SIF June review: Miners Anglo Pacific amp; Sylvania Platinum are up 40%

It’s almost the end of June, but this month I’m happy to report that I have two profitable positions to review! After recent calamities such as Staffline and Bilby, this makes a nice change. So without further ado, let’s see what’s been happening to the SIF folio’s miners.

Stocks for review

I added two companies to the SIF fund in September 2018. After nine months in SIF, both are now due for review:

• Anglo Pacific (LON:APF) – a highly profitable mining royalty firm with a dependency on coal. Can APF diversify in time?

• Sylvania Platinum (LON:SLP) – this South African tailings specialist has been cashing in as the price of palladium has roared ahead. Is it too good to last?

Here’s how these two companies have performed during their time in the portfolio:

Let’s take a closer look at the news that has driven these gains and find out whether each stock still passes my screening tests.

Anglo Pacific (LON:APF)

(Original coverage 04/09/2018)

Mining royalty group Anglo Pacific came through the 2015/16 mining downturn relatively unscathed, albeit with a dividend cut. But the balance sheet remained fairly strong and chief executive Julian Treger’s decision to maintain a dividend payout was vindicated.

The shares have quadrupled from the lows seen in early 2016, as commodity prices have rocketed ahead once more. However, I think it’s fair to say that Anglo Pacific has benefited from a mix of good judgement and good luck here.

In the right place at the right time: The firm’s main cash-producing royalty asset is a stake in the Kestrel coal mine in Australia. This accounted for 70% of Anglo’s royalty-related revenue last year.

However, this interest only covers certain parts of the mine acreage, so royalty income is dependent on which areas the mine’s operator chooses to work. The proportion of Kestrel mining taking place in Anglo Pacific’s royalty lands has moved in the firm’s favour since 2015:

The combination of strong coal prices and a bigger share of Kestrel royalties has worked wonders for Anglo Pacific’s revenue, most of which falls through to the bottom line as profit:

Heading for a blow out?

A second change has taken place during this time that might have been harder to predict. The mine’s previous owner, FTSE 100 giant Rio Tinto, has sold all of its coal operations.

The consortium which bought Kestrel from Rio appears to be running the mine to maximise upfront cash generation. They intend to increase production from the mine by 40% in 2019, according to Anglo Pacific. Management expect virtually all of Kestrel’s production to remain within its royalty lands, providing a big boost in revenue.

Analysts’ forecasts reflect this. Anglo’s revenue is expected to rise by 24% this year. Adjusted net profit is expected to rise by 37% to £44.5m.

There is a downside here. APF admits that accelerating Kestrel production will bring forward the time at which the firm’s royalty interest is exhausted. Given its continued financial dependency on the mine, that’s a key risk.

In an effort to address this, Anglo has made a number of acquisitions and new investments over the last couple of years. The company now says that the proportion of its net asset value attributed to Kestrel has fallen from 72% to 48% over the last five years.

That’s fair enough, but some of these assets are at an early stage of development and not yet producing revenue. During the first quarter of 2019, Kestrel still accounted for 71% of the group’s revenue.

I’d hope that this mismatch between NAV and revenue will start to correct over the next couple of years. CEO Mr Treger certainly has a strong incentive to achieve this, as he owns 3.1% of the company. Other notable shareholders (in my opinion) include Schroders (7.2%) and Miton (4.7%).

In the meantime, bumper income from Kestrel is providing cash flow for new investments and generous dividends. So the situation isn’t all bad.

SIF screen review

Does Anglo-Pacific still pass all of my Stock in Focus screening rules? A quick check with the checklist tool suggests there’s a problem:

On closer inspection, this turns out to be a false alarm. For some reason, the StockReport page for APF shows a dividend of 9.6p per share for 2018, which is forecast to be cut to 8.3p in 2019:

A forecast dividend cut would break one of my rules. But the figure of 9.6p is incorrect. The total dividend for 2018 was 8p per share. Oddly enough, the data on the APF dividend history page reflects this correctly. So I’m not sure what’s going on.

The upshot is that Anglo Pacific still passes all of my screening tests and will remain in the portfolio for at least one more month.

I’m comfortable with this, in the short term at least. Although the stock is arguably fully priced, on 1.8x NAV, the outlook for the next 18 months is pretty strong. Mr Treger’s judgement has proved fairly reliable so far, so I’m happy to hold on a little longer.

Verdict: Hold
Total return to date: +40.2pc

Sylvania Platinum (LON:SLP)

(Original coverage 11/09/2018)

“It is a bubble…” — not my words, but those of Anglo American chief executive Mark Cutifani, discussing the current market for palladium, one of the platinum group metals (PGM) produced by Sylvania Platinum.

In the interests of balance, I should also say that Mr Cutifani went on to say that he thought palladium prices would remain elevated for a while, as it would take time for automotive manufacturers to re-engineer their catalytic converters to use cheaper platinum.

Palladium prices have risen from about $140/oz at the start of 2009 to roughly $1,500/oz today (FT chart link). Since July 2016 alone, the price of palladium has risen by about 150%. Rhodium, another PGM, has also performed strongly.

This strong growth has provided a tailwind for Sylvania, which makes money by processing tailings (the waste from other mines), as well as mining on its own account. Profits rose by 29% during the first half of the current year, even though production was only 4.5% higher.

The stock closed about 6% higher on Monday after the company announced a 2.1m share buyback. After subtracting off the 1m shares which will be used for staff stock options, my sums suggest the net return to shareholders equates to a yield of about 0.4%.

Sell or hold? With a running gain of more than 40% on this position, I’m happy to lock in a profit at this point. History suggests that the price of palladium will correct at some point in the future. When this happens, the profits of small miners like Sylvania will be hit hard.

Although the outlook remains positive, a forecast P/E of 5.1, below my minimum P/E of 7. This suggests to me that the market sees some downside risk to earnings. I share this view.

This has been a successful trade for the SIF fund, with a share price gain of 41%. The company’s maiden dividend in October added a further 1.6% to the folio’s total return.

Verdict: Sell
Total return: +42.5pc

I will sell Sylvania Platinum from the SIF fund and my own holdings after this article has been published.

Next week, I have high hopes that my SIF stock screen will provide some new candidates for the portfolio.

Disclosure: At the time of publication, Roland owned shares in Anglo Pacific and Sylvania Platinum.

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