Questor share tip: Production worries take the shine off Petropavlovsk

There have been a couple of pieces of disappointing news from Russian miner Petropavlovsk over the last week – and the shares have been hit hard.

Petropavlovsk

999½p -20½

Questor says HOLD

First, a delay in receiving digging equipment has put its full-year production targets at risk. In fact, many analysts in the City now expect that the group’s full-year target will not be met.

On Friday, the company said it was “striving” to meet its target of 636,500 to 670,000 ounces of gold. This target was already reduced in August from 760,000 to 670,000. Of course, equipment delays are par for the course in developing any mine – and there are bound to be hiccups along the way – but this is disappointing after the target was cut in August.

Petropavlovsk produced about 140,000 ounces of gold in the third quarter, bringing total production in the first nine months to 305,000 ounces. It is clear that meeting the lower end of its target of 670,000 in the final three months will be a challenge. Nevertheless, the company remains Russia’s third-largest gold producer.

The second disappointment from the company relates to the Hong Kong listing of its iron ore unit, which used to be listed in the UK as Aircom. The Hong Kong listed company will be known as IRC.

Last week, IRC cut the size of its Hong Kong initial public offering (IPO) by half to $249m (£156m). Demand for the shares was not as strong as the company had hoped.

“The Hong Kong retail offer was over-subscribed. The total demand from investors exceeded IRC’s minimum requirements for the shares to be issued by it, but did not meet the company’s highest expectations,” Petropavlovsk said on Friday.

It is expected the company will now raise $240m and price its shares about 20pc below the lower end of the expected range. The company was originally expected to raise in excess of $500m, but the amount raised should still be ahead of the

$220m the group paid for Aricom when it brought it back into the group in February last year.

All of this means the listing, which had been scheduled for October 14, will be delayed slightly. It is now expected on October 19.

Questor is surprised by the lack of institutional demand – because the iron ore business appears to have a sound future. It should be a low-cost producer and is located close to steel mills across the Chinese border with Russia. However, institutions may have been put off by the fact that IRC is not yet profitable and there has been a raft of IPOs competing for money of late.

Of course, the production problems and the delay in the IPO of the iron ore unit are disappointing. However, Questor still sees long-term value in the shares. As JP Morgan said in a note to clients last week: “Even if we were to factor in a complete failure to hit its growth targets, Petropavlovsk’s multiples would still be compelling.”

Of the 19 analysts covering the shares and monitored by Bloomberg, 12 have buy ratings on the shares, six hold and one sell. The average price target is £14.95 a share.

The shares are trading on a December 2010 earnings multiple of 13.7, falling to just 9.8 next year. This is a substantial discount to other precious metals producers. The shares have fallen sharply over the past month, having been tipped as a buy as high as £12.62 in June. However, once production starts to ramp up, the market should be more confident with its prospects and recent falls should be reversed.

The shares were first tipped as a buy on July 21 last year at 626.2p and are up 60pc compared with a market up 27pc from then.

Questor is upbeat on long-term prospects for the group, but until the production situation becomes clearer the shares are now a hold.