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>Durban Deep ripped on accounting
By: Tim Wood
Posted: 2002/10/29 Tue 21:00 | © Mineweb 1997-2002
NEW YORK -- BOE Securities (S. Africa) does its best to keep analyst reports from wide circulation, but Mineweb has landed a fascinating examination of Durban Deep’s [DROOY] third quarter results by mining analyst, Gary Pearson.
Distributed to BOE clients earlier this week, the report is a no-holds barred dissection of the results that flips most house views upside down. “Don’t take the numbers at face value” is the headline for a section that goes on to warn that the doubling in headline earnings per share for the three months to end September could not disguise a poor quarter.
Johannesburg based Pearson writes that without a big move in the gold price, Durbans “shareholders will still suffer the same negative cash flows - around R150m ($14.7m) over the next year!” That will surprise many investors who took at face value Durbans’ claim to be entirely hedge free.
Not so, says Pearson: “Durban Deep has effectively transferred (hidden) the losses associated with its previous hedge book from the income statement to the balance sheet and cash flow statement.” This follows from closing its hedge book using forward purchase agreements that offset its hedging exposure. That effectively makes the touted gearing to the spot gold price a chimera, leaving the group’s financial position “no better than it was before.”
In an era where accounting probity is paramount, Pearson delivers a facetious backhander: “Durban Deep could never be accused of consistent accounting. Without fail the group seems to restate figures from quarter to quarter and this reporting period was no different. This time the change was with regard to the Eskom linked tariff (hedge).”
Eskom is South Africa’s state power generator, transmitter and industrial distributor. The hedge refers to a 15,000 ounce / 75 gigawatt swap the company undertook with the parastatal whilst the gold price was a lot lower and the rand rather more valuable.
The electricity deal has elicited considerable comment since Durbans has been selling itself aggressively as a member of the hedge-free denomination. However, Durbans’ chief executive, Mark Wellesley-Wood, describes it as a “cost hedge”; more acceptable parlance of late where put option protection against adverse conditions - in this case more expensive power - is not anathema to investors.
The downside protection came late though since the initial contract was a straight swap agreement that caused Durban’s electricity costs to rise just as fast as the gold price. In other words, Durbans bet against the gold price and lost. It has subsequently written calls to mitigate the negative impact and Wellesley-Wood is emphatic that “there is no exposure,” meaning margin calls.
“This is an ‘off-taker’ - a consumer with his supplier doing a deal. There are no bullion banks, no mark-to-market, no hedges, no funnies,” he told Mineweb’s sister radio show this week. Nevertheless, the market appears to be reading it as a harmful gold derivative rather than a straightforward put.
Pearson notes that Durbans did not disclose details of the hedge until the second quarter, and its accounting treatment has changed from having “the premium on the electricity bill deducted from the revenue line to showing it as a separate cost item. While there may be nothing technically wrong with this situation, we do question the motives of the continuous changes in the accounting disclosure.”
As a result, Pearson still treats Durbans as hedged and what’s more, he assigns a hefty loss on a mark-to-market basis, although Wellesley-Wood is adamant there is no such thing.
“The Eskom link tariff is a rand gold price hedge of significant proportions - estimated negative mark-to-market value of R600m ($59m) at the current gold price and exchange rate,” Pearson says. He estimates that in order to breakeven, Durbans needs a basement gold price of $243 per ounce based on a R10.20 per dollar exchange rate.
The “book” is incredibly volatile with a ten percent depreciation in the rand-dollar price and ten per cent appreciation in the gold price potentially doubling the unrealised loss for Durbans based on today’s (Tuesday) closing prices. The graph below shows the estimated mark-to-market discount based on Pearson’s formula:
“While Durban Deep has made arrangements to close out its traditional hedge book, it has still capped a portion of its upside to either rand weakness or dollar gold price strength. In an attempt to reduce the impact of the Eskom hedge, management has purchased 126,000 ounces of call options at R113,813 per kilogram (±$347/oz) at a cost of R15m ($1.47m). This will cap the losses on 23% of the Eskom hedge, in the event that the gold price surpasses this value. Management intends to continue purchasing calls but we certainly hope that the mistakes of yesteryear are not repeated.”
BOE says that even with a generous 5% discount rate and $320 per ounce gold price, Durbans only trades at 1.9 times discounted cash flow, leaving it at the bottom of the rankings. “We would caution that the forecast risk (not to mention the technical and financial risk) inherent in the group is immense.”
If Durbans cannot show significant cost control in the coming quarters, BOE says the consequence could be a “significant earnings downgrade,” and the company is maintaining its sell on the stock for both the near and long-term.
Comment on this story >
Durban Deep ripped on accounting (Tim Wood)
.. Since when does Mineweb get to publish confidential research, or was it leaked to you? (Fund manager)
.... It was right through the market long before we got it. (Tim Wood)
...... The fundamental point is that research is created in order to generate brokerage ()
........ Too precious (Tim Wood)
.......... Tim... I applaud your sleuthing efforts because it is the only way to get any real DRD info (Beam_Me_Up)
.......... You want stories but are not prepared to pay for it, you piggy-back off other people's hard work (another fund manager)
............ Bizarre (Tim Wood)
.......... Whos ays BOE did not lose money? If they wanted you and the whole world to know they would have put it on SENS or Reuters (Fund manager)
............ But that is the whole point! (Tim Wood)
.. ()
.... Thanks and comments... (Durbanite)
...... Come on Mark W.W. - Time for another radio chit chat.. (PNB)
.. Is DRD not one of Moneyweb's corporate governance finalists? How pathetic ()
.."...without a big move in the gold price..." (ni)
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