The obvious attraction is that shares in a gold miner should act differently from the typical stock you'll find in a high-yield fund; their price will respond differently to the shifting moods of investors and to the forces that propel stock markets, at least in the short term.
Granted, that means their price changes may be more volatile than the staid movements you would expect from typical high-yield components. Of course, in matters of investment, volatility equates to risk; and risk is bad, so volatile shares should be shunned. Actually, not always. So long as we can be confident that the share price holds more long-term potential to rise than to fall then volatility isn't necessarily a problem; it's even useful if the volatile share price bounces to a different beat.
Correlation coefficients: The lower, the better
| Pan African | Gold | All-Share | Bearbull Income | |
|---|---|---|---|---|
| Pan African | 1.00 | 0.59 | 0.23 | 0.04 |
| Gold | – | 1.00 | 0.17 | 0.01 |
| All-Share | – | – | 1.00 | 0.48 |
| Bearbull Income | – | – | – | 1.00 |
Source: CapitalIQ
The table tells us that has been the case for Pan African's shares. It shows the 'correlation coefficient' between month-on-month price changes over the past five years for Pan African's shares and three relevant markers - the gold price, the FTSE All-Share index and, most important, the Bearbull portfolio. Basically, the lower the figure, the better; and ideally it should be negative - that would tell us that, on average, the two prices in each pair moved in opposite directions.
Pan African's shares and the Bearbull portfolio come close to that. Only gold and the income portfolio do better. But gold does not pay a dividend; nor do gold-tracking exchange traded funds, so they are out of the question.
If Pan African's shares fly over the first hurdle, what about the second, and more important, one - the outlook for the dividend? Mixed signals but, on balance, probably favourable. First, let's sketch some company background.
In the grand scheme, Pan African is a midsized gold producer. Via four plants - two mines and two ‘tailings' operations, which reprocess mine dumps for leftover ore - it produced 205,000 oz of gold in the year to June 2016. By comparison, South Africa's biggest gold miner, AngloGold Ashanti (JSE:ANG), produced over 25 times that amount (about 5.5m oz). No matter, Pan African has the advantage of being a low-cost producer. The comparatively small tailings operations eke out gold at around $50 an oz. But even at its biggest mine, Barberton, which generates about 40 per cent of the total, production costs are below $700 an oz. That compares with, for example, average cash costs of $911 an oz at AngloGold and a current gold price of $1,188.
A combination of low cash costs, generally favourable currency movements (Pan African's costs are in the South African rand and its income in US dollars) and the potential to expand production point to a decent future. For example, stockbroker Edison thinks that revenue, which was £100m in 2011-12 and £168m in 2015-16, will top £200m this year.
Cash flow generation should be even better, reckons the broker, as operating profits surge and capital spending dips. That's important because Pan African's bosses say that in future they will distribute 40 per cent of free cash as dividends. Actually, the precise way they state the dividend policy is more nuanced, giving extra flexibility, but that's the gist and Edison reckons that will mean a payout of 1.23p this year and 1.37p next. Those amounts produce a yield of 8.1 per cent for this year and 9.1 per cent for next.
Instinct says that's too high; that there's a risk the market has spotted but Edison and I haven't. That could simply be about the shortcomings of South Africa, which may yet end up as a bigger version of Zimbabwe. Related to that is the worry that the inflationary effects of Donald Trump's domestic policies will mean higher US interest rates, which would feed through to all sorts of miseries for developing countries carrying dollar debt. The good news for Pan African is that, at the end of June, its debt all seemed to be in rand.
Yet life is full of uncertainty and maybe one gets a more reliable view of the future - certainly a more cautious one - by fixing on the rear-view mirror. Do that for the five years 2011 to 2016 and free cash flow averages £16m a year. That feeds through to a 0.43p dividend and a yield of 2.8 per cent. Think of that as the base case, while the most likely outcome is a dividend that produces a yield around the mid point of 2.8 per cent and the 8.1 per cent mentioned earlier. That would be very acceptable for an income portfolio, which means - given their diversification merits - that Pan African's shares are a real contender.
But what about that fallen retail star we mentioned last week, Next (NXT)? To be continued.
