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Is the platinum sector imploding?

Or is there value for investors at these levels?

CAPE TOWN – Investors in platinum stocks have dumped their shares in a panic over the last six weeks, fearing that the platinum sector is in terminal decline. Since April the sector has fallen by 20%, bringing the cumulative decline for the year to 30%.

But since April contrarian asset manager RE:CM has increased its holdings in Implats and Lonmin, while retaining sizeable investment in Amplats. All four of its equity funds are exposed to the platinum sector in degrees ranging from 3% of the fund up to 15% in the case of its SA-focused Flexible Equity Fund.

This begs the question, has the sell-off in platinum stocks been overdone? And more importantly, is there value for investors at these levels?

The sector is not imploding, says Jonathan Butler, precious metals strategist at Mitsubishi Corporation. This is not to deny that the South African industry faces significant difficulties in the coming months – none of which are new, he says. High costs, inadequate margins and difficult labour relations have combined in a perfect storm to wring every last cent of profitability out of a long suffering industry.

The looming period of wage negotiations, violent strikes and a possible lose-lose outcome was the last straw for investors.

However, Butler says, at a macro-level the fundamentals for platinum look good. “In the medium term we remain bullish on platinum. If the necessary restructuring takes place the demand fundamentals are good.”

Diminishing stockpiles, greater demand

Large platinum stockpiles, which have suppressed prices in a time of reduced demand, are expected to be diminished within the next few years.

Growing vehicle volumes, combined with tightening emission legislation in Europe, the US, China, India and South America will ensure long-term demand growth. In Europe, the introduction of the Euro 6 legislation next year is expected to boost demand for platinum by 400 000 ounces.

While demand is expected to increase, supply in the platinum market has been falling steadily and the industry is expected to be in deficit of around 200,000 ounces this year, largely due to the supply disruptions in late 2012, rising costs and production cutbacks.

As the world’s largest producer of the precious metal, Anglo American Platinum (JSE:AMS) (Amplats) is leading the way with its plans to cut its production to a level that makes economic sense.

The over-supply situation is expected to swing and deficits are expected to deepen in the coming years. This has led Johnson Matthey, the world’s largest supplier of platinum-based automotive catalytic converters, to forecast that the price of the metal will rise gradually in the second half of the year to as high as $1,710 an ounce, up from the current $1,469/oz.

Restructuring and other fears

While the fundamentals are positive in the long run, the industry must first face significant headwinds if it is to successfully restructure and become profitable.

“If you talk pure valuation in a perfect world where normal market dynamics are in play then these stocks are massively under-valued,” says Sholto Dolamo, head of resources at Stanlib. “I would be buying at these levels.”

The big question, he says, is if these companies will be able to realise their value, given the current market dynamics. “This is an industry where a businessman can’t take pure business decisions around costs. Too many people have vested interests, making it difficult to figure out if there is value.”

The sector has no choice but to restructure. “Platinum companies must take high cost ounces out of the market,” says Alon Olsha, metals and mining analyst at Macquarie Group. “At current platinum prices the industry is destroying value.”

The uncertainty is what investors fear. “Yes Amplats has a plan. But they are only now engaging with unions and there is a risk the shape of the plan could still change.”

He adds that the impact of restructuring is visible at Aquarius Platinum (JSE:AQP), albeit on a smaller scale, which reported stronger Q1 production and earnings figures recently. “This is indicative of its cost cutting strategy.”

While many of the big platinum stocks are trading at close to five-year lows and investors remain jittery, Olsha does not see shares falling further. “It is difficult to see the sector selling off much further from current levels; the momentum is going in the right direction.”

A bullish view

At RE:CM the investment team is not put off by the significant levels of “fear and revulsion” surrounding the resources sector, and platinum in particular. “We don’t follow the popular story. In the case of platinum, these are quality companies and is very seldom that you will buy stocks this cheap,” chairman Piet Viljoen told investors at a RE:CM update on Monday.

But buying cheap (ie below their intrinsic value) is just one part of the equation. “South Africa controls 85% of the world’s platinum resource and demand for platinum as an industrial metal is not going away,” portfolio manager Paul Whitburn noted. “South Africa determines the cost profile of the global platinum sector. If price does not satisfy returns, they will cut back production until it does.”

RE:CM certainly has the appetite to cope with significant levels of discomfort. That is because when exactly supply, demand and price will be back in balance is something it and seemingly no one else is willing to predict.


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