Coal Of Africa - A Bearish Outlook

http://www.coalofafrica.com/

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Coal Of Africa (LSE:CZA)[denoted CoAL] has had a shockingly poor share price performance on a 6 month, 1 year, 2 year and 3 year timescale. The South African based coal explorer peaked at ~112p in January 2011, but has since slipped significantly to just 9.825p/share. The company has experienced a whole array or both corporate and exogenous issues which has led to a material weakening of investor sentiment and the share price. I briefly touched upon CoAL in a brief article (5 Technically Weak Mining shares) earlier this year stating that 10p was likely to be reached again, and breached. This has now occurred and I remain equally bearish on the stock. At 9.825p, CoAL has 1.05 billion shares in issue and a market cap of £103m. I really cannot see why brokers see near term upside here.


From a technical perspective, CoAL is very bearish. Since the company IPO'd the stock has been hitting numerous all-time lows and the issue with this is that there is no support beneath the current share price. The previous support lay at 10p/share which was round number support. However, with the breach of this support today (on fundamental weakness), the short and medium term picture looks bleak. Indeed, the ask and bid prices have been adjusted to account for this breach, with the ask at the current share price and the bid below it. The result is that CoAL will likely continue to move downwards at a relatively rapid speed. Whilst the 100% spike in late 2012 did prove that investors can be rewarded very quickly if momentum quickly changes, a number of indicators are bearish and a likely first target is around 8.25p, give or take a few percent. The break of 10p is likely to mean that downward pressure will accelerate over the coming few weeks.

Starting at the positive, or rather optimistic end of CoAL, you have the broker targets. I firmly believe that at least in the short/medium term, the brokers have got their targets completely wrong. The two main brokers who follow Coal of Africa are Investec and Bank of America Merrill Lynch, and they have targets of 20p and 35p respectively. Investec recently upgraded their target price from 15p in light of corporate news and both brokers have buy recommendations on the stock although BOA have recently decreased their target price from 45p previously.

Coal of Africa operates a number of exploration, development and mining projects in the North-East tip of South Africa. The company's vision is 'to responsibly produce 10 million tonnes of coal per annum' through its array of good quality coking and thermal coal projects. The initial hurdle that CoAL has had is the operating environment. The socio-political situation in South Africa makes it very difficult for projects to be completed in a timely manner, plus corruption is a very big issue for the country. Whilst this may be set to change with South Africa recently announcing that it will set up an 'Anti-Corruption Bureau', there is an automatic psychological discount applied to the company. This discount cannot be removed without long-term progress in the country though, so it is something to be conscious of, but that is all.

Most of CoAL's projects are in the exploration stage where there is a large amount of cash burn, but the company does benefit from having two projects in development and a further two in the mining stage. The exploration properties lie relatively close together beside the former Rio Tinto properties . The close proximity allows for logistical efficiency. Furthermore, the potential upside has been touted as being as high as 8 billion tonnes of thermal coal and coking product (according to CoAL). In development are Coal of Africa's Vele and Makhado projects and in the mining stage are the Mooiplats and Woestalleen projects. Across these the company has 357MT of booked coal reserves and mineable tonnes in-situ amount to 2413MT.

The company has two main export corridors within South Africa, although the favourable one sees the coal product from CoAL's working mines being moved by rail through the Maputo Rail Corridor to the Matola Terminal in Mozambique. The Matola Terminal has a current capacity of 6.0MTPA with CoAL's current capacity stretching to half of that figure. Through an agreement with Vitol, the company is looking to expand this capacity, and furthermore, the Terminal is due to have it's capacity upgraded to 7.3MTPA by the end of October 2013 (as it stands).

However, as with most mining stocks, the companies have suffered severely from lower resource prices and that is no different with Coal of Africa. Whilst the company does use more specific coal pricing, a general feel for coal prices can be seen through the South African Coal export price. The price per ton of coal has shed almost 40% from the peak in 2011 for two main reasons. The first of these is that new producers have entered the market to take advantage of the higher prices and secondly, demand from newly industrialising nations has waned somewhat.

The price has not been helped by further weakening in China's growth rates either. All over the globe, this is leading to weaker miners with higher cash costs being pushed out of the industry or more commonly, having to suspend operations until the coal price recovers. The issue here is that its a vicious circle and until demand picks up, any price rises could be met by a flood of coal back into the market from suspended operators which could create excess demand and see it fall again. Alternatively, a prolonged period of weakness could force more producers out of the market. 

courtesy of Jeffrey Beall on Flickr
The market is not forgiving either. Russia's coal miner Sibanthracite is likely to see it's proposed London flotation fall short or fail completely. Coal of Africa has had to make a key strategic decision in light of these price falls. The company's Mooiplats thermal coalmine was also recently suspended and placed into Care and Maintenance Mode. The company has tried on numerous occasions to make the mine profitable over the past two years, and has failed. Since the start oft he 2013 financial year, the mine recorded a $2m loss per month so the decision was not particularly difficult. However, the result will likely be a loss of jobs.

The company released a Definitive Feasibility Study for its Makhado prospect earlier this year. The study revealed that the mine could have a 16 year life over which it could produce 2.3MT per annum of coking coal and 3.2MT per annum of thermal coal. At an 8% real discount rate, the net present value totalled to $697m. The project returned an internal rate of return of 30.1% which is decent and favourable considering it's above 30%, but the large CAPEX of $406m did dampen sentiment slightly considering the company's cash balance is thinning quickly. To counter this, CoAL has entered discussions with potential funding partners, which is likely to eventually lead to the project being settled by a mixture of both debt and equity. The projected mineable resource stands at circa 345 million tonnes.

With cash burn being severe for the company at the moment, and said deals taking a long time in the current market place, uncertainty will like reign over CoAL which will only damage it's share price. The plan for the funding resolution is H1 2014 as stated in the text below - until then it is very much cash conservation for the company. The DFS itself used a 2016 coal price of $180/tonne which is very generous considering the current coal price trades at and around the $130-$140/tonne level. With the market consensus that the coal price could slip further, the coal price expectations look very optimistic.

Chairman David Brown commented: "This high quality hard coking coal project will not only deliver robust economic returns but also contribute meaningfully to the economic development of the Limpopo province in South Africa. Makhado further provides South Africa with a new coking coal producing asset in the region, utilising established infrastructure for domestic and international markets. The Makhado Project represents the future of the Company and is the first step in the development of a major 8 billion tonne resource across our Soutpansberg Coalfield. We have now embarked on the financing stage of the Makhado Project and have already commenced discussions with both potential BEE (Black Economic Empowerment) groups, including our communities and strategic partners. We are working towards a funding structure which will include debt funding, whereby CoAL retains majority ownership with the incoming partner's contribution meeting CoAL's full equity requirement for the Project. Our regulatory approval and funding requirements are targeted to be completed by H1CY14."

Aside from coal prices, CoAL has experienced numerous issues outside it's control. On 22nd January the company was forced to stop production at its Vele operations due to severe flooding caused by heavy rain in the Linpopo province. Rainfall amounted to 500mm in just five days compared to average annual rainfall of around 450mm for the area. The impact was expectedly minimal. More positively, during the period the company announced the receipt of an $80m equity package with a Chinese strategic partner that saw shares placed far higher than the current price, at 25p. However, any bullish sentiment associated with this was quickly erased when, on the 28th February there was a train derailment on the Matola rail corridor. The derailment saw the corridor suspended for at least 7 weeks. The company's operations at Vele were duly suspended considering on site capacity had been filled and operations at Mooiplats and Woestalleen would continue until stockpiles were full.

Within the recently released Quarterly report, Coal of Africa reflected on what can be described as a challenging period for the company by any measurement. On a small scale, 3 lost time injuries were recorded during the period and sadly a fatality was seen at one of the company's collieries. On a large scale, coal output plummeted 79% quarter-on-quarter due to the depletion of the company's Vuna colliery and the train derailment. CEO John Wallington also departed from the company upon the expiration of his contract (in April).

In financial terms, the company had outstanding debt of $12.5m at the end of June whereas available cash stood at a lowly $28.9m. This is a real issue considering cash outflow for the period stood at $18.4m. For Q1 the outflow was around $12m. These two figures are a bit unreliable though because of the external issues the company faced. Therefore they are a little larger than standard cash outflow figures. Nonetheless, with Mooiplats offline and decreasing production from Vuna, cash will likely continue to leak quickly from the company, which will only worsen it's financial position. The company is aiming to become debt free by November, but the financial position does remain an issue. The buffer is being eroded so if the company does experience another negative exogenous issue, they could be in real trouble. The company is planning to implement cost cutting measures along with the sale of non-core assets, but I do not envisage these will be completed in due course.

There is a pretty clear bearish outlook for Coal of Africa. The company has sizeable resource figures and the potential is huge if they can be exploited. But that has been Coal of Africa's problem, delays, problems and disappointments have riddled the company for years and unfortunately, this ship will not be easy to turn around. Technically and fundamentally I am bearish on the company and it would not be surprising to see coal prices (RB1 export quality thermal) weaken further towards $70/tonne. Whilst a relative weakening in the South African Rand may partially offset the lower coal prices (currently around 10 ZAR to the dollar), sentiment in the company has been truly trashed, over the past year in particular. It may not entirely be the company's fault, but these are the risks attributed to operating in a company such as South Africa. In the long term, if coal prices recover then Coal of Africa could be a good bet, but until then I see no attraction in holding Coal of Africa shares and so I have put a sell opinion on the stock targeting the 8.25p level as a first port of call.

UPDATE 19/08/13: After hitting 8.25p on two occasions now I have moved Coal of Africa from a Sell tag to a No Rating tag for a 16% profit

12 comments:

  1. Totally agree, overvalued. I can easily see this reaching £75m mkt cap before december is out

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  2. I was targeting 8.5p

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  3. Cheers as always mate

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  4. Wow!!! Sobering indeed...
    Thank you for the insight. One thing you forgot to mention was that SA will be totally dependent on coal for electricity untill at least 2030. Eskom is looking and can't find enough quick enough. Also government has a plan with the coal fields and are targeting them as opportunity to create jobs.
    I do believe that medium to long term you will be handsomely rewarded if you stay patient and accumulate at these levels.
    I agree that bee partners and funding will be challenging, however the market will once again turn as the economies over the globe recover and now is as good a time as any to set yourself up for favorable circumstances in 2015 onwards...
    Botswana and SA governments also discussing rail infrastructure together which will lead to more development in Limpopo province and more investment over time to get the goodies out of the ground.
    Bearish now, bullish , VERY optimistic in 36 months.
    Accumulate gently....

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    1. Quite right. South Africa are heavily dependent on Coal and there has been talk about South Africa nationalising some of its mines. Transnet recently announced they are planning to increase coal transport capacity also. Problem is that the coal price is crushing producers with CZA included. What the producers need is assurance of a sustainably higher coal price plus a fall in coal price volatility. Neither of these is likely to materialise in the near future though. The LSE mining market will rebound at some point, just not yet.

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  5. Very good summary and prognosis.

    Have held shares here since early 2008 so will stay on board in the hope of rescue, or sink with the ship should she slip away.

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  6. $180 for long term price looks quite inline and conservative based on numerous forecast made by analyst consensus. Just google and find plenty of article to back up. Would be good to see why/where do you find this number 'generous'?. The current price is not deemed sustainable and near term bearish yes, but medium/long term looks much higher. The China growth 'collapse' is being oversold, it's likely that they will keep growing @7% which is still pretty ok. Commodity prices are beaten to bust and looks like bottoming, there's more upside than downside risk at this level IMO. Reading the makhado DFS I would say the variable used are ok to the safe side.

    As for cash buffer, the company next quarter forecast is only at $11m (looking at their past record these cash use forecast are quite accurate). They are looking at debt free by end of year, highlighted by management, and I tend to believe that cost control are progressing positively now. It's now a cleaner company with only Vele mine in development (minus the loss making thermals). Given their cheap asset base valuation (and the market cannot ignore forever), Makhado project will be the key booster. Funding shouldn't be a huge problem (given the DFS makes much economical sense), as they have shareholders/partners like Chinese BHE/Vitol etc. However the key would be at what price they are selling the Makhado equity for. Even at heavy discount, the potential is still much higher than current market cap. At current SP, I would say there's more of positive upside surprises than downside risk.

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    1. There are a few reasons. The first is that as the coal price has continued to drop, many companies are still stockpiling their coal for future sale meaning that fresh supply may be falling, but there is excess on the sidelines. This process started as early as H1 last year, but some of the coal was sold on the price rise around the turn of the year. During H1 the stockpiling has gradually been increasing again as an alternative to putting mines under care and maintenance.

      In China, the domestic coal producers are also getting hit hard which doesn't bode well. The Shanxi province is well known for it's coal industry, but this has declined and the companies are attributing this down to consistently falling demands. More likely than not, this will continue as certain parts of China have overcome the industrial boom. The 7% figure is probably a fair assumption although it will be difficult to see it maintain that level past 2014: http://www.businessinsider.com/nomura-chinese-growth-will-fall-below-7-next-year-2013-7

      The problem is not entirely with China either, India's growth has disappointed over the last half decade and their growth forecasts are once again being lowered for 2014. Macquarie recently cut their forecast growth from 6.2% to 5.3% which will not help the coal cause if it plays out.

      The asset base is cheap, but that is true of a lot of LSE mining companies at the moment. The company is not awash with cash, but it does have a few good agreements in place to deal with that. Th question then is how they will cope with repaying these. With the current coal climate, I would not expect potential partners to have a particularly big appetite for Makhado due to the uncertainty. The IRR is good, but there are better IRRs out there and coupled with the risk of operating in S.Africa and the problems the company has experienced to date, it might be a harder sale than the company may like.

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    2. I would prefer if you could back up the numbers with references. The consensus estimate is surely more bullish than you have written. As for china growth, well it's still a hot debate out there, just to point out that many bears has been calling for its collapse since many years ago but proven wrong so far.

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  7. Very good point .,......I am not a trader but I love fundamentals so 2015/16/17 you would have been proved very wrong

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  8. very well written and I am a big bear on mining stocks as well. From my view I really cannot seeanything that will create a demand surge.

    china is faltering (It was always oing to happen as growth will conflict with wealth at some point!), as you say india is disappointing an there is a huge surge of aupply in Aussie

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  9. Thanks - very good article. I don't think these are a bad investment at around this level (8.5p) and think things will improve. However I cannot argue with the facts and figures and will be interesting to see what happens.

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