Strategic Natural Resources - Coal at Elitheni

http://www.snrplc.co.uk/

Strategic Natural Resources logo

Strategic Natural Resources (LSE:SNRP) [SNR] is an AIM listed, South Africa natural resources focused investment vehicle that was formed in October 2004. The company currently operates within the coal industry having established control of Elitheni Coal Ltd which has licence areas within South Africa's Eastern Cape province. The company has been under financial pressure recently that has seen its shares ease off highs, although share liquidity has increased significantly since 2010. With only a few per cent of the total licence area drilled, and over 250 million tonnes of coal having been classed as 'discovered', the SNR is looking to push ahead with progress despite medium-term weakness in the South African coal export price. SNR has 171m shares in issue and with a current share price of 16.25p, this sees the company capitalised at £27.8m.


Ultimately, the shares do remain still illiquid which makes technical analysis less useful. Nonetheless, there are a few key points to take from SNR's current technical position. The most significant of these is that the shares can be classed as to have formed a long-term double bottom. In each case the decline to the trough is roughly the same (~27.5p to 11.5p) and in both cases there have been material recoveries within a short time span. Taking this into account, an implied price target on a solely technical basis would be 20p+ which would amount to a roughly 25% rise which is healthy by any measurement. However, technical analysis is only useful if fundamental analysis backs the same story. The reality is that too many question marks currently exist around the fundamentals of the company and any technical trade would be medium-risk at best as expected news could have the capacity to gap the shares up or down significantly.

There are only a few of recent director's shareholding changes which all came in late 2012. These included small multi-thousand pound purchases from directors Don Nicolson and Andrew Brennan although the latter was not reported until Q1 2013 due to a 'genuine oversight'. The final change was a huge sell amounting to £790,500 by SNR Commercial director and Elitheni Chairman Barry Nel. However, the sell was later found to be part of Nel's plan to leave SNR as he stepped down from his posts in February 2013. Institutions and third-parties have modest stakes in SNR which are reported to total around 40 million or just under a quarter of the issued share capital.

Elitheni Coal LogoSNR was admitted to the AIM in August 2007. The company "is developing the Eastern Cape Coalfield in South Africa and is intent on becoming a major coal producer and exporter in South Africa through its first mover advantage in a rich and forgotten part of the country." The resources are located just south of the country of Lesotho found within South Africa where SNR has a 74% stake in the project. Other partners control the residual 24%.

The most salient point is that the company is very well placed in terms of being able to move resources - they have a route to market which is essential for any resource company in Africa. SNR are the only coal mine in South Africa that have two underutilised ports that have both rail and road access. The company attributes this access to its "first mover advantage". As early as March, Frost and Sullivan released a report highlighting transport access as being a major hurdle for developing the industry. This hurdle is not only present in South Africa, but across the entirety of mainland Africa. Any economies that are not established with developed infrastructure make it difficult for discoveries to be monetised in a timely manner so the availability of this route is of utmost importance to the company. SNR has created plans to develop a coalfield as opposed to a coal mine due to the geographical setting which also helps boast lower operating expenditures.

SNR has also pointed out that it has a 'unique political advantage' with strong governmental backing for its project and the project being distant from recent labour market unrest over prevailing wage rates. Nonetheless, any further forms of unrest will dampen sentiment for any company that has major operations in South Africa and may delay company proceedings - this has taken place in Egypt on a large-scale. There is also growing discontent over the energy profile of the country with over 90% of all energy derived from coal. Activists have been taking part in staged protests principally in Johannesburg as recently as last month to urge the government to re-think it's energy policies and to potentially shift towards more renewable technologies with South Africa's electricity supplier Eskom, at the forefront of this movement. However, with new coal-fed power plants coming on-stream and no feasible alternative in the medium-term, coal will remain a key resource for the foreseeable future hence this is not a credible threat to SNR.

Furthermore, another London-listed company, Coal of Africa (LSE:CZA) actually announced plans recently to construct the largest coal mine in South Africa at a cost just shy of $400m. Their Chairman David Brown pointed out: “I think it is quite clearly the coal market and the whole commodity sector has obviously taken a beating in the last 12 months so without a doubt commodity prices are substantially lower than where they were 12-15 months ago,”

SNR operates further south than South Africa's
major Witbank coalfield that account for ~40%
of totalcoal production
(image courtesy of snrplc.co.uk)
Coal prices do remain a concern though with recent price weakness following what has been a disappointing several months for South African coal miners. This has been fuelled by the slowing growth of the Chinese economy - reports point towards increasing hesitance on behalf of Chinese buyers with respect to placing orders for coal shipments from the area. In addition, certain Chinese ports are starting to have coal stacked as short-term storage. The result is a drop in demand and a declining price as has been seen.

On a longer-term timescale there has been increasing demand from other asian economies such as India, for low-grade coal resources that could and should prop up prices in the long-run (barring a decline in the growth rates of these newly industrialising countries). Domestic demand could also increase although not within the region SNR operates. Recently GDF Suez and Exxaro announced plans to construct a 600MW coal-fed power plant in South Africa's Limpopo province which is found in the North-East of South Africa at the border with Mozambique.

The company has derived several targets for developing the field which include doubling the total coal resource by 2014 and to have "exports from East London and Coega and supply secured to mine mouth IPP by 2017."  Prior to setting the targets, in 2012 the company hired Minxcon to complete a Competent Person's Report for the 6% of the total rights area available. The results were very positive with a 77% rise in the official gross in-situ resource to 266.3MT. Doubling this figure implies a ~530MT target resource. Should these targets be achieved, then it would be fair to expect the market cap to increase significantly.

The start of this process involves updating the Phase 3 and Phase 4 region within the project from prospective areas to mining areas during 2013/14, and a ramp-up of exports across phases 1-4. The phase 5 block is region further west than the previous phases and is underdeveloped compared to them. Therefore the company does offer both exploratory upside and production upside if the hurdles can be passed. A pre-feasibility study is pencilled in for conclusion in 2013 with development options to be explored in 2014 and if economical, a shipment plan through deep-water ports around the half-decade mark.


Former CEO David Nel talks to StockTube about SNR's position

Based on the above, the case for the resource is definitely strong enough to attract interest, although there certainly are a number of concerns that simply cannot be allayed and that is one point that means that SNR will always draw a discount in terms of market cap. No matter how many times the company can state that the South African environment is politically sound, there will always be investors who will be put off by that sole factor considering the unpredictability and consequently, increased risk profile.. In other words, if SNR was operating in a stable European country, that discount could be removed.

Looking at the 2013 news statements so far, the sentiment has been mixed and has caused uncertainty that has hit the share price. The shares entered 2013 relatively strongly around 24p, but had slipped to as low as ~11.63p before recovering to a current price around 16p, and there are good reasons why. At Elitheni the company released an operational report in late January. It noted: "Various modifications have been made to the washing plant during January 2013 and the Company is pleased to report that the washing plant is now achieving its originally intended throughput rates. In due course, following further successful processing of coal, the Company will provide an update on the date for the first shipment of coal mined at Elitheni." Former CEO David Nel also said that the company had successfully completed the profitable delivery of traded coal for its New Year cargo.

Despite this, investors were soon given a taste of uncertainty with sour news in the form of a series of board changes. David Nel was stepping down as CEO of SNR and from the board to focus on Elitheni where he would remain CEO, with NED Gabriel Ruhan taking his place on an interim basis. In addition Barry Nel stepped down (as mentioned earlier) and Don Nicolson transferred role from Deputy Chairman to Executive Vice Chairman. This move shook up investors considering the crucial stage the company is currently progressing through. Furthermore, in March the company announced another disappointing update which had a distinctly negative tone. The RNS read: "The SNR board acknowledges and regrets that key delivery targets have been missed due to various factors, including wash plant engineering and commissioning issues and the on-going optimisation and supply chain challenges associated with establishing a mine in the Eastern Cape for the first time in over 100 years. These challenges, which contributed to our failure to meet our planned shipment in late January/early February 2013, continue to be actively addressed by the Company and Elitheni's management."


image courtesy of SNR's website
By far the most interesting news came in early May when the company first announced that it had initial indications to create an agreement with a strategic investor who would fund the company's operations on a long term basis through an equity-based transaction (potentially at a premium to the prevailing share price). Tied with this, the company announced it had drawn down a further £1m through its loan facility taking the total drawn down to £3.5m. Combined with this, a number of terms were changed in the agreement which included "the entire amounts drawn down under the LCL Facility and all accrued interest are repayable by no later than 30 July 2013". Considering that the company still has not succeeded in reaching an agreement with external investors, they must work fast to secure the cash required through that method or a general placing could be enforced to cover the costs.

Following this, a positive operational mine update was released in early July that focused upon increasing yields at the washing plant among other factors. Also within the RNS it was noted that strategic investor discussions continued with 3 parties, but that no bid for the company has been tabled as per circulated rumours. Personally I think that it is unlikely that any deal will be tied up before the 30th and whilst the company has been in talks with LCL to extend the deadline, the likelihood of an equity placing/debt funding will increase. Being critical of their funding access, it may be difficult to secure a suitable debt package on such a short time frame which might mean that a round of equity dilution is the preferable method that could hit the share price as a discount would be likely. Solely based on what the company is saying, a strategic investor still seems the favourable outcome.

To round up, SNR has a number of clear positives that set it aside from a large number of other Africa focused resource companies, the main advantage being the clear route to market. The technical position is strong, but it has to be faced that the uncertainty with regards to the management situation, financial situation and operational situation that have arisen recently simply mean that there are too many unknowns at the moment to invest with confidence. Equally though, it would be inappropriate to put a sell tag on SNR as if they do grab a wealthy strategic investor then the shares should re-rate towards that implied 20p level. At the moment though a No Rating tag is most appropriate although it is worth keeping an eye on SNR and the South African coal price as the company could present investors with a more transparent opportunity in the future.

5 comments:

  1. thx elite :) dont forget to archive the ta posts!

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  2. Hi elite thanks again for your efforts. seems like SNRP has only a small amount of cash in the last financial report so definitely need some good quality insti backing

    CraigJ

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  3. I have held ono some of these shares for a good few years and they have disappointed in share price appreciation. The current uncertainty as you put it is unfortunately turning investors away and you can't really look at the long term potential without getting rid of the current smog! Thanks

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  4. \do you believe that charts work? why should they?

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  5. Good call to not put a buy tag. It goes from bad to worse :(

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