No end to Lonmin woes

The full-year production report that South Africa-focused platinum miner Lonmin delivered on October 22 was every bit as bad as City analysts had expected. It revealed that, with platinum sales of 683,000 oz for the year to end September, the group had just scraped its target of 680,000 oz, which had been reduced from 700,000 oz originally. For at least the fourth time in five years, a major unplanned stoppage at the company's number one smelter, which has suffered a succession of explosions, accidents and leaks since 2004, played a large part in expectations being massaged downwards from June onwards.

Lonmin is now aiming for refined production of 700,000 oz for 2009-10. Given that it has missed every one of its original production targets since 2006, sometimes by a considerable margin, this seems a big ask. Yet it is worth remembering that even 700,000 oz of platinum production is vastly down on what Lonmin's bosses told investors it was set up for just a few years ago - in 2006, Lonmin was aiming for refined production of 1m oz a year. Three years later, it is producing just two-thirds of this (as opposed to sales, actual refined platinum production for 2008-09 came in at just 663,000 oz).

In addition, the smelter issue doe not just affect output, but also profitability. This is because, with the number one furnace out, management has to use smaller, older and less efficient so-called Pyromet units, which raise operating costs and so erode margins.

But the processing issue is not Lonmin's only problem, far from it. Another reason output has fallen far short of expectations is that the company made a hash of introducing fully mechanised production at its Limpopo operations, which have now been mothballed.

Operationally, 2009 has also seen Lonmin's mines suffer an unusually high incidence of so-called Section 54 shutdowns, which are triggered by mines' inspectors over safety concerns. Nor are relations with elements of its workforce particularly good - Lonmin's miners have just rejected their latest pay deal, and strikes now seem likely. Issues such as these have prompted Lonmin's chief executive, Ian Farmer, who got the top job a year ago, to announce that the company is moving its headquarters from London to Johannesburg to get a better grip on operations.

One thing that Mr Farmer cannot do with this move, however, is to change the dollar-rand exchange rate. The rand's current strength is another major problem for Lonmin, along with the rest of the South African mining industry.

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What about the outlook for platinum itself? The key factor behind demand is automotive production as platinum is a key component of auto catalysts. Clearly, demand is being badly dented by the global slowdown and, for this year and next, analysts expect that supply will exceed demand. However, the platinum price is more resilient than might have been the case because it is also linked to the price of gold, which has defied gravity thanks to that metal's status as a store of value.

The price of platinum averaged $1,070 per oz through Lonmin's financial year to end-September. While this is a price at which rival producers can make profits, for Lonmin, with all its problems, such a level is too low to break even. It is making some profits at platinum's current price - around $1,300 - but will fall into losses sooner than its competitors if the price drops.

One bright spot to focus upon has been the supposed persistence of bid interest from the acquisition-driven diversified miner, Xstrata. As part of a bid approach, which was rejected by Lonmin's bosses just before metals prices crashed last autumn, Xstrata bought almost 25 per cent of Lonmin's equity at an average price per share of around £22. That helps analysts spot a bid premium supporting Lonmin's share price. Certainly, Xstrata will do something with its Lonmin stake; but, with its own balance sheet severely constrained, that won't be any time soon. Given Lonmin's deeply ingrained problems with both production and costs, we also think it quite likely that Xstrata will decide to sell its stake.