Polymetal : To Buy or not to Buy?
“…For those willing to buy, the wild oscillations in Polymetal’s stocks show there is money to be made: at the time of writing they have risen to around 300p in just a few days. The longer term prospects for a company once a sure bet because of its dividends and stable output depend on the ending of a conflict generated within, and which can seemingly only be resolved within, the enigmatic walls of the Kremlin…”
Gold and commodity prices may be surging in the wake of the invasion of Ukraine, but gold miners focused on Russia suddenly find themselves in a curious, and not to say, alarming position.
The rise and rise of Polymetal International (LON:POLY), a long-time investor favourite operating eight Russian and Kazakh mines and a state of the art processing plant, has come to an abrupt halt since war broke out last month. Two-thirds of the company’s assets are located in Russia, and its management team is based in St Petersburg. The natural resources giant’s share price crumbled from 1,097p on the eve of the invasion to 92p a fortnight later, and its market cap from more than £5bn to around £1bn. Norway’s sovereign wealth fund, one of Polymetal’s top shareholders, has withdrawn its holding, and the company has fallen out of the FTSE 100. But Polymetal’s stock has begun to rise again, rising nearly 75pc over the past few days, as some investors bet on a resolution to the conflict. Now the company is considering the drastic option of cutting itself in two, listing its Russian and Kazakh businesses separately. With the outcome of the war still radically uncertain, is it possible to indicate what the future might hold for Polymetal?
Out in the cold
One thing that is clear is that the ‘shock and awe’ sanctions imposed on Russia have serious implications for the company. Polymetal sells gold ore to China, but has made most of its revenue from selling gold to Russian banks, which had traded the metal on international markets. But since the war Russia has been all but shut out from global economic networks. Moscow’s equity markets were suspended after the invasion, and have only partially reopened. Russian stocks have been removed from MSCI’s emerging markets indices. International trading in many Russian companies has stopped, and prohibitions have been placed on the exchange of the country’s bonds. Russian banks have been barred from Swift, the messaging network that underpins global payments. Perhaps most seriously of all, the country’s central bank has lost access to around half of its foreign reserves, access to which has been vital in supporting the rouble’s value and shoring up Russia’s still fragile post-Soviet economy.
With domestic Russian banks cut off from the international banking system The Central Bank of Russia has resumed gold purchases to bolster its capacity to support an economy effectively exiled from global markets. The bank had already built up significant reserves after the annexation of Crimea in 2014, generating significant income for Polymetal, and now has the sixth largest gold stockpile in the world, worth more than $150bn. But the value of the resource was thrown into doubt last week as G7 leaders agreed to crack down on the bank’s ability to use its reserve to prop up the rouble. For its part, the Putin administration has threatened to find ‘legal solutions’ to seize assets located in Russia from international groups that have closed their operations.
Polymetal’s evolving response
Polymetal’s response to the crisis continues to evolve day-by-day, as it seeks to pacify both Western investors and the autocracy in which its assets are based. British Chairman Ian Cockerill and five other board members resigned from its board immediately after the invasion, to be replaced by Riccardo Orcel, the brother of Andrea Orcel, chief executive of Italian lender UniCredit and one of Europe’s best-known bankers. Though an experienced hand, Mr Orcel’s appointment underlines the extent of Polymetal’s ties to the Russian establishment (although the company insists it is not a Russian entity). He was previously head of global banking at VTB Capital, the investment banking arm of Russia’s second-largest lender, which was instrumental in financing Putin’s war machine prior to its invasion of Crimea in 2014. A primary target of Western sanctions, VTB is now winding down its European operations.
Polymetal’s first major statement on the impact of sanctions and Russia’s capital control legislation, published on 9 March, reported that the company’s operations in Russia and Kazakhstan ‘continue undisrupted’. Sales of gold bullion in Russia had ‘been impacted’ by sanctions but it had ‘received assurances from off-takers that all existing contracts continue in good standing’. Domestic physical demand for gold in Russia was being supported by the central bank (though the statement was published before the G7 announced plans for a crack down). Sales of bullion and gold concentrate from Kazakhstan ‘continue as usual’: Kazakhstan operations generated 43pc of Polymetal’s adjusted EBITDA and 48pc of its net earnings in 2021. And the company says it has built up a safety buffer against supply chain disruptions, routinely carrying at least three months’ worth of consumption in stockpiles of critical materials, consumables and spare parts. Polymetal has $0.4bn in cash and cash equivalents deposited with non-sanctioned financial institutions, sufficient buffer to allow it to ‘continue to fulfill its obligations and capital commitments in the next 12 months even in the absence of new borrowings’.
But the collapse in the value of the rouble is taking its toll. The Russian central bank’s emergency ramp in interest rates since the invasion – from 9.5pc to 20pc – is driving up the cost of servicing Polymetal’s net debt of $1.87bn. And the statement was ambiguous regarding the company’s ability to pay the generous dividend it had signalled in its preliminary results for the year ended 2021. A final dividend of $0.52 per share, worth around $246m, representing 50pc of net earnings for 2H 2021, had been proposed, bringing the total dividend declared for FY 2021 to $459m. Polymetal ‘currently intends to pay the final dividend as proposed by the Board’ but ‘retains the discretion to re-evaluate its dividend recommendation prior to the Annual General Meeting with a view to ensuring liquidity and solvency of the business.’ The company’s hand may be forced by technical as well as financial considerations: sanctions introduced earlier this month restricting foreign currency transactions make it ‘unclear whether the Company will be able to remit dividends from its Russian subsidiaries to the holding company level’.
The statement also conceded the possibility that sanctions may be imposed on Polymetal itself. The company ‘believes that targeted sanctions on the company remain unlikely, but are not impossible. Contingency planning has been initiated proactively to maintain business continuity.’ For its part, it is complying ‘rigorously with all relevant legislation and is implementing comprehensive measures to observe all applicable international sanctions’.
Earlier this week the Financial Times reported that Polymetal is considering whether to divide its ‘operationally good’ Kazakh assets from its ‘reputationally bad’ Russian business, listing the latter separately to insulate the wider company from the knock-on effects of western sanctions. According to company insiders, investors ‘would have the option to retain holdings in both companies, or to sell their shares in the Russia business, if they were worried about the reputational risk or additional western sanctions’. The company said the demerger was being ‘evaluated’ after suggestions ‘that we explore ways to modify asset holding structure to enable distinct ownership in various jurisdictions’.
Polymetal’s cogitations follow a series of positive updates just before and immediately after the invasion. Q4 2021 production results published in January reported production had exceeded guidance and the payment of record dividends in 2021. Gold production for the year amounted to 1,677 Koz, a 2pc increase year on year and 5pc above the original production guidance of 1.6 Moz. Solid production at a new Russian mine at Nezhda had encouraged a $471m investment in another project in the country, at Veduga, expected to produce 200 Koz of gold per year on average over a 21-year mine-life. The company offered gold production guidance of 1.7 Moz for FY 2022 and 1.75 Moz of GE for FY 2023. It paid $632m worth in dividends in 2021, a new high.
A resources and exploration update published at the beginning of March reported a year-on-year increase in ore reserve of 7pc, to 30 Moz of gold. Mineral resources (additional to ore reserves) grew by 13pc or 2.8 Moz year-on-year to 24.6 Moz. And preliminaries for the year ended 31 December, published on 2 March, reported ‘excellent financial results’. Revenue in 2021 had increased by 1pc, totalling $2.89m, up from $2.865m for 2020. Gold sales were stable year-on-year at 1,386 Koz, and free cash flow amounted to $418m. Net debt had increased $1.647m from $1.351m due to ‘materials and wage inflation’ capital spending, but still below the Group’s target 1.5 leverage EBITDA ratio. The results incorporated the company’s first statement on the crisis, saying that it was ‘shocked and appalled by the events going on in Ukraine’, which was likely going to ‘require a lot of management efforts to maintain company performance.’
The present storm enveloping the company comes after years of strong performance that had made it a firm investor favourite: Polymetal’s shares had risen from just over 600p in September 2018 to nearly 1,500p in the weeks prior to the invasion. During the summer of 2020 the value of Polymetal’s stocks outpaced even the gold price, allowing it to steadily ramp up its dividend. 12 months ago the company more than doubled its annual net profit, to $1.1bn, after a 28pc rise in annual revenues and falling costs, allowing it to devote additional resources to copper exploration, a critical energy transition metal.
Polymetal’s rally over the past few days reflects optimism among some investors that a company with essentially strong fundamentals will come good again should Russia and Ukraine reach some kind of resolution, allowing – in time – the most severe sanctions to be lifted. Clearly, would-be buyers should be wary. Strong ethical as well as financial considerations come into play. The mood today is very different from the market’s matter-of-fact response to Russia’s annexation of Crimea, when the oil and gas industry turned out in force at the St Petersburg International Economic Forum, Russia’s Davos, at which BP signed a deal with Russian state-owned Rosneft, then CEO Bob Dudley saying that the company had ‘a responsibility to stand with our partners in difficult times’. Today, Russia has no Western friends. BP responded to the invasion of Ukraine by ditching its 20pc stake in Rosneft, and Shell has said it will end its joint ventures with Gazprom, ditching the bulk of its Russia operations.
The financial calculus is also much more uncertain. There are concerns regarding investors’ continued ability to trade Russia-exposed companies: indeed the London Stock Exchange cancelled all trades in Polymetal shares for a 20-minute period on 8 March as the share price began to rebound. The company is entangled in the machinery of an economy facing severe and prolonged crisis. Emerging markets have weathered several storms since they were popularised as a collective asset class in the 1980s, including the Asian financial crisis, Argentina’s serial defaults, and, of course, the debt crisis that engulfed Russia at the turn of the millennium. But so long as the Putin administration holds power the Russian economy seems likely to be subject to sanctions of some degree of severity, even if a form of accommodation is reached with Ukraine. In the meantime, Russia is effectively reduced to a siege economy. Though it is self-sufficient in food and energy, the wider economy is shut-off from Western supply chains, leaving it perilously reliant on China, itself under huge pressure not to comply with Putin’s war effort.
For those willing to buy, the wild oscillations in Polymetal’s stocks show there is money to be made: at the time of writing they have risen to around 300p in just a few days. Get the timing right, and there are short term gains to be had. The longer term prospects for a company once a sure bet because of its dividends and stable output depend on the ending of a conflict generated within, and which can seemingly only be resolved within, the enigmatic walls of the Kremlin.