Anglo Platinum: The World's Largest Platinum Producer

Anglo Platinum (ticker: AGPPY) is the world's largest producer of platinum group metals (PGM), producing on an annual basis approximately 40% of the world's production primary platinum from its South African operations. Anglo Platinum is unusual among the (limited) platinum group metals universe (note that only two countries and produce platinum group metals on a large scale, South Africa and Russia) in that it has large reserves of proven platinum reserves -- verses probable and measured and indicated reserves -- translating to a future capability to maintain and increase production without corresponding large capital expenditures to start up new mines.

Introduction:

Anglo Platinum is the largest operator by production and ore reserves of of the Bushveld Complex in South Africa, a freakish geological deposit which contains an estimated 75-90% of the world's known reserves of platinum group metals (see link here for further information on this deposit). Anglo produces currently from two major mines, Ruthenburg and Amandelbelt, and two medium sized but important mines, Union and Potgietersrust, (in addition to 4 smaller mines) which will be discussed in detail below. Anglo's overall reserve life of platinum group metals -- including proven and probable reserves but excluding undeveloped (measured and indicated) reserves --at current production rates is approximately 60 years, which is a very high number in comparison to most other mining firms in other resource extraction industries (oil and gas producers typically have reserve lives of 10-20 years, while gold producers typically have 20 or less year reserve lives based on proven reserves).

Platinum Metals Market Overview:

The value of Platinum metal has increased in value over the past 5 years as strong growth in mainly autocatalyst demand has outpaced production. A good overview of the Platinum metal market for 2007 can be found here by the South African firm Johnson Matthey. In summary, according to Matthey, Platinum is projected to be in a small deficit for all of 2007 (supply of 6.660M ou and demand of 6.925 M ou) after several previous years of deficit but relative equilibrium in 2006 (supply = demand). The deficit in platinum production is expected to support or increase prices for the near term. In the Palladium market, Palladium is expected to continue to be in production surplus (production outpacing demand) leading to near term downward price pressure for the metal. The more rare PGM metals -- Rhodium and Ruthenium, which are used in speciality ceramics and electronics -- are expected to continue to be at deficit levels over the near term.

Production increases of Platinum and rarer platinum group metals outside of South Africa has been essentially non-existent in 2007 according to Matthey, illustrating South Africa's dominant market position in these metals. On the demand side, demand continues to go up due to autocatalyst demand and, to a lessor extent investment demand. Note further that investment demand is still only expected to be approximately 1% of total demand of platinum production in 2007 according to Matthey, which means (in the author's opinion) investment demand for platinum can go significantly higher in future years, putting further upward pressure on the price.

Brief Overview of the PGM Mining Universe:

One can say that there are two groups of PGM miners, those which mine from the Bushveld Complex in South Africa and those which do not. Of the firms outside of Buchwald, only Russia's Norilsk Nickel is a major producer, and this is due to Norilsk's production of mainly Palladium as a by-product of its massive nickel operations in Norilsk, Russia (in the far north of Russia, in mines that account for approximately 30% of the world's nickel reserves). As a percentage of revenues, palladium is estimated by Norilsk at 9% and Platinum at 7% of total 6 month 2007 revenues.

The other relatively high profile miner of PGMs outside of South Africa is Stillwater Mining, which produces palladium and platinum in a 3 to 1 ratio (3 units of palladium per unit of platinum) from its mines in Montana. Stillwater states that it is the only significant producer of PGM metals in the Western Hemisphere, according to its homepage. A review of Stillwater shows that it is more dependent on Palladium verses Platinum, and that it will be expecting high capital expenditures over the next 40 months as it moves from its proved reserves (at total of approximately 2 million ou) to probable reserves (total of approximately 20 Million ou).

Within the Bushveld complex, there are two major producers of PGM metals -- Anglo and Impala Platinum, and one minor producer, Lonmin, and several smaller producers. Impala is generally, by the investment community in South Africa, considered to be better run than Anglo in terms of planning, execution and presentation of financial results, but holds significantly lower reserves of platinum and sells at a higher premium to reserves than Anglo, as seen in the chart below. Impala (ticker: IMPUY and Anglo Platinum (ticker AGPPY) are compared as follows:

* Information concerning reserves are from the reserves and resources sections from the Company's respective websites and annual reports.

As indicated in the comparison chart above, Anglo Platinum and Impala sell at similar multiples to earnings and cash flow currently (11.07) -- although Anglo is a bit cheaper. The most striking difference between the two firms is that Anglo has far larger reserves overall of PGM metals and much larger Proven reserves, although, to date, Impala has been more somewhat more successful in developing its reserve base (higher interim 2007 net income growth for Impala of 67% verses 47% for Anglo, mainly due to larger production increases at Impala for this time period) . Note that the significantly larger proven reserve base for Anglo (103M ou proven of PGM metals for Anglo verses 10.6 M ou reserves for Impala) means that Impala is expected to have to spend significant capital to develop probable and measured resources in a closer time frame. Anglo's reserve life based on proven reserves is 36.7 years verses 5.4 years for Impala.

Anglo Platinum Mine Analysis:

Anglo produces currently from two major mines, Ruthenburg and Amandelbelt, and two mid-sized mines, Union and Potgietersrust, in addition to smaller mines. Anglo's 4 largest mines will be discussed below. As shown in the chart below, Anglo's major mines have a high proven reserves -- and therefore represent "cash cows" for Anglo over a very long period of time.

* Note that in the comparison chart, the future Sum of Operating Profits is crudely taken, by adding up the proven cash flows over future years and not using a discount factor, and assuming a constant operating profit for the life of the proven reserve mine life.

The 4 major producing mines of Anglo Platinum have at current production rates, and assuming constant prices of PGM metals, very high expected operating profits over the next several years without large expected costs and capital expenditures to access probable and measured reserves. Note that the above values for the mines does not take into account probable and measured resources -- resources that could be available with additional mine infrastructure and development. As noted above, Anglo has approximately 8x the measured, estimated resources compared to its proven reserves compared to Impala (103 m ou of proven PGM metals and 804 m ou of PGM resources). These numbers not only indicate high future cash flows for Anglo -- significantly higher than its current market capitalization of $35.7Bn -- but also a dominant position in the PGM industry.

Anglo's two largest mines merit some discussion in detail, as they represent the largest earning assets of the firm. Rustenberg is Anglo Platinum's largest mine by output, 100% owned by Anglo Platinum, which produced 833,000 ounces of platinum group metals in 2005. Anglo plans to increase production up to 900,000 ounces to 950,000 ounces of annual production by 2010. During 2007, due to safety concerns, Rustenberg was shut down for 7 days which has caused output to be lower than expected for the full year, but no adverse long term effects are expected. During the first half of 2007, Anglo spent R4.7Bn on Rustenberg, R3.0Bn which was for expansion purposes and R1.7Bn to maintain operations. The mine has a proven reserve life of approximately 18 years at current production rates, and has an additional probable reserve base of 15.8M ou PGM, which translates to an additional 16 years of mine life based on probable reserves, translating to a total reserve life of 34 years based on proven and probable reserves.

Amandelbelt is Anglo's 2nd largest mine and highest operating margin mine, 100% owned by Anglo, with an impressive 64.1% operating margin for the first 6 months of 2007. Amandelbelt accounted for an estimated $US700M in operating profit for Anglo in 2006. Anglo expects Amandelbelt to produce 625,000 ou PGM in 2006, and plans to increase production to over 700,000 ou by 2012, as mine upgrades impact production. Based on proven reserves, the mine has a 61 year reserve life, and based on probable reserves (excluding proven reserves) Amandelbelt has an additional 60 year reserve life, translating to a 121 year total reserve life based on proven and probable reserves.

Is Anglo Platinum at Risk due to Technological Change or Lower World Economic Growth?

The greatest risk to Anglo and the PGM industry over the long term is substitution in the autocatalyst market for PGM metals. Both Mazda and Nissan have reported breakthroughs in experimental catalytic converter technology, which could lead to 70-90% lower platinum use per converter, utilizing nanotechnology (see here for details). RBC Capital Markets has stated that the technology is potentially commercial in 3-5 years from mid to late 2007, but cannot quantify the potential impact of the technological change. As such, development of this new technology remains a risk for Anglo investors to watch closely in future years.

Related, the demand for PGM metals is dependent on economic growth, particularly economic growth in China and India. Much of the additional demand for industrial usage of PGMs and jewelery usage comes from Asian countries. If there is an economic slowdown in China and India, then demand for PGM metals will drop and Anglo's profitability will be negatively affected.

Third, a risk to Anglo is its location in South Africa, which could potentially have resource disputes between the various ethnic groups. Further, the South African government, while historically supportive of its domestic mining industry, could pass laws requiring greater taxation of mining profits. At this point in time, the odds (by the author) of significant taxation issues has not been analyzed in detail, so the author has not quantified this risk.

Conclusion:

Anglo Platinum is the world's dominant producer of Platinum group metals and has vast reserves of PGM metals, resulting in a good probability of high future profitability, and therefore represents a compelling long term buy. Compared to its most close competitor, Impala, Anglo is several times larger on a reserves basis currently (at 11/07), but sells, unjustifiably in the author's opinion, at a discount. Anglo is also relatively cheap compared to its future expected profitability based on proven reserves alone. Risks are mainly exposure to the PGM metals prices, and potential government issues, but these risks are partially mitigated by the positive prospects for economic growth of China and India, the pressure to add catalytic converters for environmental reasons, and the historical moderate governmental treatment by South Africa of its domestic mining industry.