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The recent fall in the gold price, combined with rising costs and labour problems in South Africa, look set to hit profit margins at gold miner Pan African Resources, which recently - and unexpectedly - lost its chief executive and has been subject to director share sales.
June 13, 2013

Last summer, with gold preparing for its last major run-up to nearly $1,800 (£1,185) an ounce, we tipped shares in South African gold miner Pan African Resources (PAF) as a way to play the rising price of bullion. We closed out that tip in February, but with gold now hovering much lower - about $1,400 an ounce - Pan African's share price is at almost the same level as when we tipped it last year. This time, however, bullion looks to be firmly in a short-term downtrend from a technical perspective, and Pan African has unexpectedly lost its chief executive and another director has sold millions of shares.

IC TIP: Sell at 15.3p
Tip style
Sell
Risk rating
High
Timescale
Long Term
Bull points
  • Rising gold production
  • Could reinstate dividend
Bear points
  • Gold price in technical downtrend
  • Profit margins slipping
  • South African labour problems
  • Mysterious resignation of chief executive
  • Director selling millions of shares

Should gold plunge through the next $1,325 an ounce support level, it could certainly test its $1,200 an ounce support, widely considered the average 'all-in' cash cost level for miners, or even $1,000 an ounce which gold hovered around shortly before and after the financial crisis. That's a worrying prospect for gold producer Pan African, whose mines in South Africa will this year operate at an average all-in cash cost of $1,224 an ounce, according to estimates by broker Canaccord Genuity. True, core operating costs should be lower at an average of $778 an ounce. But costs across the group's operations have been ominously rising year on year because of spiralling labour and electricity costs in South Africa.

Combined with a lower gold price, this means profit margins will likely come under pressure - negating some of the positive effects of increasing gold production. Pan African's major acquisition of Harmony Gold's Evander mines should double gold production this year, but the move hasn't come without sacrifices. Pan African had to slash its annual dividend in 2012 and take on debt, although management have stated it "intends to resume a dividend payment in 2013". However, with R350m (£22m) owed following the acquisition, we see this as unlikely given the current gold price environment.

PAN AFRICAN RESOURCES (PAF)

ORD PRICE:15.3pMARKET VALUE:£278m
TOUCH:15.3-15.5p12-MONTH HIGH:21pLOW: 13.5p
FORWARD DIVIDEND YIELD:3.2%FORWARD PE RATIO:5
NET ASSET VALUE:6p*NET CASH:£48.3m*

Year to 30 JunTurnover (£m)Pre-tax profit (£m)Earnings per share (p)Dividend per share (p)
201068.522.21.040.37
201179.226.41.200.51
201210142.22.020.0
2013**13149.82.100.31
2014**21193.63.30.49
% change+61+88+57+58

Normal market size: 15,000

Matched bargain trading

Beta: 0.79

*Prior to completion of Evander acquisition

**Edison Investment Research forecasts

There is also the major threat of labour trouble in South Africa. Mining unions there have been undergoing significant change over the past 12 months, with power shifting from the traditional National Union of Mineworkers (NUM) to the upstart Association of Mineworkers & Construction Union (AMCU). Tensions could return to breaking point this summer with unions due to renegotiate their annual work contracts in June and July. Admittedly, Pan African has largely avoided any labour trouble at its operations thus far, but the major acquisition of Harmony Gold's Evander mines could change that.

Pan African's cause also hasn't been helped by the mysterious departure in February of the company's long-serving chief executive, Jan Nelson. Mr Nelson resigned for "personal reasons" just before the Evander purchase was finalised. He resurfaced a few months later when shell company Xtract Energy (XTR) appointed him chief executive. His new job is to find assets for the £6m market capitalisation company. Meanwhile, Pan African has yet to find a permanent replacement for him.

In another hit to sentiment, non-executive director Rob Still has been reducing his shareholding in the company. The Alexandra Trust, of which Mr Still is a trustee, has sold 4m Pan African shares in the past six weeks for R9.1m (£570,000). The trust still holds 11.7m shares and Mr Still controls a further 4.8m shares in other indirect and direct accounts.