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May 15, 2013
The Agreement With Village Main Reef Is The First Of Many Deals in That Continental Coal Has In The Pipeline
By Sally White
Continental Coal has now made the quantum leap that it has been working on for months. In an A$8 million private placing with JSE-listed diversified precious metals mining group Village Main Reef (VMR) Continental’s management has given shareholders a concrete reassurance that it can commercialise its vast portfolio despite the difficult conditions in capital markets.

Penumbra
As finance director Jason Brewer says, Continental needs to show shareholders that “the company is moving forward, operationally and at the corporate level”.

Nor is this the only deal that he and chief executive Don Turvey have been working on – their desks are piled high with paperwork for negotiations on joint ventures, financings and sales.

It just so happened that VMR were roaring to go so got first on the list.

The VMR money will strengthen the balance sheet by cutting debt (group borrowings were around US$39 million at the December 2012 half-year stage) and providing working capital.

With a market capitalisation of US$139 million, VMR has cash of US$50 million and its forecast cash flow is soaring.

As Don Turvey comments, the deal will “strengthen the company’s growth strategy and operating credentials in South Africa with a major, well credentialed partner.”

From VRM’s side chief executive Marius Saaiman described the move as part of a diversification strategy.

He says VRM was at “an inflection point” in its development.

Continental has, he says, “a strong portfolio of projects and has demonstrated its ability to develop and operate mines and we look forward to working and supporting the management team as production continues to increase and as greater value is recognised”.

The deal, at a price of A$0.80 a share, also gave VMR the option to acquire small shareholders’ parcels and it has added 11.8 million shares at an average price of A$0.521 to take its total holding up to 16.34 per cent.

And it can acquire further Continental shares on the market at a price of up to A$0.10 to bring its stake to 19.9 per cent of the company.

Not that the share price is going to roar ahead immediately, given the dilution the 100 million new shares creates. And an earlier A$5 million debt refinancing had also been equity dilutive.

As things stand, at around 3.4p, the shares are 70 per cent lower than a year ago. But that’s not the dilution at work, rather it’s that in its highly nervous state the market has focused on the costs rather than rewards as Continental commercialises its portfolio of exploration targets.

Yet these probably host over 10 billion tonnes of coal.

As Jason points out, the market seems to be overlooking the fact that Continental has a track record of implementing low-cost starts to projects.

For example, the latest plan for the De Wittekrans project plan has a start-up bill of just Rand 161 million (£12 million) to first production, helped along by the planned use of existing coal wash plants and rail sidings.

Continental has already three mines in production and has just put out a bullish third quarter statement on operations. This showed a 35 per cent jump in production on the previous quarter to 631,557 tonnes run of mine (ROM).

Thermal coal sales reached 463,671 tonnes in the quarter, up eight per cent, and export sales rose by 16 per cent. In the year to date ROM production has reached 1.6 million tonnes.

The latest mine is the newly commissioned high-margin Penumbra underground mine, which is targeting 500,000 tonnes per annum of export quality thermal coal and is forecast to produce 212,964 tonnes this year. The project is now 95 per cent completed and the ramp up to full production is progressing well. Underground production reached 52,876 tonnes in the quarter, up 99 per cent on the previous quarter.

At the large De Wittekrans project the company boasts a combined JORC Resource of 250 million tonnes, and with this scale it could become the flagship project. It could produce 2.4 million tonnes per year for sale to the Asian export market, with a mine life of 30 years.

If those numbers are added in to broker Breakaway’s valuation estimate for Continental, the valuation figure moves up from A$0.13 to A$0.34 a share – significant a multiple of current levels.

The total De Wittekrans capital cost is puts at around US$160 million and to move it forward Continental is in joint venture talks with the likes of Indian utilities and global trading groups.

As Jason Brewer says, De Wittekrans is currently key. “To announce a transaction on De Wittekrans would really enable that project and allow us to push ahead in the second half of the year.”

Having said that, De Wittenkrans is by no means the only string to the company’s bow. At the Ferreira mine production was up nine per cent in the last quarter, and in the year to date it is five per cent ahead of budget.

Other opportunities include the Vlakplaats Coal project, not far from Vlakvarkfontein mine. Here Continental has a joint development agreement with KORES, the South Korean government-owned minerals company.

And there is more - Continental has a 100 per cent interest in three exploration licences in Botswana. Among them, a maiden JORC inferred resource of 2.2 billion tonnes has been estimated at Kweneng with a further five billion tonne exploration target, while at Serowe consultants have reckoned the target at four billion tonnes. A Botswana joint venture is likely this quarter.

Before the deal with VMR, broker Investec was forecasting a swing well into the black this year with US$2.9 million at EBITDA level, followed by US$11.2 million next year and US$34.8 million in 2015. Last year Continental showed an EBITDA loss of US$24 million.

With a busy few months ahead, which should generate even more deals, market perceptions should improve. Even before the deal with VMR, Investec was already saying that Continental was “over the worst” with production at Ferreira and Penumbra rising. Analyst Hunter Hillcoat was suggesting a price target of 9p.

New share price targets, when they are ready, are likely to be higher. Meanwhile Hillcoat’s view was: “we do expect cash flows to improve henceforth, with potential upside from the strategic partnerships and/or asset sale process that is underway.” Watch this space.