Sylvania Platinum - Cash Rich, Growing And Cheap

3rd Mar '20 by Jack Brumby

26 comments 9387 reads

In prevailing market conditions, where participants are fixated on downside risk, looking for quality, growing companies with safe balance sheets and margins of safety is more important than ever. Sylvania Platinum (LON:SLP) might be one of those companies - if you believe the current prices of palladium and rhodium can be maintained.

Sylvania is a low-cost South African producer and developer of platinum, palladium and rhodium. Surging platinum group metals (PGM) prices have propelled the group’s shares ever higher in recent weeks. Barring a one day drop last Friday, it has also held up relatively well in the recent risk-off market conditions.

That is probably due to an attractive combination of rocketing profitability, stacks of cash on the balance sheet, and a shareholder-friendly use of prodigious amounts of free cash flow. The group’s shares currently trade on just 2.8 times forecast earnings and brokers have been busy more than doubling their EPS estimates for FY20 and FY21.

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Sylvania has a market cap of £135m, but it also has $33m of cash, virtually no debt, and there is every indication the company will have added to this cash pile by the year end. The group also holds untapped mining assets with option value.

So what’s going on? Am I late to the party here or will the market at some point wake up and aggressively rerate this cash-rich South African miner’s shares?

Not without risk…

While the PGM metals Sylvania produces are in demand from auto industries for their pollution-reducing properties, it is worth remembering the Sylvania, as a low-cost operator, is operationally geared. That means profits that seemingly materialise out of nowhere can likely evaporate just as fast.

It is impossible to look at stocks without considering the Coronavirus at the moment, and I believe Sylvania could have some exposure to the economic disruption that has occurred so far. It is hard to quantify anything at this stage, but a lot of demand for PGMs comes from China’s automobile market. Assuming that spot prices for these metals can be maintained is central to the thesis that Sylvania shares are cheap.

The group itself flags other risks. In its FY19 results, it notes:

There are clouds on the horizon in automotive markets – China trade wars, Brexit, and such mean that we will remain with our conservative views of metals prices…

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Cambourne

3rd Mar '20

Looks like a no brainer £SLP. A great time to invest in this dip before it really takes off. Good Luck All

pgs501

Great article Jack. This is my largest position and it is good to see you reaching a similar conclusion. Personally I believe that this is a very large pricing anomaly and in a years time should produce an excellent gain so long as the PGM prices do not crash.

To me whilst this is a well run operation (all in costs / oz have barely changed over the last couple of years and have been consistently low for the industry) the price anomaly has come about from the scale of the PGM price increases over the last year not being reflected in the share price. As you say H1 2020 average basket price rose to $1,830 / oz, and this is continuing to rise. However this rise has taken the basket price to $2,712 / oz (an almost 50% increase from H1 average).

I feel that the share price has yet to reflect even the basket price rise to $1,830, let alone the additional further rise to $2,712 / oz. It is as though institutions believe the price must be a spike that will drop rapidly down, however even if PGM prices dropped by 50% and stayed there long term (despite the various environmentally friendly car legislation suggesting demand will outstrip supply and additional supply is hard to come by for Palladium and Rhodium) Sylvania Platinum (LON:SLP) would still produce good profit rates.

Coronavirus has significantly reduced car production short term (though the Palladium & Rhodium prices have been marching higher regardless) however historically people put off large purchases in a recession or any disruption like this only to then purchase them in droves afterwards. It is more of a delayed than cancelled purchase.

Adding to that the significant percentage of net cash on the balance sheet and this feels like a pretty huge margin of safety, with an expectation of large appreciation, to me.

Alexicek

What brokers are you using to purchase this stock?

Frap

Hargreaves Lansdown. It is quoted on AIM.

Peter171

very interesting Howard, as this story becomes more public which I have no doubt will happen as Sylvania Platinum (LON:SLP) newsflow becomes more public through greater editorial coverage then it might be a case of sell the story.

Martin VT

Re Howard’s comments about legal issues:

1. The legal case is against Samancor, by a Trade Union seeking financial compensation for what was ‘taken from the workers’
2. The case deals with events covering the period 2005-2007. I would think that 13-15 year delay might make it harder to substantiate any claim
3.There is no legal action against SLP

4.The case appears to be about behaviours of new owners and related parties about treatment of various assets and profits. Some of this pertains to SLP contract with Samancor, but much does not

5. It could be argued that assertion of demands for compensation against Samancor coincides with the improvement of profitability of SLP over the last three years.
6. Given that SLP has made losses in a number of years since the deal was done its hard to argue that it was given an unfairly cheap asset (particularly, and importantly, at the time the contract’s were set)

7. That said, the case for the defence by Samancor has not been made nor heard

This is South Africa, so who knows what will happen, but it appears that 14 years after the event, there are no allegations against SLP, and no legal case is being made

On that basis I’m happy to hold

NK104

On all metrics it does look very cheap. Even if the PGM basket falls swiftly to $1,200 per ounce, Sylvania will have been coining it in during the period of the bubble.

The key downside is the political risk. This is a factor with South Africa - just because something should not be legally actionable does not mean this will hold if the ruling party (or greedy elements therein) fancies a larger slice.

Disclosure: I hold

mojomogoz

Great report, but Just to be out of sync with consensus onion ;) ...

I held Sylvania Platinum (LON:SLP) but sold out today and yesterday. Why?

Low valuation high margin is often not a good wear for deep cyclicals....SLP may not have a straight economic cycle but it has acute cycles driven by end market fluctuations, but...

...its a growth market and not simple commodity you might say. Recent history and pricing says yes to that of course...but there are ongoing globally disruptive events (coronavirus which was preceded by a meaningful economic slowdown too). There are many examples of acute demand-supply imbalances in niche commodities. The dynamic always looks unassailably good. Anyway, I was happy to have the momentum behind the underlying commodities and cheap valuation as things looked good but the unfolding global dynamic provides challenge.

On top of that there are issues around supply. Admittedly they got stockpile so not heart attack risk but a change to dynamics of chrome producers they piggyback on for plant feed could lead to negative expectations being built in and a visible end of life of mine sort of valuation dynamic.

What about the cash hoard that SLP has?...very good point....but you can be guaranteed management will not deploy that meaningfully until its clear whether TSIHTF or not....that's best case 2 months (assuming phenomenal China snapback and RoW containing quite successfully and with low stress)...and then mgt will take a few more months just to be sure all okay.

Whilst I'm quite positive relative to consensus quite broad based Africa risk, I'm specifically negative SA -> worried tipped to negative around coronavirus. SA has ongoing political, economic and social fragility. It doesn't need more problems. On top of that it has a more aged and less healthy (in terms of chronic illnesses) population than many others bits of Africa. It is more prone to a coronavirus epldemic.

On a balance of risk perspective I'd rather own other things for upside from here rather than cheap commod company supplying a very richly priced niche. Supply-demand gets very edgy in these situations potentially and the customer behaviour (car manufacturers) can quite easily switch from anxious knee jerk hoarding to a bit of wait and see on the price (with some stores of commodity coming onto market too now that the price is falling rather than rising)

Overall, my feel is that from a portfolio perspective SLP correlated too acutely to the downside risks that could effect many other parts of market. Obvs the cash buffer limits it compared to many others....and I'll be interested again on significant downside volatility perhaps....but my feeling we are having as much of a correction of growth expectations (particularly in US where they were high) as virus panic (virus just let it out the bag) so the opp may be to pick up high growth at a cheap price

Geoffrey Collins

When I read the Strong Buy recommendation in the Investors Chronicle, I decided to do some research. My conclusions are somewhat different, and I would not buy this stock. There were three issues for me:

- Sustainability of current high commodity prices for palladium and rhodium. Sylvania is a low volume producer. The big suppliers appear to be Norilsk Nickel, Anglo Platinum, Sibanye-Stillwater and Impala. If they were to ramp up production of PGM metals, this would mean higher supply volumes and potentially lower prices. In other words, the current windfall profits might evaporate.

- Mine lives. According to the company's London Investor Presentation, the company's resources have a profitable operational life of at least 10 years. So one can expect that over the next 10 years one or more of their operating complexes will have to be shut down. A case in point is their Steelpoort SDO which was decommissioned in 2017. In a worst case scenario, by 2030 all of these operations will have ceased for a variety of reasons.

- Capacity constraints. Also in their presentation they say that their current annual production capacity is 78k oz max. The Production Profile graph shows that production has effectively plateaued from 2017 onwards.

Taking all the above into account, I did the following maths. Assuming a current share price of 50p, the company is valued at say £150m. In return for this, you get:

(1) the current equity. At 31 December 2019 this was US$148m or £115m, assuming US$1.28 to £1; and

(2) the value of future earnings. This is the big unknown. For example, if you assume that the company will continue to produce 78k oz for 10 years at a gross basket price of US$1,300 per oz, then this equates to around US$17m net income p.a. (see 30 June 2019 financials). So over 10 years, this is US$170m or £133m.

According to my calculations, an investment today of £150m yielding £248m in 10 years has an internal rate of return of only 5.2%.

Obviously if you assume that the higher basket price for PGM metals is sustainable (which I don't), then the rate of return will increase. If earnings were to increase to US$40m p.a., then this gives total equity of £428m at the end of the 10 year period. This is a rate of return of 11%.

Now considering all the risks that have been highlighted - labour unrest, power outages, lack of rainfall, drop in PGM market prices, GBP/USD/ZAR exchange rate movements etc - I personally would want to see a much higher return on my investment than the 11% in the most optimistic scenario.

One of the reasons companies have high P/E ratios is the belief that management will be able to grow revenues and profits by developing new products, finding new markets or increasing production through new manufacturing plants. I can't see that any of this applies to Sylvania.

Jack Brumby

4th Mar '20

I always appreciate hearing counter arguments - in fact, it’s vitally important…

Whether or not you believe spot prices can be supported is a key part of the thesis here, I guess. Is this merely a cycle or is it exposure to a structural growth opportunity? And then, depending on which side you come down on, what are the implications for prices? The Matthey report suggests to me that at least for the next year, the overall supply/demand mix will be broadly maintained, in which case, FY20 growth might still be undervalued.

With its untapped mining assets, growing cash pile, and a current basket price that might not yet be fully reflected in the share price, the Sylvania Platinum (LON:SLP) opportunity might also be framed as a value-momentum rerating opportunity in the shorter term?

Of course, the Matthey report came out just before the Coronavirus sharpened the global community’s focus on downside risks and China essentially shut down for a week or two…

Thanks for the considered response. Curious to know what stocks are on your watchlist (if you feel like sharing ;))

Rusty2

China shut down was for about 4 weeks, it already had the New Year shut down which is for 2 weeks.

Fair... I had this BBC pic in mind when writing, quite interesting:

Interesting images, Jack. Chinese New Year started on 25th January, 2020. Of course weather can play it's part, Bangkok has had bad pollution recently but that is nothing to do with activity, it is more to do with the weather.

Howard Marx

Not surprisingly, auto sales in China plummeted last month.

What is more surprising is that sales in China have been falling for 20 of the last 21 months:

This is of significance given the scale of auto sales in China:

Anthony127

Jack thank you for the great analysis.

Looking at the stock report I am particularly struck by the fact that even if the Sylvania Platinum (LON:SLP) share price was to treble the forward PE Ratio would still be comfortably in single digits. Warren Buffett and others emphasize the Margin of Safety and I think there is a very strong margin in this case. I purchased this share last month and I will be keeping an eye on commodity prices and the business cycle as this share is clearly cyclical in nature as pointed out by the weather forecast.

For me the big question is how quickly China will recover, as you can see in Howard's chart above, this could have a significant effect on car sales and therefore demand for PGMs. I believe EV sales in China were even harder hit. I'm holding on at the moment.

5th Mar '20

Hi Jack - it got long so I put here:

https://www.stockopedia.com/content/i-not-so-quickly-said-to-jacksome-general-current-views-569152/

ricardow

6th Mar '20

Excellent article, Jack. Thank you.

Do you have any thoughts on Jubilee Metals £jlp which appears to have basically the same business model?

Ricardo

bobsandy12

7th Mar '20

Excellent piece, thank you. Reinforces why hI am a subscriber. I will not buy as I hold other high risk stocks and have no room for more in this environment

John Gutai

8th Mar '20

Great article Jack. Thanks.

A significant additional long term risk is the replacement of ICEs with EVs or hydrogen powered vehicles. This could reduce the demand for PGMs by 80% over 10 years. Does anyone know whether there are any other use cases for PMGs on the horizon?

Sylvania Platinum - cash rich, growing and cheap

Not without risk…

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Jack Brumby

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