Platinum supply and demand dynamics are increasingly making headlines. The debate mostly revolves around a sustainable level of primary demand, growth in demand, uncertainty about above-ground stockpiles, and growth in recycling. Nevertheless, we maintain a positive outlook for platinum over the medium term. Specifically, we believe Northam is well positioned to benefit from the unfolding dynamics.
The primary platinum supply base is shrinking
To understand the supply side of platinum it’s useful to define some of the characteristics of a typical capital project:
- It requires large amounts of capital upfront – up to R10 billion for a single vertical shaft.
- It can take up to 10 years for the project to reach steady state production levels.
- The remaining ore bodies are getting deeper and are costlier to operate.
- Shallow orebodies require significant investment in above-ground processing infrastructure.
Roughly 70% of the 6.2 million ounces (Moz) of primary supply is mined from South African ore bodies. Production from South African producers in 2015 was 4.5Moz, a significant decline from the peak production level of 5.3Moz in 2006. The sustained low level of platinum group metal (PGM) prices and increased cost pressures from labour and utilities, have left many producers with very little cash flow to re-invest back into their operations to sustain production levels over the medium to long term. In addition, many replacement projects have been cancelled or postponed due to cash flow and balance sheet constraints.
Secondary supply, however, is growing in the form of recycling
Secondary supply in the form of recycling has grown from 0.5Moz in 2000 to a peak of 2.1Moz in 2013 – an increase in contribution to total supply from 8% to 27%. However, there is a natural cap to recycling’s contribution to total supply due to unrecovered ounces (inefficient collection process of catalytic converters) and some of the PGMs being lost in the refining process. Recyclers are also exposed to the industry economics and low prices affect their returns. Although we believe recycling will continue to grow we do not believe that its relative contribution to supply will increase significantly above the 35% level.
Demand for platinum is driven by industrial use in vehicle manufacturing, which we expect to grow
Unlike gold, platinum has an industrial use. Autocatalytic converters are the primary driver of demand for platinum. Demand for these converters has fallen from a peak of 4.1Moz in 2007 to 3.4Moz in 2015 on the back of poor vehicle sales in Europe, which is a key diesel vehicle market. Platinum is the only PGM that can be used in diesel vehicles (whereas palladium is more common in petrol vehicles), which is why Europe is an important driver of platinum demand. The share of diesel vehicle sales in total vehicle sales in Europe remains solid due to the European Union’s focus on reducing carbon dioxide (CO2) emissions. Diesel engines are far more effective in reducing CO2 emissions than petrol vehicles.
Growth in vehicle sales in Europe has, however, picked up and, although it is still in the early stages, we believe continued growth from the region will drive demand for platinum. The implementation of more stringent Euro 6 and 7 emission standards will require higher PGM loadings (a higher level of PGM content in the catalytic converter), adding to growth in demand.
Even with growth in electric and hybrid vehicles there will still be a platinum supply deficit
On the other hand, growth in the use of electric and hybrid vehicles has sparked debate around the need for platinum, since electric vehicles replace combustion engines. Although we view this as a real threat, it will take a very long time for the substitution of electric vehicles to have a significant impact on PGM demand. Although electric vehicles require no PGMs, hybrid vehicles still require PGMs to satisfy emission regulations. Figure 1 shows that even if electric vehicles claim a 30% share of total vehicle sales by 2030 , there will still be a PGM supply deficit. This translates into annualised platinum demand growth of 0.3% to 2030 (from 3.4Moz to 3.7Moz), compared to the World Platinum Investment Council’s (WPIC) forecasted demand growth of 1.2%.
According to the WPIC, industrial demand for PGMs (demand from autocatalytic converters and other industrial uses) should grow at rates similar to global GDP growth over the medium term. This view is supportive of the looming supply deficit that will support higher PGM prices. (We believe it is prudent not to forecast growth in demand from investment and jewellery, as this is volatile and speculative.)
Growing demand and decreasing supply will push up depressed prices
The growth in above-ground stockpiles since 2008 has been blamed as the primary cause of depressed platinum prices. Several studies estimate the level of above-ground stocks, and their conclusions vary dramatically. While we cannot say for certain which studies are more accurate, we are confident about the underlying fundamentals in the market – decreasing supply and growing demand should erode stockpiles and bring about prices that incentivise expanding production. However, when the world realises there is a shortage of platinum and is willing to pay a higher price, it will take time for supply to respond due to the long-term nature of capital projects. As a result, prices could remain high for a sustained period. Figure 1 illustrates the divergence in supply and demand.
Northam is well positioned for this scenario with its low-cost, capital-light strategy
Northam is a relatively small platinum producer with two operations – Zondereinde in the Western Bushveld and Booysendal in the Eastern Bushveld. Both operations are low cost and capital light. Zondereinde is the original mine near Thabazimbi in the province of Limpopo. Zondereinde is one of the deepest mines in the industry, with a mining depth of 1,750 metres. However, due to the high-quality orebody and the high grades (metal content per tonne mined) it is still a low-cost operation. In addition, Zondereinde will require minimal capital investment to sustain annual platinum production at the current levels of 180,000 ounces for the next 16 years. This is in stark contrast to most other producers in the industry, especially in the Rustenburg area, where operations require huge amounts of capital to sustain production levels.
All of Northam’s future growth will come from its Booysendal operations
These operations have many favourable characteristics that most of its competitors don’t have. Booysendal near Lydenburg, consists of two projects – Booysendal North and Booysendal South. Booysendal North reached steady state production in 2016 at an annual rate of 90,000 platinum ounces (Pt oz). It is a shallow orebody, making it low cost, and it has a very long life. Many small, low-risk, capital-light deepening and expansion options exist that could increase annual production to 130,000 Pt oz in the near term.
With minimal capital requirements, the Booysendal South project should be highly profitable
The Booysendal South project illustrates management’s strong capital allocation capabilities.
Management acquired the adjacent Everest operation from Aquarius Platinum in 2015. Everest was constrained in the hands of Aquarius, as it only had three years of mining left before it would have imposed on Northam’s Booysendal property. This acquisition gave Northam an existing decline shaft and a concentrating plant that would have cost them more than R2 billion to build as a greenfield project. Instead they acquired it for R450 million from Aquarius, who desperately needed the cash.
This acquisition enables Northam to develop the Booysendal South property using the existing infrastructure, which significantly reduces the capital requirement. As the orebody is very similar to Booysendal North, it is low risk with similar favourable characteristics. Northam will spend R4.2 billion over the next five years to build a mine that produces 140,000 Pt oz annually and that has a very long life. To put the project into perspective, Impala Platinum will have to spend R12 billion on 17 Shaft to achieve a production level of 180,000 Pt oz, with a much shorter life. As the project will be done through on-reef development (extracting ore to sell during the development process), it will generate revenue while the mine is being built, which will partly fund the capital expenditure. This is a big advantage compared to a typical vertical shaft project that generates revenue only at the end of the project, requiring the entire funding to be secured in advance.
A positive net cash balance and management’s capital allocation capabilities seal the deal
With a recent BEE transaction, Northam increased its BEE shareholding while raising capital, reducing the regulatory and balance sheet risks. While many of its competitors are in a net debt position, Northam currently has a net cash balance of R2.4 billion. The capital is earmarked for the Booysendal South project and, according to our calculations, will add significant value to the business. Even at current spot prices of R25,000/Pt oz, Booysendal South will generate returns above the cost of capital. Last, but certainly not least, we have a high regard for management as they have demonstrated an ability to allocate capital prudently throughout the cycle.
Northam’s low-cost, capital-light strategy will reward patient investors
When it comes to commodity industries where management has no control over the price at which the product is sold, we believe that a low-cost strategy is the only one to pursue. Both of Northam’s operations are in the bottom 20% of the industry cost curve and are generating cash at current prices. This low-cost and capital-light strategy will allow Northam to grow production when primary supply is expected to decline, making Northam a very attractive proposition. In addition to the relatively low business and financial risk, the current share price of R48 implies very little appreciation in the real platinum price. Overall, we see Northam as an attractive investment opportunity with substantial growth potential and we believe clients in our local funds will be adequately rewarded for their patience.
Joachim attended St. Charles College High School in Pietermaritzburg and matriculated in 2004. Before enrolling for B.Com Financial Management at UNISA in 2009 he operated his own catering business in Stellenbosch. He graduated in 2011. Joachim worked at Integrated Mine Seismology (IMS) in Stellenbosch as a technical assistant, but his passion for the financial markets led him to enrol for CFA in 2012. He has subsequently passed all 3 levels of the CFA program, and joined SIM Unconstrained Capital Partners in September 2012 as a junior equity analyst.