Lonmin announces update – covenant issues resolved, $800m rights issue planned. CONVICTION BUY CALL @ 480P

Highlights from this mornings RNS – 

Employees returned to work, ramp up to full production going better than expected.  First Platinum ounces to be produced on 31 October

Platinum metal in concentrate for the fourth quarter down 45.7% (vs Q4 2011) due to illegal strike action in August and September

o  Strike impact of around 110,000 ounces of mined Platinum

o  Refined Platinum production only down 20.8% as ounces extracted from stock pipeline

Full year 2012 sales of over 700,000 ounces of Platinum.  Immediately available ore reserves of 18 months, improved grades and recoveries and further improvement in safety statistics underlines quality of operational performance

30 September 2012 covenants to be formally tested in early November and on balance of probabilities covenants are not expected to be breached at that test date

Debt levels will rise significantly over the coming months to fund the production ramp up and stock pipeline rebuild – may breach covenants at 31 March 2013 absent additional equity and amendments to existing bank facilities

A proposed Rights Issue of approximately US$800 million (gross) planned to reduce indebtedness and increase financial strength

Proposed Rights Issue underpinned by a signed Standby Underwriting Agreement.  More details of proposed Rights Issue to follow in due course

Amended US Dollar and Rand bank facilities already signed removing EBITDA covenants and reducing quantum of US Dollar facilities

o  Resolves covenant issues

Over the longer term, the Board also believes that improved PGM pricing should be supported by underlying positive demand dynamics. Automotive demand is expected to be driven by a combination of increasingly stringent emissions legislation, the ongoing extension of this regime to non-road applications and a positive outlook for vehicle sales in US and Chinese markets.  Although Chinese growth expectations have recently been downgraded, consumer expenditure in China is still expected to increase

Balance sheet refinancing

In accordance with the principles outlined above, Lonmin is announcing that:

it intends to raise approximately US$800 million (gross proceeds) of new equity capital by way of a Rights Issue (the “Rights Issue”) to reduce the Group’s level of indebtedness and increase its financial strength; and

it has reached agreement with both the USD and ZAR lenders on the terms of amendments to its existing debt facilities (the “Amended Facilities”).

In connection with the Rights Issue, Lonmin has entered into a standby equity underwriting letter pursuant to which the Rights Issue will be underwritten at a minimum price of US$1 per share, or such higher price as may be agreed.  The Company will announce further details of the Rights Issue, including as to its terms following consultation with shareholders, in due course.

This mornings RNS is a “ship steadying” statement. Many of the points we have stated in prior blogs are re-affirmed here, in particular highlighting the large discount to tangible net book value (almost 40%) and the re-setting of the covenants from an interest cover basis to a more appropriate balance sheet/net worth test – 

In addition, the Group has agreed that the existing net debt / EBITDA and EBITDA / net interest covenants in both its existing US$700 million and ZAR1.98 billion facilities will be removed from the Amended Facilities and that they will be substituted with the following covenants:

consolidated tangible net worth will not be less than US$2,250 million;

net debt will not exceed 25% of consolidated tangible net worth

The forward looking projections of production levels is particularly encouraging – 

Beyond the 2013 financial year, the Company is continuing to target growth in production which the Directors believe will result in an improvement in its relative position on the cost curve.  On the basis of the Lonmin Renewal Plan, the Directors are targeting sales in excess of 750,000 Platinum ounces in each of the 2014 and 2015 financial years, and in excess of 800,000 Platinum ounces per annum by the 2016 financial year.  K4, which when at full capacity will be one of Lonmin’s largest shafts and which is currently on care and maintenance, is expected to restart mining operations in the latter part of the 2014 financial year although the impact on production will initially be gradual until capital expenditure levels increase.  This revised growth profile reflects both the anticipated short-term demand outlook for PGMs, and the impact on Lonmin’s operations of the Events at Marikana.

A number of cost cutting measures have been implemented that will result in improved profitability going forward – 

The Directors believe that, taken together, these initiatives will improve the productivity performance of the Company.

The Directors expect that over the medium to longer term, the Company’s earliest generation of shafts will reach the end of their economic lives as their mineral reserves are depleted.  However, the Company has, over the past several years, undertaken a number of capital projects, principally at its second generation of shafts, K3, Hossy, Saffy and K4, which, when fully ramped up  should drive production growth and improve its relative unit cost position. 

Taken together, the cost savings, volume-related operational benefits and efficiencies anticipated in the Lonmin Renewal Plan lead the Directors currently to expect that unit costs for the 2014 financial year will increase by less than the wage inflation in South Africa

With the shares trading at a 35% discount to TANGIBLE book value, we accordingly make Lonmin a Conviction Buy today with a price target of 800p (sorry Soc Gen!).