DRDGold: Assessing The Share Buyback Effort

|
About: DRDGOLD Limited (DRD)
by: Gold Panda
Summary

DRDGold has announced a small share buyback program just a year before the costly Phase 2 of its flagship FWGR project.

The default option for Phase 2 will require around $220 million.

I think that the management of DRDGold genuinely believes that it’s defending shareholders' best interest with the share buyback due to the low valuation of the company.

Introduction

On May 22, DRDGold (NYSE:DRD) launched a share buyback program under which it plans to repurchase up to five million shares, or about 0.7% of its share capital. The limit of the program is just 14 million South African rand, or just below $1 million. It will also last a very short time - until the next annual general meeting or until February 28, 2020, whichever is the earlier date.

The conditions under which the shares can be repurchased are restrictive - the buybacks can't be carried out at a price greater than 10% above the volume weighted average trading price of the shares over the five trading days immediately preceding any particular repurchase.

Questionable Timing

I find the timing of this share buyback surprising considering that there are plenty of analysts doubting whether DRDGold can finance the ambitious Far West Gold Recoveries (FWGR) project without diluting shareholders.

Construction of Phase 1 started in August, and the project is currently ramping up towards its planned throughput of 500,000 tons a month. The final commissioning of Phase 1 is expected to be completed before the end of the current financial year in June 2019 and DRDGold recorded a 15% quarter-on-quarter jump in production for the March quarter to 41,120 ounces of gold, thanks to FWGR.

Source: DRDGold

The capex for Phase 1 was around $22 million and its net present value is almost $100 million, but the problem is the second phase. Phase 2's capex stands at more than $220 million before including contingencies and project services, which is almost 1.5 times DRDGold's current market capitalization.

Source: DRDGold

I think that this amount will be very hard to raise considering that very few companies are lining up to finance gold projects in South Africa.

As of March 31, DRDGold had less than $12 million in cash and cash equivalents and about $1.2 million in debt.

A total of $10 million can come from the sale of infrastructure of East Rand Proprietary Mines (ERPM), a mine that had been mined for over a century until it was mothballed in 2008. At the end of March, DRDGold gave away the mineral resources of the project to OroTree, an exploration start-up company registered in Malaysia. The latter has an option to acquire the related infrastructure. However, I think it's unlikely for DRDGold to get a significant amount from this as there's been no maintenance of the shaft underground infrastructure and only limited maintenance of above-ground infrastructure for the past decade. This is not the first time DRDGold has tried to monetize this asset. In FY2018, a deal with Australian company called Walcot Capital lapsed after dragging on for four years.

Some funding for Phase 2 could come from Sibanye-Stillwater (NYSE:SBGL), as the latter has an option to increase its stake in DRDGold to 50.1% by acquiring additional shares at a 10% discount to the 30-day VWAP. However, I don't think it's a done deal given that Sibanye is moving to deleverage its balance sheet following the purchase of Lonmin and several other acquisitions over the past years.

I think that DRDGold is likely to choose an alternative option for Phase 2 of FWGR, which includes upgrading the Driefontein 4 tailings storage facility and would cost just around $30 million:

Source: DRDGold

Likely Reason for the Share Repurchase Program

Over the past three months, DRDGold CEO Niël Pretorius has bought shares on the open market on four different days while Riaan Davel purchased shares on May 31. Overall, Pretorius has added a total of 40,295 shares since March 25, and I think that the reason for a share buyback could be that the management of the company genuinely believes that the company is severely undervalued. The small size of the share buyback program could be due to the high funding requirements of the company in the near future.

It's very unusual for a gold mining company to buy back shares, and DRDGold has a history of looking after the interests of shareholders. For example, in June 2012, the company made an on-market repurchase of 4.4 million shares. Pretorius said back then that shares were trading well below the average sell-side outlook, which made a repurchase a very attractive option for returning funds to shareholders.

Investor Takeaway

DRDGold has launched a share buyback program just a year before it chooses a path forward for the costly Phase 2 of FWGR. This move seems illogical, but I think that the management genuinely believes that it's defending shareholders' best interests due to the low valuation of the company. This could prove to be a good move if the price of gold remains stable.

Regarding the funding for Phase 2, I view the most likely scenario as being a combination of debt and cash flow from Phase 1. The Ergo operations are still cash flow positive, but barely. The management of DRDGold has stated several times the company can finance the project without diluting shareholders, and I think it's possible if it chooses the alternative option.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am not a financial adviser. All articles are my opinion - they are not suggestions to buy or sell any securities. Perform your own due diligence and consult a financial professional before trading.