Platinum set to undermine Aquarius

It's not that Aquarius Platinum is a bad company, but its shares look very pricey relative to near-term earnings and are highly geared to the platinum price, the current direction of which looks to be downward. Any further fall in the platinum price is likely to drag Aquarius's shares down with it.

Unlike gold, the platinum price is largely driven by industrial rather than speculative demand, with around half of all platinum being used in automotive catalytic converters. Auto demand turned down sharply with the global recession and, although various car-scrappage schemes bolstered new car sales, these incentive schemes have now ended and auto demand is likely to slip back in developed countries.

Weak auto demand has led to a significant surplus of platinum. The market is likely to remain in oversupply until 2011, despite continuing pressures on South African miners (which account for 76 per cent of global production) due to power shortages that will be exacerbated as football's World Cup forces high power users, such as platinum smelters, to suspend operations. With investment buying also slowing, the platinum price could drift from its current $1,530 (£1,050) per ounce towards $1,100 per ounce.

That would be especially bad news for Aquarius's shares as their price has been more sensitive to the platinum price than, say, shares in Lonmin.

In addition, Aquarius has suffered a number of setbacks that have hit platinum production. Its Everest mine started producing in 2005 but operations were suspended in late 2008 due to subsidence. The incident didn't result in the loss of any resources and resuming production is understood to require just the construction of new access points and associated infrastructure. Nevertheless, operations at Everest won't resume until later this year.

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The closure of Everest constrained production attributable to Aquarius to 208,857 ounces in the six months to December 2009, which was 20 per cent below the previous first half. Production was also hit by strikes at the Kroondal and Marikana operations in September 2009. In the most severe incident, employees of the underground mining contractor MRC took industrial action at three of the Kroondal shafts. This resulted in the mass dismissal of the workforce, and intimidation by former employees slowed the recruitment of new workers, which further hampered output.

Profits have also been hit by the strength of the rand against the dollar, which has increased cash costs by 23 per cent at Kroondal, the company's largest mine. Electricity tariffs were raised by a third in June 2009. And the early redemption of the rand convertible notes cost the company $20.8m.

On the positive side, production continues to ramp up at Blue Ridge, the mine acquired when Aquarius bought Ridge Mining last year. However, the Blue Ridge grade was slightly below management's expectations and attributable production in the six months of 16,534 ounces won't make up for the 64,000 ounces of production lost from Everest.

Management has indicated it expects the second half of 2009-10 to be better than the first half, and has restored an interim dividend at 2¢ a share. Nevertheless, broker Evolution Securities expects 2009-10's production to be 60,000 ounces lower than in 2007-08 when the platinum price peaked.