on June 1st 2021). CEO Neal Froneman states that the buyback of shares supports their commitment to creating value for their stakeholders, only buying back shares when they are undervalued. Importantly, this new initiative does not detract from the Company’s dividend policy. During the same month, Sibanye Stillwater announced it entered into investment agreements to acquire a 19.99% shareholding in New Century Resources Limited, extending their reach to Australia. Sibanye Stillwater returned $1.8B back to shareholders in 2021 through a combination of dividends and buybacks as a testament to their shareholder friendly capital allocation policies.
In addition to returning capital, Sibanye has a history of adding value through M&A by purchasing assets at a discount and restructuring to allow for profitable mining (see chart below). Notably, the Lonmin acquisition has resulted in an 8x payback on investment in less than 3 years. More recently, Sibanye announced (January 2022) the acquisition of the other half of Rustenburg Platinum Mines (from Anglo American Platinum) giving them complete control over the Kroondal Operations for 1 Rand (plus some associated liabilities). This transaction is projected to increase extraction efficiency and lower production costs while more than doubling the life of the mine.
Source: Company Reports (financial data through 12/31/2021)
Sibanye-Stillwater incentives prudent capital allocation and efficient operations through their executive pay structure. Like most companies, executives are paid heavily through stock issuance, but the vesting requirements vary significantly by company. Sibanye disclosed in their 2021 company financial statements that the shares vest over a 3-year period based on two criteria: total shareholder returns relative to their peer group (70%) and return on capital employed (30%) relative to cost of capital. We believe this is the best method for alignment of management and shareholder interests. In addition, the remuneration committee can claw back up to 20% of the vesting shares should any extreme ESG incidents occur during the vesting period which provides some protection for material events that would future financial results. Executives are highly incentivized to make decisions that will result in the stock outperforming the peer group with returns on capital exceeding its cost and reducing ESG risks.
Sibanye-Stillwater is poised to maintain steady production of their legacy commodities (gold and PGMs) moving forward while adjusting the portfolio over time. The company’s long-term target for their portfolio is an evenly weighted mix of gold, PGMs, and battery metals. Given this target, we expect a high proportion of their M&A going forward will be focused on the development of commodities like lithium and nickel which should experience an increase in demand as electric vehicles gain adoption and should provide a hedge to the PGM portfolio over the long run. The graphic below provides an overview of Sibanye-Stillwater’s operating footprint by geography and commodity type.
Neal John Froneman has been the CEO of Sibanye Stillwater since its establishment as a gold mining company in 2013 when it was unbundled out of Gold Fields Limited. At 62 years old he has nearly 40 years of experience in the mining and investment industry, Gold Fields Limited, Harmony Gold Mining Company Limited, and JCI Limited. He has ample experience in C-level roles and high leadership positions, particularly as a CEO of Aflease Gold Limited (April 2003) and Vice President of the Minerals Council South Africa (May 2016).
As of April of 2022, Sibanye Stillwater’s Board of Directors is 85% independent, with an independent non-executive chairman, a lead independent director, and other independent-non-executive directors. As for gender diversity, their BOD is 31% female and 69% male, and the board age is mostly over 60 years, with nearly 80% of their members. Members of the Board have a well-rounded set of experience in financial services, risk management, engineering, geology, mining and sustainable development.
Valuation – Is there a Margin of Safety?
For this exercise, I used a DCF (Discounted Cash Flow) analysis starting with FCFF (Free Cash Flow to the Firm). Based on this analysis, I estimate the value of the shares to be worth somewhere between $15 in a bear case scenario and $42 in a bull case scenario. This compares to a stock price of $12.32 as of market close 05/25/2022.
Some basic assumptions
For Sibanye, I use a WACC (Weighted-Average Cost of Capital) of 10.80%. This is high relative to most equities due to the volatile nature of the mining industry as well as country specific risk in South Africa. Sibanye also uses little debt in their capital structure which carries a higher cost of capital but helps to reduce risk in the business. In general, I have assumed that prices for palladium and rhodium decline from here (due to their reliance on demand for catalytic converters in gasoline engines) and am more constructive on future pricing for commodities such as platinum and gold due to the long-term supply/demand dynamics discussed earlier in this report. Volume assumptions are mostly consistent with Sibanye’s investor reports with the exception to more bearish scenarios that account for more disruptions in the future that could be caused by factors such as labor disputes, power interruptions, and/or political instability. There are quite a few puts and takes with the various scenarios I worked on, but below are the high points.
Sibanye Stillwater Base Case
This scenario values the stock at $30/share. It assumes that the North American PGM business grows volumes as expected and achieves modestly higher operating margins of about 15% in the face of weaker palladium pricing due to an improving cost structure. It assumes that volumes tail off for both the South African PGM and gold business in-line with expected mine closures. I assume a modest green metals investment of 3% of revenue annually (this has currently been suspended due to a high asking price on assets for sale) with a cash flow ROIC (Return on Invested Capital) of 12%, just above the cost of capital.
Sibanye Stillwater Bull Case
This scenario values the stock at $42/share. The main driver of this scenario is the possibility for supply disruption in Russia and/or green battery metals leading to a prolonged period of high palladium prices. I assume a robust green metals investment of 5% of revenue annually with a cash flow ROIC of 20%, a strong yet achievable rate.
Sibanye Stillwater Bear Case
This scenario values the stock at $15/share. The main driver of this scenario is the dual threat of production disruptions at their mines and a resolution to the war in Ukraine that leads to a surge in palladium volumes out of Russia. I assume a modest green metals investment of 3% of revenue annually with a cash flow ROIC of 5%, which is below their assumed cost of capital meaning the investments are capital destructive.
Risk
While I attempt to capture risk within my valuation framework, the greatest risk is often in the unknown. I foresee the greatest risks to this investment to be weak commodity prices due to unforeseen supply/demand dynamics. Another is political turmoil in South Africa that could lead to stranded assets, higher taxes, and/or loss of permits. Mining is subject to a myriad of risks that are extremely difficult to forecast. It is possible there are holes in my thesis I have not yet found that could materially depress the intrinsic value of the company. By the time you are reading this, I may have changed my opinion on this investment. Do your own homework prior to investing.
Further Reading/Sources
Johnson Matthew - https://platinum.matthey.com/
Sibanye Stillwater - https://www.sibanyestillwater.com/
USGS on Russian PGMs - https://pubs.usgs.gov/of/2003/of03-059/of03-059.pdf
USGS on Global Production Capacity 2012 - https://pubs.usgs.gov/sir/2012/5164/pdf/sir2012-5164.pdf
USGS on PGMs 2017 - https://pubs.usgs.gov/pp/1802/n/pp1802n.pdf
International Platinum Group Metals Association - https://www.ipa-news.com/
Nedbank PGM sector report - https://cib-research.nedbank.co.za/portal_files/890E2303-5ED1-473F-82AE-D4221DCC7532.pdf
World Platinum Investment Council - https://platinuminvestment.com/
Mining.com - https://www.mining.com/
In Summary
At Aurora, we are constantly looking for “the right pitch” in our sweet spot where we believe the probabilities are in our favor. This blog represents our thinking at the time of publication. By the time you read this, our opinion may have changed. If you are a DIY investor, use this only as a starting point for your research and be sure to do your own due diligence. For questions regarding our individual stock strategies, please reach out to us!
Invest Curiously,
Austin Crites, CFA
Austin Crites is the Chief Investment Officer of Aurora Financial Strategies, a financial advisory firm based out of Kokomo, IN. He can be reached via email at austin@auroramgt.com. Investment Advisory Services are offered through BCGM Wealth Management, LLC, a SEC registered investment adviser. This blog does not constitute advice. This is not an offer to buy or sell securities. Advisor is not licensed in all states. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. BCGM Wealth Management, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results. Clients may own positions in the securities discussed.
