Harmony Gold: The Earnings GIANT

May 8, 2002

After the latest round of quarterly earnings reports, Harmony (HGMCY) has extended its lead as the clear favorite based on a combination of stellar earnings, rapidly growing production and massive reserve/resource figures.

What factors do investors use when choosing which stocks to buy, and which are most important? Is it Earnings? Production? Reserves? Resources? Chat room comments? Eye-catching stock symbols? Name recognition? Location of production? Management's reputation? I'll touch upon the first four, and leave the plethora of others for another day.

Certainly one of THE most critical measurements of a company's success is its earnings. On a dollar for dollar basis, Harmony has a commanding lead which will grow even more pronounced in the coming months.

(see notes below spreadsheet)

Before going any further into my views on why Harmony is grossly undervalued, let's quickly review a few others for comparison. My apologies for not having the time to review dozens of others, but I think the companies selected serve as a good point of reference.

Barrick (ABX), the king of HEDGING, reported earnings of 9 cents per share. Barrick's net income was $46 million for the quarter, down $41 Million from the March 2001 figure of $87 Million. Why this stock trades as high as it does, with a current P/E of over 58 is beyond me. For comparison, Harmony is below 9 based on present conditions.

Agnico-Eagle Mines (AEM) reported first quarter net earnings of $0.5 million, or $0.01 per share unchanged from the same period in 2001. Operating cash flow was $5.0 million, or $0.07 per share, compared to $5.8 million, or $0.11 per share in 2001. Earnings of 1 CENT per share for a company selling for $15 doesn't meet my criteria as a screaming buy. Harmony sells for less per share and earned 33 TIMES as much for the quarter.

GoldCorp (GG) had a good showing at 23 cents per share including bullion gains, but the North American companies simply can't compete with the leverage of the South African Miners, especially on a per dollar invested basis. This will be even more pronounced as the price of gold increases, as the PRODUCTION levels per dollar invested are far greater with the South African companies, and even more so with Harmony.

Here, have a look:

(see notes below spreadsheet)

Why are production levels so important? Present earnings being equal, companies with more production will benefit much more in a gold bull market. Companies with the greatest production have the greatest leverage to the price of gold.

The land of Gold: South Africa...

Durban (DROOY) had a rather disappointing quarter, reporting a small loss of 0.3 cents per share. On the positive side, production problems have been corrected and they spent a big chunk of cash to put a major dent in their hedge book. Hopefully one more quarter of pain and they'll be back on track and hedge-free! "hedge buyback programme resulted in an investment of US$ 5.6 million (R 64.5 million) towards this objective during the quarter. This, together with our normal deliveries has reduced the commitment to less than 400 000 ounces. The "bunching" of hedge deliveries in March, however, meant that our average gold price received was US$ 35 per ounce (R 2 444 per kilogram) lower than for the previous quarter."

Goldfields (GOLD) had a strong showing up 6 cents from 15 to 21 cents, but Harmony's earnings were nothing short of awesome.

Harmony (HGMCY) added a whopping 13 cents to its quarterly earnings, increasing from U.S. 20 to 33 cents per share for the quarter. Even more impressive is the story within Harmony's MARCH quarterly report. In short, the JUNE quarter, based solely on March production rates, looks to be over 40 cents per share!

Add to this increased production and a rising gold price, and we're in for another shocker come JUNE reporting time.

WHY SHOULD JUNE EARNINGS BE 40+ CENTS PER SHARE?

March 2002 Earnings were $53,340,000 which, using 160 million shares, works out to 33.34 cents per share. If people are making their investment decisions based on this number however, they're missing the real story, which takes some digging.

Harmony chose to spend $10,840,000 this quarter to completely wipeout the Randfontein hedge book that was assumed during Randfontein's acquisition. This is clearly a ONE-TIME event and it makes sense to take the time to calculate what the numbers would have been in order to more accurately estimate the JUNE quarter.

Adding the two figures above gives us $64,180,000, or 40.1 cents per share. This is a stunning figure, but there is another important factor that need to be included in the bottom line.

The FreeGold earnings of 6.4 cents were based on a shortened quarter. Not even considering the potential opening of more shafts, just factoring in a full quarter's production puts the Freegold earnings at 7.7 cents per share. This will add an additional $1,965,000.

So, factoring in the above items, earnings for the MARCH quarter would have been approximately $66,145,000. Using 160 million shares out (159.5 mil), yields 41.34 cents per share. Annualized, this is $1.65.

PRICE TO EARNINGS RATIOS BASED ON 5 MAY 2002 DATA
(see notes below spreadsheet)
5 May 2002 Data

NOTES:

ABX has 18 MILLION ounces hedged!

GG: earnings of 23 cents include 3 cents from bullion earnings

DROOY: Used DEC 01 Earnings Figure. March figure was a loss of 0.3 cents due to hedge buyback / production problems:

GOLD: Earnings increased 6 cents per share from DEC 01 to MAR 02

HGMCY: Earnings increased 13 cents per share from DEC 01 to MAR 02. Reserves now at 40 Million ounces due to successful HILL50 Acquisition
(number of shares in issue during the quarter: 159,5 million)

HGMCY JUNE: estimate includes 1 cent for MAR shortened quarter for Freegold production due to changeover date. HGMCY eliminated the entire Randfontein hedge leftover from acquiring Randfontein. The cost of this was 6 cents per share, thus MAR earnings would have been 39 cents were it not for this one-time charge. Finally, 3 cents added for acquisitions and increased production.

"Harmony's current annualised production totals 3.2 million ounces per annum, with 2.7 million ounces from its South African operations, and 500 000 ounces from Australia." (click here for the article.)

HARMONY'S STUNNING GROWTH RATE

Harmony's Freegold- Grand Slam Homerun

BIG RESERVES for the S. AFRICAN MINERS

(see notes below spreadsheet)

A CRITICAL QUESTION:
What gold price are Harmony's reserves based on?
67,500 Rand per Kilogram, but the current price
is now 105,000 Rand!

As the Rand Price of gold increases, more gold becomes economical to mine. Having a large resource figure will thus produce a correspondingly large increase in reserves.

Reserve cut-off grade (from JUNE 2001 annual report) In order to define that portion of a measured and indicated mineral resource that can be classified as a proved and probable mineral reserve, Harmony applies the concept of a cutoff grade. The cut-off grade is determined using the company's 'Optimiser' computer programme which requires the following as inputs:

  • the database of measured and indicated resource blocks (per shaft section);
  • an assumed gold price which, for this ore reserve statement, was taken as R67 500 per kilogram (US$ 262/oz and R/$ = 8.00);

With the Rand currently at 10.5 and gold at $312, the current Rand gold price per kilogram is a stunning R105,000 !

This will have a HUGE effect on the JUNE 2002 reserve and resource calculations. First, potentially TENS OF MILLIONS of OUNCES will migrate from the RESOURCE category to the RESERVE category. Secondly, TENS OF MILLIONS OF OUNCES could also be added to the RESOURCE category.

HGMCY: 223.97 MILLION ounces of resources,
(Harmony's annual report page 25)

NOTE: This figure of 224 Million Ounces is nearly a year old and does not include any of the acquisitions that have taken place over the past 9 months. (Australian Bendigo, Australian Hill 50, and S. African FreeGold).


IMPORTANT NEWS ARTICLES
Delivery of value to Simane - Black
Economic Empowerment
on track

Harmony shareholders agreed, in a general meeting in May 2001, to issue 10,9 million Harmony ordinary shares for cash to the IDC and Simane, a black economic empowerment company. The IDC subscribed for 10,7 million ordinary shares on behalf of Simane and Simane themselves subscribed for 0,2 million ordinary shares. In addition, the IDC, on behalf of Simane, subscribed for 10,9 million redeemable convertible preference shares, each share granting the company the right to subscribe for a Harmony ordinary share at R41,50.

The preference shares were converted into ordinary shares and were placed in the market from 16 January 2002 to 4 February 2002, realising an average price of R85,46 per ordinary share. This has enabled Simane to take transfer of the ordinary shares after the repayment of their loans. Harmony's cash resources increased by R430 million as a result of this initiative. Simane now hold 10,9 million unencumbered shares in Harmony, representing 7 per cent of Harmony's issued ordinary share capital, making it the company's largest shareholder.

HARMONY RAISES US$112 MILLION

Johannesburg, 30 April 2002 - Harmony today announced the successful placement of 8,5 million ordinary shares at a price of US$13,20 per share. The proceeds of the placement, which was completed overnight, will be used to retire its offshore debt of approximately US$95 million.

"Financing our growth activities offshore have always been subject to exchange control regulations which has resulted in the company having to raise debt offshore," commented Bernard Swanepoel, chief executive.

"To enable the company to continue with its strategy of growth through acquisitions, it was necessary to redeem our Dollar denominated offshore liabilities. The company is now ideally placed to continue with our strategy of creating shareholder value locally and outside South Africa," he concluded.

HARMONY CLOSES RANDFONTEIN HEDGE BOOK

Johannesburg, 12 April 2002 - Harmony Gold Mining Company Limited today announced that the company had closed the balance of the Randfontein hedge book it inherited with the acquisition of Randfontein Estates Limited in January 2000.

"The closure of the Randfontein hedge book is a continuation of Harmony's strategy of being unhedged. We believe our shareholders want the exposure of a potential increase in the gold price," says financial director Frank Abbott.

All the remaining forward sales contracts and call options totaling approximately 490 000 ounces, have been closed. In addition, as result of the higher gold price, the company closed a further 220 000 ounces of forward purchases.

The closure of the hedge book resulted in a net cost after tax of R125 million (US$11 million), which has been financed from existing cash resources. The closure cost of the hedge book will however not have an impact on the company's financial results, as these had been accounted for previously.

MARCH 2002 RESULTS

The Strengthening Rand. A MINOR issue at best!

I occasionally read comments by investors expressing concern over the effects a strengthening Rand will have on S. African Miner's earnings. When these mining companies were barely staying afloat, the Rand/U.S. exchange rate was a significant factor. Now that they have implemented tremendous cost cutting measures and have greatly reduced their cash cost per ounce, the Rand exchange rate has become much less significant. You'll see from the chart below, as an example, a gold price of $350 and Rand 10.5 vs. Rand 10.0 is less than $2 per share. I'm sure I can speak for all Harmony shareholders in saying we'll be thrilled when our company's share price blasts through $30. A two dollar difference at that point will be insignificant. Also note an even bigger move in the Rand to 9 and 8 at correspondingly higher gold prices is equally insignificant.

Is Harmony's share price getting ahead of itself?
The share price hasn't yet even caught up to the massive increase in earnings! Harmony is very inexpensive based on a current P/E between 8-9. A more reasonable P/E would be 15 (Goldfields is currently selling at a 15 P/E.)

 


HARMONY vs. GOLDFIELDS RESOURCE BASE

According the each company's annual report, Goldfields has resources of 139 Million ounces. Harmony has resources of 224 million ounces. Because Goldfields has 300 Million more shares issued than Harmony, the RESOURCES per share are significantly higher with Harmony.

CONCLUSION

After digesting all the facts and figures I've thrown at you, I think you'll agree that given the present performance levels, the top two companies are clearly Goldfields and Harmony. However, investing is fundamentally an exercise in determining what you are getting per investment dollar.

If Harmony was trading for $20, and Goldfields $10, I'd be proclaiming Goldfields as the best bang for the buck. However, in my own opinion, Harmony's current share price suggests VERY STRONGLY that it is grossly undervalued compared to Goldfields. Of course my opinion is certainly prone to a bias toward Harmony as I continue to have a very large portion of my investment capital in Harmony's hands.

That said, given all the fundamentals I've presented here, the best buy, without a doubt, is Harmony.

  • With Harmony's earnings per share being well over 50% greater than Goldfields,
  • With Harmony's production being far greater per share,
  • With Harmony's significant lead in RESERVES per share,
  • and a MASSIVE 4-FOLD advantage in RESOURCE ounces,

I am very comfortable in stating that compared to Goldfields -- one the best gold mining companies in the business -- Harmony is clearly a better buy, and deserves to be trading at a similar Price to Earnings Ratio as does Goldfields.

Based on Goldfield's share price of $12.74 (P/E of 15), what would an equivalent Harmony share price be?

If Goldfields commands a P/E of 15, why should Harmony be trading at a P/E in the 8-10 range?

If you've made it this far, you've done a great deal of reading. We've looked at EARNINGS, where Harmony is miles ahead and the JUNE numbers will be even more impressive. We've covered how LARGE production will be extremely important as this baby gold bull picks up steam. EARNINGS and PRODUCTION are great, but you've got to be able to sustain it with MASSIVE RESERVES and RESOURCES. Harmony again is the clear favorite. Again, it bears repeating, Goldfields is a great company! That's why I chose to use it as a reference for Harmony's fundamentals. I've owned GOLD in the past, and will most likely buy it again in the future.But for now, it is clear to me that Harmony is unmistakably the best buy around.

China is poised to become world's biggest gold consumer.