Caledonia Mining: Buy For Dividends, But Watch Carefully

Caledonia Mining Corporation Plc (NYSE:CMCL) is a microcap gold miner, domiciled on the isle of Jersey, whose operations are primarily within the nation of Zimbabwe. Operating in a country deemed to be risky, Caledonia has been a consistently profitable company since acquiring its assets in Zimbabwe. In this article, I will make the case for why CMCL is a Buy for those who want to accumulate dividends over time, but I will also highlight the various risks that come with this thesis at the end.

History

Zimbabwe’s gold production peaked in 1999. The seizure of land owned by white Zimbabweans in the early 2000s (as part of their land reform policies) scared away investors and the country’s economic prospects for many years. The government began to reverse course in order to change this and encourage outside investment again.

This roughly coincides with Caledonia’s acquisition of the Blanket mine in 2006, which it purchased from Kinross. Since then, Blanket has been Caledonia’s primary asset.

2010s

It was a few years before Caledonia was in a position to renovate the mine and begin significant production at Blanket. By 2012, the company had gotten annual production up to about 45,000 oz of gold, with the completion of No. 4 Shaft.

Caledonia began paying a dividend and declared its intentions to return value to shareholders primarily in this manner, going forward.

Initially domiciled in Canada, the company shifted its strategy toward American capital markets. In 2015, it began reporting its financial results in US dollars. In 2016, its quarterly dividends also shifted from Canadian to American dollars, while the company re-domiciled to Jersey. It also declared in 2017 a reverse stock split in order to raise the individual share price and allow for listing on NYSE.

The company also stepped up its ownership in the Blanket mine itself, from 49% to 64%. Development of its central shaft began in 2015, preferring to invest its capex in Blanket, which it viewed as less risky than acquiring other mining assets.

Recent History

In 2020, the company began increasing its quarterly dividend again, from 6.8 cents per share to 14, where it has since remained.

Much of this was made possible by the completion of the Central Shaft, which has allowed annual production to reach 80,000 oz.

In 2021, the company began development of a solar power plant located on site, in order to reduce its electrical costs and protect it from interruptions in Zimbabwe’s electrical grid. This was completed in Q3 2022 and provides about 25% of Blanket’s electrical needs. It cost nearly $13 million to build and was funded by selling new shares of CMCL the year prior.

Caledonia also began to look beyond Blanket for other assets in Zimbabwe. It ultimately acquired the rights to the Maligreen site in 2021 and Bilboes in 2022. Maligreen remains prospective, needing further evaluation before any serious operations. The Bilboes acquisition was followed by a short-term project to mine more accessible ores, with the site returned to a status of care and maintenance in 2023 until the company is in a position to develop it further.

The company has enjoyed a strong relationship with the government, not being materially impacted by the ouster of Robert Mugabe in 2017. Additionally, they were a leading company in the opening of the Victoria Falls Exchange, signaling that Zimbabwe sees the success of Blanket and Caledonia’s other operations as a key part of the country’s economic development.

Cash Flow And Capital Allocation

In the past, Caledonia forecasted declining capex and thus increased free cash flow. With the acquisitive opportunities for other sites in Zimbabwe, capex has not declined, but cash outflows from dividends have increased recently.

I participated in the Q3 2023 earnings call on Nov. 16, and Mark Learmonth, the CEO (and CFO prior to that), stressed that capital decisions are made with a mind to the per-share value of CMCL. If new equity is issued (and this has happened in recent years), they do so with a mind of growing the cash flows for the long term at a higher rate than the effect of dilution. He specifically stated that they would not choose to double or triple the number of shares through dilution if it were to double or triple production because that would be “standing still.” From there, it depends on how much you trust their ability to value the company’s shares (and I trust them in this regard).

Balancing Capex and Dividends

The company had 10.8m shares in 2019. That amount rose to 12.1m in 2020 to fund the solar plant. As of today, there are 18.5m shares outstanding. Let’s look at their recent financial data to get an idea of how well they are managing this.

Capex has led to increasing cash flows from operations (OP CF). We also see that capex (PPE, Acquisitions) stepped up in accordance, sometimes leading to a negative free cash flow. It’s a deviation from their previous view that OP CF would rise and be followed by a drop in capex, but it is also true that these acquisitive opportunities presented themselves afterward.

Cash dividends paid grew as both a consequence of rising OP CF, increasing the per-share dividend, and the rise of total shares outstanding. Dividends paid for 2023 will be higher as a consequence of the shares issued to acquire Bilboes.

Naturally, this limits how much CMCL can increase its dividend going forward until OP CF rises again or until capex starts to decline. Learmonth confirmed to me that it would be hard to justify a dividend increase for the foreseeable future.

Balance Sheet

The company has often had no debt at all, and the loans it does take are usually small. So far this year, the company has raised about $6.4m in long-term debt through note issuance.

Bilboes

The next key step in these recent moves is how Caledonia will realize the benefits of the Bilboes acquisition. Detailed here, the company believes that an open-pit mine with a ten-year production life of 168,000 oz per year is possible, meaning that company-wide production could triple once the site is developed. As an open-pit mine, the operating costs would also be smaller than that of a shaft mine like Blanket.

Valuation

The value of CMCL really depends on what you believe about the company’s ability to reduce its capex in the coming years, combined with the effects of dilution, which I think is reasonably likely.

This slide from a 2019 corporate presentation indicates their beliefs about the ability to reduce capex.

Operating cash flows did reach levels estimated here, and capex can decline as well. It’s reasonable to believe that the company is able to generate $20m in free cash flow per year, bringing this to about $1.08 in FCF per share. With that, I can do Discounted Cash Flow Valuation for a single share.

Here are my assumptions:

• 5% annual growth in FCF over the next five years from recurring improvements
• 10% growth in the five years after that as production at Bilboes is realized
• Not assuming higher than that to account for the effects of possible dilution
• A P/FCF multiple of 5 to allow for an unimpressed market in the future

The fair value for CMCL is $13.27, making it somewhat undervalued even after the recent rally. Lacking a major discount, buyers today will have to be satisfied with its current dividend yielding around 4.7%, which is unlikely to increase for the next few years. Others may have to wait until the price falls again, which has sometimes been as low as $10.

Risks

Folks who are happy with today’s dividend should carefully watch the company’s commitment to reducing capex and distributing excess cash to shareholders. Similarly, with these cash flows being dependent on just a handful of projects, they should pay attention to any disruptions or setbacks that would foil these estimates.

Changes in Zimbabwe’s economic policy

It’s unclear what the government in Zimbabwe may choose to do with its economic policy in the future. Their seizure of land in the early 2000s was sudden and hurt their economy. While the government seems to have learned from this lesson, we can never be sure. Robert Mugabe was ousted in 2017, and it’s not clear if the country will function as a stable democracy.

That said, partial, indigenous ownership of the Blanket mine and other such assets in the country is already policy and therefore priced into Caledonia’s cash flows. A change therefore requires Zimbabwe to feel that it must compel a greater stake in industries like gold mining.

Impacts of unusual weather

Given that nearly all of Caledonia’s revenues come from Blanket, disruptions there can have a major impact on cash flows. In 2021, unusually high rainfall and flooding delayed output. While the solar plant is complete and protects the mine from disruptions in Zimbabwe’s electrical grid, this also exposes it to risks from weather that blocks adequate sunlight for an extended time.

Major mine accidents

In 2023 alone, there have been two fatalities at Blanket, one in February and one in August. These create financial liabilities for the deaths and could invite regulatory intervention if the government becomes concerned. Similarly, other accidents that result in damage to the mine itself could result in higher capex for the foreseeable future and delayed returns to shareholders.

Unfavorable fluctuations in the price of gold

Since the cash flows will fluctuate depending on the price of gold, a significant decline in global demand for gold would squeeze margins and hurt long-term returns, as well as the company’s ability to cover its capex with its own cash generation, forcing them to forgo reinvestment or to raise capital under unpleasant terms.

As the last decade shows, price per ounce can be as low as $1,200. While Caledonia’s costs are below that, it’s still significantly less profit for however long that persists, should prices return to that level.

Conclusion

While there are risks specific to Zimbabwe, Caledonia’s size, and the price of gold, this company has taken a simple asset at Blanket Mine and transformed it into a fountain of cash that has already rewarded long-term holders of CMCL. Management allocates capital with a mind to cash generation and shareholder value. With a strong balance sheet and room for growth in a country that is eager to see investment and economic development, shares of CMCL provide long-term potential to investors. Given the capital-intensive nature of this business, today’s buyers will have to be happy with a dividend ranging between 4% and 5% in the meantime and should watch carefully for any risks that may materialize while they collect.