DRDGOLD: Low Risk Access To The Gold Price

DRDGOLD (DRD) is a relatively low-risk way for investors to gain exposure to the gold price. It has a strong balance sheet, with net cash of ZAR268m at end June 2012, and we forecast strong cash flow generation leading to its dividend yield rising from 1.4% to 3.9% over the next two years. Earnings and valuation are highly geared to the gold price and we see 39% upside potential to our ZAR5.31 base case valuation through the implementation of several low-cost near-term projects.

Relatively low-risk operations
We consider DRDGOLD’s surface tailings retreatment operations to be low risk within the South African mining sector, with limited exposure to exploration, development, mining and geological risks. In addition, DRDGOLD’s relatively more highly skilled workforce is less likely to participate in illegal strike action.

Strong balance sheet and cash flow
DRDGOLD has a strong balance sheet with ZAR268m net cash at 30 June 2012 and we forecast strong free cash flow generation, enabling a rising dividend pay-out as debt is repaid over the next couple of years. We forecast the dividend yield will rise from 1.4% in FY12 to 3.9% in FY14 and see an opportunity for additional returns to shareholders through share buybacks or special dividends if a modest level of balance sheet gearing is maintained.

Earnings highly geared to the gold price
We forecast declining EPS from FY12 to FY14 due primarily to the sale of the Blyvoor operations in 2012 and the forecast exhaustion of the tax credit from accumulated losses during 2014. Cost inflation of around 10% pa is also pressuring margins and making DRDGOLD’s earnings more highly geared to the gold price. A 1% increase in the gold price would increase our FY13 and FY14 earnings estimates by 6% and 13% respectively.

Valuation: Significant upside
We see 39% upside potential to our ZAR5.31 base case valuation through the implementation of several low-cost near-term projects. Our valuation is also highly sensitive to both the gold price and the ZAR/US$ rate. A 19% increase in the gold price to US$2,000/oz would increase our base case valuation by 80% to ZAR9.56. Further speculative upside comes from residual resources at the Ergo operations containing 9.2Moz of gold.

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