DRDGold Limited (NYSE:DRD) is a South Africa based gold producer specializing in gold tailings recovery and surface retreatment. Essentially, DRDGold focuses on the extraction of gold from tailings which are by-products of traditional mining operations. With cutting edge technologies and expertise, the business model is recognized as efficient resulting in a low-cost of production supporting consistent profitability. The stock has been a big winner over the past year, up over 200% driven by not only the bullish pricing environment in gold but also the ramp-up of new facility acquired through a deal with Sibayne-Stillwater Limited (SBSW) which has strengthened its long-term outlook. The company recently reported its fiscal-year 2020 earnings highlighted by strong earnings despite some COVID-19 disruptions. We think DRD with its solid fundamentals and world-class assets is a quality pick in the sector and the recent pullback in shares represents an attractive buying opportunity.
DRDGold reported its fiscal 2020 year-end results on September 3rd highlighted by a 9% year over year increase in gold production while a 320% y/y increase in its operating profits was driven by improved efficiency. The combination of a 13% y/y decline in cash operating costs in the context of a rising pricing environment supported the higher earnings.
(source: Company IR)
The story here is the contribution of DRDGold's Far West Gold Recoveries "FWGR" operation which was in full production for the entire period since ramping up at the end of fiscal 2019. For reference, in a transaction going back to 2017, DRD entered a deal to acquire the facility in exchange for giving up a 38.1% equity interest to Sibayne-Stillwater Limited. SBSW has since increased that stake to 50.1% making it a majority shareholder.
(source: Company IR)
FWGR production at 1,435 kg for fiscal 2020 climbed nearly 200% compared to 484kg for fiscal 2019 although he COVID-19 pandemic resulted in some downside to prior targets. Management is looking forward to phase-2 of the FWGR project which is in the planning and permitting stage expected to eventually double the output highlighting the positive long-term outlook for the company.
DRDGold's ERGO operation remains its flagship asset producing 3,989kg of gold this past fiscal year, but down 11% year over year. ERGO faced a larger shutdown during the early stages of the pandemic which limited its output in the second half of the year to just 1,715kg, down 24% year over year. The company faced a slow restart with ERGO based on caution by authorities in the region while also experiencing some power supply interruptions. Management intends to focus on power storage solutions to avoid a similar situation in the future. (source: Company IR)
Overall, while the COVID-19 pandemic hurt production in the second half of the year although the impact was balanced by the higher average price of gold. DRDGold was able to recognize a 33% increase in the average price of gold received over the year resulting in improved financial performance across the board.
(source: Company IR)
An operating margin of 40.6% in the second half fiscal 2020 increased from 17.9% H2 2019. For the year, the all-in sustaining cost at $1,075 per oz, declined 7% compared to 2019 driven in part by the depreciation of the South African Rand this year and related impact on costs like wages and salaries. The result here is that free cash flow in the second half of the year reached R520, double the result for H2 2019. Notably, the company ended the fiscal year with R1.7 billion in cash and equivalents of approximately $100 million and no long-term financial debt indicative of a strong financial position.
The company also announced its final cash dividend of the fiscal year with a payout of 0.35 South African Rand per share. ADR shareholders are set to receive a dividend of $0.20 with an upcoming dividend ex-date of September 24th. Investors need to own the stock before the dividend ex-date to receive it. This is the 13th consecutive year DRDGold has made a dividend payout. DRD yields 3.5% which is one of the highest dividend yields among large-cap gold miners. On a forward basis, considering the upcoming distribution and potential higher payouts next year, we estimate a forward yield closer to 4.2%.
Moving past the COVID-19 setbacks, management expects to ramp up production in its ERGO operation while pushing ahead with phase 2 of the FWGR project. Production guidance between 165k and 185k ounces for the year ahead if confirmed at the midpoint would be approximately flat compared to 174.4k ounces in fiscal 2020 considering the ramp-up timing at ERGO. The targeted cash operating cost of R535/kg is about 10% higher compared to fiscal 2020 pressured by investments in FWGR phase 2 along with efforts to expand power storage capacity. That being said, the price of gold is still higher on a year over year basis which supports a revenue and earnings tailwind against comparable results against H1 2020.
(source: Company IR)
The commodity price of gold reached an all-time high of $2,075 per ounce in early August and has since pulled backed, consolidating this year's gains in a relatively tight range between $1,900 and $2,000. With the current price approximately 6% off the recent high, we consider the trend and market technical to still be positive. In our view, only a breakdown under ~$1,750 would force a reassessment of our view. Our price target for 2021 is $2,250 per ounce.
The case here is simply that the combination of record-low interest rates along with continued macro weakness and uncertainties supports the outlook for gold as a store of value. Any underperformance of global activity levels or growth scare would force Central Banks into further dovish monetary policy and more aggressive QE and catalyst for gold to move higher. Separately, physical demand globally has been at record levels reflective of investor sentiment coupled with tighter mining output this year across the sector including from DRD based on t the COVID-19 distributions have been positive factors.
Despite some recent volatility in gold and precious metal miners, we remain bullish and continue to view DRDGold as one of the highest quality names among junior miners. DRD has underperformed the price of gold and mining stocks more recently an is now down 33% from its high in August. We believe this correction now represents a new buying opportunity at an attractive valuation.
The year ahead through fiscal 2021 is set to be a transitional year for DRDGold as it normalizes operations. Some of the guidance for the year ahead with limited production growth and higher cash costs may be the reason for weaker sentiment in the stock more recently. Still, investors can look towards progress updates on phase 2 of FWGR project. What we like about DRDGold is its global leadership position in the segment of gold surface tailings retreatment with a world-class operation at ERGO and FWGR. The upside in production from the FWGR project supports a higher earnings outlook through the next decade.
The relationship with Sibayne-Stillwater is positive as the company provides a secure source of potential new projects on a global scale. There have been comments made by management in developing a surface tailings retreatment operation in SBSW platinum mines as a future growth opportunity.
In terms of valuation, we highlight that DRDGold trades at a discount to mid and large-cap market leaders on consensus revenue. A forward EV to Revenue ratio of 2.8x compares to 3.6x in GoldFields Ltd (GFI)and 3.1x from AngloGold Ashanti Ltd (AU) which are also South African based gold producers. One explanation for DRDGold lower growth premium is based on its smaller scale with only 2 major operating projects. Separately, the market may be discounting the stock given the controlling interest from Sibayne Stillwater while other names are more independent.
With the same group of companies, we also highlight that DRDGold is an exception among gold miners as it does not carry long term debt. In some ways, the financial leverage is positive in a bullish commodity pricing environment but the strong balance sheet from DRDGold adds to its quality and should limit risk in a potential market downturn. Finally, as mentioned, DRDGold has one of the highest dividend yields in the sector.
Shares of DRD have had an exceptional run this year even considering the more recent selloff. We believe the combination of strong earnings, attractive dividends, and positive long-term growth outlook offers a compelling buying opportunity. The company is well-positioned to benefit from the current bullish trends in Gold where we see more upside for the year ahead.
While there is always the risk that the stock can see further pressure should gold pricing decline, DRDGold's unlevered balance sheet could limit downside volatility on a relative basis. Monitoring points going forward include production levels as the ERGO mine operation normalizes and we want to watch closely the operating margins indicative of yields.
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Disclosure: I am/we are long DRD. 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.