Polymetal still as good as gold

Polymetal still as good as gold
Operations at Polymetal's Dukat underground gold mine.
By Ben Aris in Moscow March 8, 2016

Russia’s raw material producers have been amongst the few winners from the sharp fall of the ruble, but until recently that has not been reflected in their share price, despite rising production, improved margins and generous dividend policies. That is starting to change.

Leading Russian gold-producer Polymetal International has seen its shares rally strongly since August 2015 as a combination of the benefits of the ruble devaluation and a rise in the gold price lifted the share price by 70%. “The benefit of the ruble devaluation is that it has pushed down our costs and improved our profitability,” Vitaly Nesis, CEO of Polymetal, tells bne IntelliNews in an exclusive interview.

Following a rally of almost 20% in gold prices since the start of this year, the company is looking attractive to investors, and in the context of a deep Russian recession its luster glows even brighter. Leading Russian investment bank Sberbank CIB issued a note on February 26 entitled, “Polymetal: Hitting the Sweet Spot”, which contended it will be a member of an elite club of Russian companies that will actually see their earnings rise this year.

“Russia’s gold miners could be almost the only exporters among public companies to see earnings expand in 2016,” Irina Lapshina, a precious metals analyst with Sberbank CIB, wrote. “Gold has surprised even the bullish, rising 16% year to date on the possibility of slower US monetary policy tightening and fears of a slowdown in China. Meanwhile, the ruble has continued to lose ground against the dollar and is down 5.5% year to date on the weak oil price and dim prospects of the West lifting sanctions on Russia.”

Polymetal is one of Russia’s three leading gold mining groups. Operating in Russia and Kazakhstan, the company mines gold and silver and develops platinum projects. Polymetal was set up in the 1990s in St Petersburg as part of ICT Group controlled by Russian oligarch Alexander Nesis (Vitaly is his younger brother).

Russian financier Alexander Mamut and Czech billionaire Petr Kellner joined as shareholders in 2008 shortly after Polymetal’s IPO on the London Stock Exchange (LSE). Following the promotion to the premium listing on the LSE in 2011, Polymetal is now a constituent of the FTSE250 with a market capitalisation of about £2.9bn.

Over the years, the company has grown through a combination of acquisition and exploration, and has seen production grow steadily to fluctuate between 200,00 and 300,000 troy ounces gold equivalent a quarter. And like many of Russia’s raw material producers, about three-quarters of Polymetal’s costs are denominated in rubles, while the company’s revenues are in dollars, making the company one of the big winners from the fall of the ruble’s value against the dollar.

Revenue in 2015 was $1.44bn, 15% down from the previous year. But while the revenue declined (and are not expected to change much this year either, say analysts), Ebitda margins according to Credit Suisse estimates have improved from 41% in 2014 to an estimated 45% last year.

At the same time, the price of gold has, after almost five years of steady declines, turned. Since the start of the year, the value of gold has risen nearly 20%, breaking above its 200-day moving average. Analysts are looking at the chart and wondering if it’s time to short gold or if this is the start of another sustained rally. Nesis, for his part, says over the medium term he expects prices to continue to climb, as the mismatch between demand and supply asserts itself.

“The price will be sensitive over the next two years and depend on the health of the US economy. The reduction in the supply of gold could start to accelerate in the second half of this year and into 2017. It should lead to a classic supply-and-demand boom in prices over the next two or three years,” Nesis says.

Proud production

Either way, the dynamics of the gold price has not affected the company’s investment strategy much: Polymetal is continuing its investment strategy and plans to spend another $340mn this year in continuing its exploration activities. Polymetal beat its 2015 production guidance by 4%, though it expects to see a slight decline in production this year to 1.23mn oz of gold equivalent from 1.40mn oz in 2015, rising to 1.30mn oz in 2017.

And even with gold at $1,000 per ounce, Polymetal is a highly profitable concern and the company has gone out of its way to share profits with its investors as part of a generous dividend policy. In December it paid out a special dividend, when many other gold companies paid no dividends at all. “Our dividend policy is what marks out from many of the international companies. On average we return a dividend yield of 4.5-5.0% a year and we want to continue with this policy, as it offers our investors value,” Nesis says.

Sberbank CIB estimates that Polymetal could generate $770mn in Ebitda and $320mn in levered free cash flow (LFCF) this year (up a respective 18% and 31%), which would offset the decline in output last year, Sberbank’s Lapshina believes. “The stock is trading at a 2016E EV/Ebitda of 6.4 and 8% LFCF yield, implying a 15% discount to the historical average. We raise our target price to £8.16 per share and upgrade the stock to BUY,” Lapshina wrote.

Russia’s grinding crisis, now in its eighth year, has changed the way the company works. Since 2011 the focus has been shifting away from growth to improving capital returns, though Polymetal has used its shares as “M&A currency” in the past and intends to use them again for such, according to Nesis.

Despite the crisis and sanctions, Nesis says he doesn't think the investment climate in Russia is that much worse than before. “What has gone down is the amount of money invested in Russia, not because there has been a change in the investment climate, but simply because the bulk of investment into Russia has been into the oil and gas sector. With low oil prices naturally that investment has fallen and that is impacting everything. The investments into retail, consumer services and the government were all ultimately investments driven by oil prices,” Nesis says in flawless English, in an interview at Polymetal's headquarters in St Petersburg. “But look at things like the World Bank’s ‘Doing Business’ ranking – Russia has been rising steadily. It is still not the best, but it is improving.”

Nesis follows up this point by highlighting that his company still has access to funds raised on the international capital markets. Polymetal recently raised $327mn from a syndicated loan with seven banks – five from Europe and two Chinese banks, adding the company was able to borrow even at the peak of the clash with Ukraine in the second half of 2014. “Even now we can access banks and borrow at the normal level of interest rates,” notes Nesis. “We can see there is still a lot of interest in Europe to retain its business relations with Russia. We have to pay at most 1pp more over Libor than we did before, but its true the banks have become a bit more cautious.”

The Russian economy is suffering and the official optimism in December that the economy would return to growth this year has faded and given way to expectations of another year of recession and a 1.4% economic contraction. But the country’s raw material producers remain largely insulated from the pall that has descended over the country. “There has been no appreciable impact from this crisis on our business. It’s nothing like 2009 when there was a global liquidity crisis,” says Nesis. “Also for Russia that crisis was a ‘V’ shape as oil prices rebounded very quickly. This crisis is structural due to an oversupply in oil, so it will be much more painful and go on much longer.”


Polymetal 4Q15 operating results











Gold, koz








Silver, mln oz








Copper, tonnes








Total gold equivalent*, koz








Total sales in gold equivlent*, koz








* based on 60:1 Ag oz/Au oz and 1:5 Cu mt/Au oz conversion ratios.


Source: Company, Sberbank CIB Investment Research