Roodepoort Rocket Fueling
Adam Hamilton October 19, 2001 4557 Words
It has been a heck of a year
for Durban Roodepoort Deep investors! Long a beloved favorite amongst gold
investors worldwide, Durban has traveled an exciting journey in 2001.
As the first days of 2001 arrived, Durban was languishing near $0.66 per share and much of the gold investment community was wailing in despair at the seemingly perpetual bear market in gold. Durban investors had just finished a tough year in 2000 when the company faced many turbulent rapids but had managed to successfully navigate through all the jagged rocks and violent eddies. With gold prices limping into the New Year virtually comatose at $270 per ounce, 2001 was ushered in as the short-term future for gold investors looked bleak on multiple fronts.
As the year unfolded, the roller-coaster ride for Durban investors continued. Durban suffered through a NASDAQ delisting scare in the United States, gold plunged into the dismal $250s several times, and a raging Marxist labor union leadership fomented unrest among impressionable South African miners. Yet, just as the battle-hardened company has done for well over a century, it once again proved itself far more than a mere survivor, actually thriving during very tough times in the gold mining industry.
As I hammer out this essay, Durban is trading around $1.15, a spectacular 75% year-to-date performance in 2001! This magnitude of gain in little more than nine months would be stellar in pretty much any market, let alone compared to the 33% year-to-date loss in the NASDAQ and the 19% YTD loss in the S&P 500. Durban investors have had much to celebrate in 2001 as it has been a wonderful year to be invested in world-class unhedged gold stocks.
On October 18, 2001, Durban Roodepoort Deep released its latest quarterly operating results, and they were awesome. Durban’s first quarter of its 2002 fiscal year ended on September 30, 2001 and the longtime favorite gold mining company glittered brightly for happy investors. We will discuss these latest quarterly results and other things Durban in this essay.
Before we begin, as always, a few critical disclaimers are in order.
I am a Durban investor. My partners are Durban investors. My company recommends Durban to our clients investing in the gold arena. My partners, our clients, and myself are long Durban and we stand to make spectacular amounts of money in a mega-bull market in gold by investing in Durban Roodepoort Deep. I have written several past essays about Durban including “Roodepoort Rocket” where I coined that very name by which so many Durban investors now proudly and affectionately refer to their favorite gold mine.
If you are looking for unbiased disinterested commentary on Durban, you won’t find it here. I have followed, liked, and owned the company for a long time and I have my money where my mouth is. After years of comprehensive research, I believe that Durban is one of the most leveraged major gold mines to the price of gold on the entire planet earth and I believe it is one of the ultimate stocks to own to capitalize BIG on the coming rally in gold. I am NOT impartial as my own capital is at risk in Durban. If you are uncomfortable about reading a biased stockholder’s thoughts on Durban, you had best stop reading right now.
Second, investing IS inherently risky. Period. Distilled to its naked essence, investing is essentially little more than highly-refined gambling. Investors deploy risk capital that they can afford to lose in investments in the hopes of reaping gains. These potential gains come with substantial risks of loss. There is no such thing as a risk-free investment! Virtually every equity investment, including Durban, bears the risk of real and potentially catastrophic capital loss. You should not invest any capital in Durban or any equity investment if you cannot afford to lose it. If you want to invest in the gold market with the lowest possible risk, buy physical gold, not gold mining equities.
Finally, my worldview is unashamedly bullish for gold. At my company’s website, www.ZealLLC.com, you can find literally dozens of essays that explain in exquisite detail from a myriad of perspectives why myself and legions of other investors all over the world are so bullish on gold. The wisdom and prudence of placing capital at risk in Durban depends tremendously on the future direction of the gold price. If gold is going to $400 per ounce and beyond as the gold bulls claim, Durban will probably prove to be one of the best investments on the planet. If gold is going to careen down to $200 per ounce or below as the gold bears trumpet, Durban will probably prove to be one of the worst investments on the planet.
Durban is a world-class, lightly-hedged, highly-leveraged major gold mining company that is strategically positioned to reap legendary gains in a major new bull market in gold. If you have already done your own extensive due diligence and yet still believe in omnipotent central banks and the uncanny ability of unaccountable bureaucrats to dump other people’s gold indefinitely to suppress the global gold price, Durban is not for you.
If, on the other hand, you have studied the history of markets, the unblemished record of total failures of past government attempts at subverting free markets, the central monetary role of gold in world history, the perpetual cyclical nature of both world markets and human economic endeavor, the effects of negative real interest rates on gold, and the incredibly bullish global supply/demand fundamentals for the Ancient Metal of Kings, you understand why gold is on the verge of exploding and you need to take a serious look at Durban.
For a highly-leveraged marginal major mining company like Durban, there is NOTHING more important to its future than the price of gold. Durban’s latest excellent quarterly operating results underscore this key fundamental truth for understanding both Durban’s operational and stock-market performance. The results are available at Durban’s hip website, www.durbans.com .
In the calendar third quarter of 2001, gold averaged $276 per ounce, up 3% from the previous quarter’s $269 average closing price. The slightly higher average gold prices coupled with an outstanding job by Durban management in cutting operating costs yielded a superb quarter for Durban Roodepoort Deep.
The company’s quarterly gold production was up 1% to 262k ounces while cash costs per ounce dropped slightly to $227. The slightly higher gold production and gold prices together with the lower costs yielded a headline accounting profit of 2 cents per share for the quarter, a significant improvement over the previous quarter’s nine-penny loss.
The shrinking operating costs were especially impressive in light of an 8% wage increase for miners that went into effect during the quarter. Unlike the heap-leaching gold-mining operations common in the southwestern United States, South Africa’s old and deep shaft mines require vast amounts of skilled labor to liberate the gold out of the bowels of the earth. Labor expenses run roughly half of the operating costs for a deep South African mining operation. Durban’s management deserves much praise for aggressively containing operating costs while at the same time keeping the actual men chiseling the rock well-paid and happy.
While the income statement looked good, its achievements are almost overshadowed by the big improvement in Durban’s balance sheet during the quarter. Short-term debt dropped by an impressive 29% as Durban plowed some of its operating profits into paying down trade payables and the current portion of long-term debt. The ratio of current assets to current liabilities improved dramatically to 0.95 and the cash balance grew by almost $1m to $15m. Durban’s balance sheet, a concern late last year, continued to improve this quarter as management prudently used its increased operating cashflows to augment and buttress the financial strength of the company.
On the cashflow front, I was extremely happy to see the sale of new shares drop dramatically, from almost $6m in the previous quarter to under $1m in Durban’s latest quarter. During some of the tougher times of the last couple years when operating cashflows ebbed, Durban had to sell new shares into the market to finance operations which had the unpleasant side-effect of significantly diluting the holdings of existing shareholders.
In the last Durban essay I wrote before this one, called “The Durban-ator Lives”, I let loose with a scathing attack on the serious dilution of existing shareholders through the rapid issuance of new shares. As I am a straight-shooting no-nonsense kind of guy, I have never been afraid to voice my opinions regardless of whom they offend. In January I chastised management about issuing too many new shares. Now I am absolutely thrilled to see that dilution trickled off to virtually nothing in the latest quarter!
In calendar Q3 2001, Durban common shares in circulation increased by only 7/10th of one percent! This is a quantum improvement in the dilution rate by roughly an order of magnitude and it warms my heart. I have to admit that out of all the wonderful news in the latest quarterly results, the discipline by management in using operating cashflows to finance the maintenance and expansion of the business rather than issuing ever-more new shares is the most outstanding development from my perspective.
All you fellow shareholders out there who joined with my partners, clients, and myself in voting NO on new share issuances this year should be sure to give our excellent management team a great big pat-on-the-back for hearing and heeding our cries about dilution earlier this year. Way to go Durban!
In another fantastic and encouraging development, management continued to trim Durban’s remaining hedgebook. As I have had the great privilege of chatting with Durban investors from all over the world, I know that there is a universal sentiment among Durban shareholders that the company should be essentially unhedged, completely exposed to the most bullish gold market fundamentals the world has seen in decades. Thankfully, Durban management appears to share this opinion and continues to zealously whittle away at the remaining hedges as the opportunities arise.
In its official annual report for Durban’s fiscal year 2001, ended June 30, 2001, our hard-charging Chairman and CEO, Mark Wellesley-Wood, made the following comments on hedging, “… DRD’s hedge book continues to cost the Company dearly. If we had received the average spot price for our gold sales in 2001, we would have increased our operating profits by $23m. Now that the gold price shows increasing signs of having turned the corner and the Company’s cost position has improved, it is becoming less appropriate to hedge our forward gold production.”
In Durban’s Q4 FY2001 quarterly report, the Chairman was far more blunt (my kind of guy), “The cost of our hedge book is totally unacceptable. By comparison, if Durban Roodepoort Deep had received the spot price for its gold price last year its cash operating profits would have been $23m higher than reported. Resolving this aspect of our business has consequently become the utmost priority.” Right on Mr. Wellesley-Wood!
Like many gold mines all over the world, bullion bankers seduced Durban into ridiculous hedges in late 1999 and early 2000 in response to the spectacular Washington Agreement gold rally. The blood-sucking bullion bankers, some of which are named in Reginald Howe’s landmark Howe v. BIS et al lawsuit fighting for a global free market in gold liberated from covert government molestation, are convinced gold prices are going to zero. This is the elitist “gold is a barbaric relic” crowd. Because of these erroneous beliefs, not to mention enormous profits for themselves, the bullion bankers coerce gold mines around the world into entering dangerous financial derivatives hedging contracts where the gold mining companies are forced to surrender their upside profits in a major gold rally.
Call me old-fashioned or just plain belligerent, but I still strongly believe that gold mines should MAKE money for their shareholders in a major gold rally, not be contractually bound to give away all their profits to scheming manipulative bullion bankers. Many of the hedging arrangements the scoundrel bullion bankers scheme up are even dangerous enough to cause bankruptcy in a rapidly rising gold rally. Something is VERY wrong when a rising gold price pushes gold mines into ruin like the notorious Ashanti Goldfields episode rather than making them stronger businesses!
Thankfully, more gold mining companies around the world are realizing what key central banks and private bullion banks have perpetrated to artificially flood the global gold market with their hoards of the yellow metal to effectively eviscerate the gold mining industry. Durban’s management is not alone in realizing the wisdom in closing out these Machiavellian hedge contracts with the vampire bankers. Gold mining companies all over the world are waking up and realizing that they are in the business of mining gold for the benefit of their owners, not the business of being hedge funds in drag for the bullion bankers to abuse.
Gold mining companies across the globe ought to start issuing orders to their security teams to shoot bullion-banker snake-oil salesmen on sight when they come to peddle their noxious derivatives wares to rob shareholders of their rightful profits in the coming mega-rally in gold. If shooting on sight is too violent for the bankers’-rights crowd, attack dogs could be let loose to run the marauding bullion bankers out of town. One of the biggest threats to the well-being of the gold mining industry and its owners are the bullion bankers shamelessly attempting to bind, gag, and financially rape the once proud gold mines of the world.
It is very exciting to see Durban management publicly and forcefully express the paramount importance of reducing its hedges and creating a gold company for its owners with maximum exposure to the price of gold. Durban announced in its latest quarterly results that one of its ugliest sets of hedges, disastrous forward purchase contracts at $339 per ounce foisted upon the company by vampire bullion bankers during the Washington Agreement gold rally, will likely be eliminated by December 2001, three months ahead of schedule. This is awesome news for shareholders!
For a primary gold mining company like Durban, obviously THE single most important driver of operating and hence stock market performance is the price of gold. Our first graph shows a simple comparison of Durban stock (the American NASDAQ “DROOY” ADR) with the price of gold that is illustrative of Durban’s incredible leverage to the price of gold and monumental potential when “The Big One”, THE mega-rally in gold, arrives.
During the last couple years all the biggest rallies in Durban were driven by underlying rallies in the price of gold. The primary examples are marked with arrows. Durban’s leverage to the price of gold is legendary among the global gold investing community and with good cause. While gold itself has risen almost 4% thus far in 2001, Durban is up 75% as I mentioned in the introduction to this essay. This is extreme leverage to the price of gold!
In the heart-breaking hours following the horrible terrorist attacks of September 11, Durban traded up 40% in the German stock market (which was still open after the strikes) because the gold price was rising. This is extreme leverage to the price of gold.
Also, please note the dotted-blue support lines for Durban in the graph. Late in 2000, after the surreal suspended-animation trance that gold lapsed into during November 2000 (see our “November Gold” essay), Durban began a major rally that continues to this day. This major trend change is quite evident in the graph at the intersection of the two dotted-blue support lines.
At its peak close of $1.40 during the May 21, 2001 gold spike (discussed in our essay “Gold Prepares to Erupt”), Durban had rocketed 137% from its November 30, 2000 low in the gold doldrums of $0.59 in less than six months. Heck, these kinds of spectacular moves should provide enough adrenaline for even the most jaded veterans of the halcyon dot-com mania of late 1999 and early 2000! Over the same period, gold managed less than a 5% gain. Recent real-world trading examples of Durban’s extreme leverage to the price of gold abound!
Savvy investors around the world have been gradually accumulating Durban since its late November 2000 bottom and buying has spiked up dramatically during gold rallies. Our next graph shows Durban’s closing stock price in the US (NASDAQ-DROOY) over the same period but has daily volume superimposed on top. Volume is graphed on the right axis and is denominated in millions of shares.
The arrows mark the three biggest spikes in Durban volume in the last couple years. Interestingly, the majority of all the major spikes in trading volume occurred on major UP days for Durban. This is a very bullish technical indicator for a couple important reasons.
First, large amounts of capital are apparently waiting on the sidelines and biding their time, licking their chops and salivating over the incredible potential in Durban during a major gold rally. Each time gold spikes, some of this capital buys frantically and floods into Durban to attempt to board the Roodepoort Rocket before it launches into the stratosphere on the back of a major gold rally.
If the little gold spikes we have seen in the last couple years cause these kinds of heavy-volume buying frenzies, can you imagine the mad rush to buy the relatively small number of Durban shares around the world when gold jumps $25, $50, or limits-up in a single day? The carnage as the herd rushes in to snatch-up Durban will be spectacular and the stock will be propelled to undreamed-of heights when The Big One arrives in the world of gold.
On the other side of the Krugerrand, having the heaviest volume spikes on the big up days is a very bullish omen. Compare Durban’s volume and price chart to that of a fallen tech-darling like Cisco or one of the dot-coms of lore and notice that in overvalued companies the biggest volume spikes occur on massive DOWN days, not on huge up days in the respective stock’s price. In this case of contrast, much capital is looking for an exit and leaps on bad news to abandon ship.
Large volumes of Durban trading marking the biggest up days imply that far more capital is anxious to flood into Durban than is waiting to sell into a rally. This interesting volume behavior indicates that the Roodepoort Rocket is in its fueling stage, careful accumulation by bigger and bigger players until they are flustered by a gold spike and aggressively buy just to make sure they don’t miss out.
Many Durban investors talk about the company’s extreme leverage to the price of gold, but unfortunately how that leverage technically works is not often explained which can lead to confusion among investors doing their due diligence for a potential Durban investment. The latest quarterly results can be used to illustrate just how geared Durban Roodepoort Deep is to the price of gold. Understanding how extreme leverage to the gold price works in Durban is very important and the logic behind the leverage is very simple and easy to grasp.
In this latest quarter, Durban mined 261,932 ounces of gold and made an accounting profit of $2.7m. Dividing the accounting profit by the ounces mined yields the ultimate average profit earned on each ounce of gold, $10.31. Since gold averaged about $276 per ounce during the quarter, Durban’s total accounting cost (broader than just the cash cost per ounce) for gold during the quarter can be approximated by $276 less the $10.31 profit per ounce, or roughly $266 per ounce.
So, with total accounting costs of around $266 per ounce, Durban managed to show a quarterly profit of $2.7m. To understand its extreme leverage to the price of gold, imagine that the average price of gold last quarter had not been $276, but 50% higher at $414. If Durban’s profits had only risen 50% along with the 50% gold price rise in this hypothetical example, it would have no leverage to the price of gold. But, as we will see, Durban really does have extreme leverage to the gold price.
When Durban mines gold, in general its costs don’t change regardless of what price gold is fetching on the open market. Miners cutting $414 per ounce gold-laden ore out of the earth cost no more than miners cutting $276 per ounce gold-laden ore out of the earth. It doesn’t take any more managers to produce and sell gold at $414 than it does to sell it at $276. As the gold price rises, a mine’s fixed costs generally don’t rise, nor do its variable costs unless production increases. Assuming constant production, an increase in the price of gold that Durban can realize flushes right through to its bottom line and catapults profits to the heavens.
By using the latest quarterly data and assuming a $414 gold price instead of $276, we can easily illustrate how Durban’s extreme leverage to the price of gold works.
It STILL costs Durban $266 per ounce total accounting cost to mine the gold, but that same gold is now hypothetically sold for $414. The $414 selling price less the $266 total accounting cost yields an accounting profit per ounce of $148. This $148 per ounce profit multiplied by the 261,932 ounces of gold mined last quarter equals a total accounting profit of $38.8m. This hypothetical $38.8m profit at $414 gold is 13.37 times higher than the actual $2.7m profit at $276 gold.
In this quick and easy example using real operational data and a hypothetical higher gold price, a 50% increase in the price of gold yields a staggering 1300%+ increase in profits for Durban. Needless to say, these vastly improved profits would drive the stock price of the company MUCH higher as investors around the world clambered for a piece of the action!
Durban’s leverage to the price of gold is truly extreme!
For past Durban essays I have written including “Roodepoort Rocket” and “The Durban-ator Lives”, we have created an Excel 2000 spreadsheet that models hypothetical “What If?” scenarios using the most recently available quarterly data from Durban. We have once again plugged the latest quarterly results into our simplified financial model to update this spreadsheet.
The spreadsheet can be useful for investors interested in Durban who wish to do their own financial modeling as well as test our assumptions. I strongly encourage EVERY investor, regardless of where they deploy their scarce and precious capital, to do their own extensive due diligence and not rely on anyone else to make investment decisions. Our simple spreadsheet, coupled with the actual Durban financial data which can be downloaded directly from the company’s website, www.durbans.com , can be a jumping-off point for you to build your own financial models of Durban’s leverage or tinker with ours to apply other hypothetical gold scenarios to Durban.
Our final graph illustrates the most recent hypothetical Durban leverage numbers based on our simple spreadsheet. In these projections, we strive to be ultra-conservative in several ways.
First, we assumed that South African corporate taxes will consume 33% of every penny of profits Durban makes as gold rallies. Second, we assumed that 20% of all cash profits will be obliterated by Durban’s remaining hedgebook, which is far higher than is probable as a more intricate analysis of its hedgebook indicates (see our “Roodepoort Rocket” essay for a deeper discussion on Durban’s hedges).
Third, we assume that Durban’s share price will only be bid-up to 13.5 times potential cashflows spun off for investors, using cash as a proxy for earnings in the historic average equity P/E of 13.5. In a mania situation where great masses of investors chase a rapidly rising gold market, P/Es on gold stocks will almost certainly be bid-up to stratospheric heights far exceeding normality just as they were in the later stages of the maniacal NASDAQ bubble.
Finally, we make no allowances for the dramatically increased gold production that Durban can rapidly mobilize at higher gold prices. We hold production constant in the spreadsheet. In the real world, Durban has enormous reserves and resources that become economically extractable as gold prices move north past $325. Gold production could probably easily double if gold approached $400 an ounce, in effect strapping on a strong secondary rocket booster to the Roodepoort Rocket.
Our spreadsheet ignores these and other positive factors for Durban in order to be as conservative as possible. In the graph below, built from the spreadsheet, hypothetical gold prices are graphed on the horizontal axis, the potential share price of Durban is graphed in blue on the left axis at a P/E of 13.5, and cashflow spun off per share is graphed on the right axis in green. These numbers are computed off the base quarterly results just provided by Durban and nothing is changed other than the price of gold.
Behold the extreme leverage of Durban Roodepoort Deep! ‘Tis a beautiful thing that brings joy to the hearts of gold investors!
As Durban’s latest quarterly results abundantly show, the Roodepoort Rocket is waiting on the launch pad and continuing its final pre-launch fueling process. Durban management is cutting costs and gradually eradicating the remaining hedges, the gold price is trending higher, the income statement is showing investors some green (or gold?), and the balance sheet is fattening-up. Dilution has abated, investors are salivating on the sideline and pouncing on Durban each time gold spikes, and the knowledge of the legendary leverage of Durban Roodepoort Deep is spreading far and wide beyond the traditional gold investor community.
If you are an investor who has studied the gold market and analyzed the incredibly bullish scenario unfolding on a myriad of fronts, you owe it to yourself to consider placing some risk capital in Durban Roodepoort Deep. The Roodepoort Rocket is loading up and, unlike the highly-publicized NASA space-shuttle launches, this Rocket will roar towards the heavens with little warning as the new gold bull continues to unfold.
Unfortunately for those investors who don’t yet have a seat, space is limited. The whole company, bordering on being one of the ten largest gold mining companies in the world in terms of annual ounces mined, only has a trifling US market capitalization right now of roughly $180m. This unbelievably tiny valuation exists because an insane market reeling from the US equity bubbles bursting has not yet sniffed out the beginnings of the next great bull market in commodities and primary commodities-producing stocks.
One day, perhaps not too far in the future, billions of dollars of capital around the world will begin aggressively bidding for the scarce seats on the Rocket and its price will soar as it launches to the astral realms. Thankfully, the Roodepoort Rocket is still fueling and those who are not yet onboard still have a chance to buy a stake. Those who remain indecisive until after liftoff will miss what could turn out to be the ground-floor investing opportunity of a lifetime.
Adam Hamilton, CPA October 19, 2001 Subscribe at www.zealllc.com/subscribe.htm