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Polymetal set to weaken

Despite solid operational progress, Polymetal's share price is still being weakened by the faltering gold price, concerns about Russia's politics and the group's rising debt
October 29, 2015

Shares in Polymetal International (POLY) have halved in value since their peak in January 2013. Even so, we reckon the share price could weaken further as the gold price falters in the face of the continued strength of the US dollar (the price of the dollar and gold tend to move in opposite directions). That's a poor prospect given that Polymetal, whose gold mining operations are focused on Russia and Kazakhstan, needs to meet mounting debt obligations. To make matters worse, the crisis in Ukraine continues to hit sentiment towards Russia-related stocks. All of this is weighing on the share price at a time when it's struggling to breach an established chart barrier of 600p.

IC TIP: Sell at 574p
Tip style
Sell
Risk rating
High
Timescale
Short Term
Bull points
  • Faltering gold price
  • Mounting debt obligations
  • Negative sentiment towards Russian stocks
  • Revenues constricted by dollar strength
Bear points
  • Unit cash costs down
  • Strengthening production

True, Polymetal continues to drive through operating efficiencies in a bid to offset these difficulties, but, short of a sudden gold price recovery, we reckon that further falls in the share price are probable. So really adventurous punters could establish a short position in the stock. But those who already hold the shares are essentially locked into a leveraged position on the gold price - and it's uncertain whether this will bear fruit over the long run. For now, the risks associated with the miner's share price are firmly weighted to the downside.

Valuations for mining shares always depend, to a large extent, on underlying commodity prices. But Polymetal's share price was already in a downward spiral long before the record sell-off in asset-backed gold contracts in April 2013. Precious metals prices had crashed through key support levels in the early part of the year, but Polymetal also had to contend with rising operating costs in Russia as a result of higher labour, diesel and power bills.

The good news for shareholders is that Polymetal reported a 16 per cent year-on-year fall in all-in cash costs for the first half of 2015. The miner's operating expenses fell largely because of the Russian rouble's weakness against the dollar. But that weakness is a double-edged sword. The trouble is that the gold price, as noted, is negatively correlated to the dollar's exchange rate. So, while costs may have come down appreciably, revenues are being held in check.

 

 

And debt remains a major issue for the miner. Net debt as a percentage of shareholders' funds came in at 132 per cent at the June half-year, but it had crept up by another $35m (£23m) by the end of the third quarter, leaving a total commitment of $1.27bn, half of which is due for repayment within 12 months; then the lion's share of the remainder is due by the end of 2018.

The ratio of net debt to cash profits stands at 1.8. That's not enough to set alarm bells ringing, but finance costs were around $45m at the half-year mark, up from $16.2m a year earlier. Again, that's manageable as a proportion of operating profits, but any step-up in funding obligations is bound to eat into free cash flow.

Although external factors and the accumulation of debt (net debt stood at $1.04bn at the end of June 2014) have depressed the share price, there's no doubt that Polymetal's operating performance has been good. Gold sales increased by 3 per cent to 261,000 ounces (oz) in the quarter to September, lifting nine-month sales to 614,000 oz, a 1 per cent year-on-year increase. At the same time, Polymetal reported production of 1.06m oz of gold equivalent for the first nine months of 2015, an increase of 2 per cent year on year. As a consequence, Polymetal's bosses think they are in a strong position to hit their target of producing 1.35m oz of gold equivalent for the full year.

POLYMETAL INTERNATIONAL (POLY)
ORD PRICE:574pMARKET VALUE:£2.43bn
TOUCH:574-575p12-MONTH HIGH:634pLOW: 424p
DIVIDEND YIELD:4.5%PE RATIO:7
NET ASSET VALUE:144pNET DEBT:132%

Year to 31 DecTurnover ($bn)Pre-tax profit ($m)Earnings per share (¢)Dividend per share (¢)
20121.8565111031 †
20131.71-158-51.09
20141.69-138-53.021†
2015*1.6055211534
2016*1.7063513240
% change+6+15+15+18

Normal market size: 3,000

Matched bargain trading

Beta: 0.4

£1=$1.54. *JPMorgan Cazenove forecasts (profits & EPS not comparable with historic figures).

†Excludes special dividends of 50¢ (2012) and 20¢ (2014)