Polymetal Stock: Inflection Point Reached (OTCMKTS:AUCOY)

In my first take back in August on Polymetal International plc (OTCPK:AUCOY, OTCPK:POYYF, POLY.L) I gave it a hold rating. I noted that the company was hugely undervalued based on past performance and book value, but invited caution based on: the lack of clarity concerning its future profitability, the impact of sanctions, the risk of selling the Russian assets at a discount, the buildup in debt, and the absence of any short term catalysts. I then upgraded my recommendation to a buy in September, despite terrible financial results, arguing that the bottom was likely already in.

After the Q3 2022 results, I am now convinced that all remaining doubts have been answered in a satisfactory manner, and I am upgrading my rating to a strong buy. The reason is that Polymetal has probably reached an inflection point: after months of bad news, the situation is normalizing and the share price has been reacting to this by creeping up about 30% in a month. Despite the recent runup, there is still obviously plenty of upside, even if a full recovery to pre-war levels will be impossible in the short term.

Selling of inventory

One of the most important drivers of the significant debt accumulation since the beginning of the year has been the inability to sell a large part of its production, and the consequent buildup in inventory. As a matter of fact, Polymetal has refused to sell its gold to the Russian Central Bank, both because of the discount and because of sanctions. At the same time, the company has been forced to stop selling its gold in London, also because of sanctions.

This has spurred the company to look for alternative sales channels, which has required time and put pressure on its balance sheet. In particular, total debt reached the concerning level of $2.8 billion at the end of Q2 2022.

The good news is that the company has succeeded in arranging alternative channels, with the gold previously sold to Russian banks in London now being sold to a variety of buyers in Asia. Part of the gold from Kazakhstan continues to be sold to the National Bank of Kazakhstan.

This has led to a drawdown of the accumulated inventory, which has started since the end of September, and is projected to continue strongly for the rest of the year.

Deleveraging

The immediate consequence is that Polymetal is starting to quickly deleverage. Debt is already down from its peak by around $150 million. Because of both seasonal cash inflows and the continued unwinding of inventory, it is projected to further come down during Q4 2022. The objective is to get the total debt below the $2 billion mark by 2023, and the net debt over EBITDA ratio below 2x, which management believes is a realistic objective.

Dividend payments

This deleveraging is instrumental to a return to dividend payments. The Board may already be able to resume dividend payments in March 2023. After the invasion of Ukraine, the company was forced to stop dividend payments, because of both deteriorating financial conditions and the impact of sanctions. As already discussed, the balance sheet is likely to be improved significantly over the next couple of quarters. The other key point is that the restrictions on dividend payments due to sanctions is also likely to be removed.

Polymetal is currently prevented from paying dividends because of sanctions against NSD (the Russian National Settlement Depository). Being incorporated in Jersey, Polymetal is forbidden from transacting with NSD. Since a considerable fraction of shareholders (mostly Russian investors, including members of management) are locked into the NSD system, the company has preferred to suspend dividend payments, rather than penalize such a large number of shareholders.

The company then announced in September an offer to eligible shareholders to tender their shares in exchange for certificated shares. To date, about 10.5% of the company’s shares have been submitted for the share exchange. Since around 22% of the issued capital is registered via NSD, only around 11% is currently prevented from receiving dividend payments. With such a relatively low percentage, management has stated that a resumption of dividend payments is possible, and indeed likely, starting from 2023.

Change in the company’s structure

Many readers will recall that the company expressed interest in restoring shareholder value via a “Potential Transaction” involving a change in the company’s asset structure. The risk was, of course, that management would decide to divest from its Russian operations at a significant discount. This risk is now gone:

[…] sale of the Russian assets is no longer an option. We are not even considering it. So the goal is to preserve the shareholder value by not selling the assets, but the optimal scenario is the legal separation of assets into two different jurisdictions, which would allow the shareholders to retain full exposure to the value of assets in both countries.

The LSE listing (POLY.L) will remain in place, but the splitting of the company will allow to remove part of the Russian stigma. The CEO, Mr. Nesis, has put the likelihood of such a restructuring at “more than 50 per cent but less than 100 per cent” in a recent interview. I speculate that Kazakhstan and possibly Hong Kong are the most likely jurisdictions.

Operational results

Operationally, Q3 was a good quarter. Gold equivalent production increased by 7% year-on-year, mostly as a result of the ramp-up of the new mine in Nezhda and the new Kutyn Heap Leach Project at Albazino. The company has also been forced to change its suppliers from European manufacturers to Chinese ones, especially in relation to mining equipment and spare parts. The switch is in progress and is projected to continue, with logistical delays finally decreasing thanks to the partial lifting of COVID-related measures in China. In addition, the partial mobilization is also not expected to have any material impact on production or cost guidance. As a result, Polymetal has confirmed its production guidance of 1.7 million gold-equivalent ounces for the full year.

Conclusion

With logistical problems abating, the provisioning of new sales channels completed, and a clearer path to resuming dividend payments and potentially restructuring the company’s asset structure, it is difficult not to be bullish on Polymetal despite the risks. I expect the company to re-rate significantly on the back of strong financial results over the next few quarters and the potential spinoff of the Russian assets.

I believe, however, that a return to a pre-COVID valuation is unlikely for Polymetal, at least in the short term, and assuming gold prices stay around the current level. After all, Polymetal likely is going to have no significant growth until 2025 (when Veduga is expected to start up), and the profitability of its operations has been hampered by the stronger ruble and by global inflationary pressures, like for many other precious metals miners.