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Lonmin's recovery plan doesn't inspire hope

Faced with “persistent adverse macroeconomic conditions”, the platinum miner this week launched a drive to generate cash by any means
August 10, 2017

Less than two years after a highly dilutive $407m (£313m) rights issue, stubbornly low platinum prices have left Lonmin (LMI) both unable to generate sufficient free cash flow and overly reliant on tricky cost reduction measures. Are those forces coming to a painful head? Or is the South African miner about to turn a corner? We’ll soon find out. Citing “persistent adverse macroeconomic conditions and the inflationary cost pressures”, Lonmin has launched a strategic review into its business.

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Shares in the group bounced on the news, on hopes that the plan might improve a fading cash position. The first way this might happen, Lonmin suggests, is through the sale of 500,000 ounces per year of excess capacity in the miner’s refining and smelting operations at Marikana. In theory, this seems smart: Lonmin gets cash, while a producer of platinum-group metals (PGM) concentrate gets to “access the profit margin benefits of an integrated beneficiation model”.

But it begs the question why logical buyers have not shown interest so far, assuming they have been sounded out. Furthermore, as Deutsche Bank analyst Patrick Mann notes, the South African platinum industry already has ample spare refining capacity, meaning the assets are unlikely to attract much in the way of a premium.

That could be problem. As JPMorgan points out, the failure of any sale to realise anything short of book value could test a key debt covenant, which requires Lonmin’s tangible net worth to exceed $1.1bn (£848m). Another plank of the operational review – to explore the whole or partial sale of the Limpopo and Akanani projects – will therefore require a fine balancing act to preserve shareholder equity.

Funding partners are also being sought for the K4 and Rowland mines, both of which are in need of investment capital Lonmin cannot generate. In the quarter ended June, hailed by chief executive Ben Magara as “a pleasing operational performance”, the group’s unit costs were R11,278 (£658) per PGM ounce – just 2 per cent below the average ‘basket’ price fetched by each ounce of platinum and related metals the company sells.

In case a reminder was needed, the price of platinum remains Lonmin’s biggest headache. Unlike many other commodities, it has shown few signs of a price recovery. An ounce fetched $1,500 three years ago, but has fallen below $1,000 amid softening demand from car manufacturers, Chinese jewellery buyers and investors in precious metals exchange traded funds. Earlier this summer, market authority Johnson Matthey reiterated its forecast for supplies of the metal to slip into a surplus this year, for the first time since 2011.

Unfortunately, Lonmin has limited room to lower its cost base. This week’s strategic review promised at least R500m of annual overheads, largely from non-production central functions, will be cut by September 2018. Further redundancies could entail fresh political fallout, while relations with the miner’s 30,000 employees have a chequered and at times violent recent history. It is against this fraught backdrop – and the uncertain eventual impact of a currently suspended mining charter – that Lonmin acknowledged that it was too early to define the ultimate effect of the review, other than a somewhat vague aim to be cash positive after capital investment.