nec

I've requested for permission to post the following analysis of NEC from a mate. I think it shows that NEC represents a very good play in the speculative portfolio.
Cheers.

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NEC looks like a very good opportunity. It’s in the right sector (coal), the best part of that sector (HARD coking coal) & has a known resource, although not JORC yet. It’s all on historical information. No new drilling done. They think they have 6-7mt of coking coal around the old Ashford works in Northern NSW. They are looking to drill out from there and find 100-300mt. But that will take time.

There is a fall back position in that they only need to put a few holes down to be able to prove up a JORC resource. With current high prices, it would then be feasible to start up a small (say 0.5tpa) plant & ship it all by road, as there is no local infrastructure/rail line. If US$65/t is seen as a fair low point in current cycle, then the small fall back option puts some solid ground under this one. If not, it’s a BIG PUNT on them finding & then proving up at least 100mt (their minimum) for a 2-4mtpa plant a few years down the track, that would need the infrastructure.

On the plus side the Chinese have already “knocked on the door”. They are desperate to tie up long term contracts and there just isn’t any hard coking coal available. So if they do find a lot more, they will have no trouble funding it & the infrastructure.

Plant about $250m, other $150m, for an all up $400m requirement.

C/w other junior coals, it’s CHEAP, BUT they have to find more first to prove up value.

SP has started to move, but you can still get on in mid 30’s if interested. Someone was feeding out 100,000 lots at 30, then 33; that seems to have stopped. I also know some are expecting the “normal” post stag drop. They’re waiting for mid 20’s. They might be right; who knows. I’m after at least $1 with this one, possibly multiple $’s, so I don’t care about 5-10c at this time. Then again, the traders are now in, so volatility will increase. Actually, I wouldn’t mind a decent retrace to load up with a lot more. I see the risks in this one as relatively low, BUT, that’s only talking medium-long term. I NEVER know short term & generally get short term wrong.

I’ve spoken to a good mate who works in the coal game & he is the source for the US$70 bottom of the cycle (I’m using US$65); he suggests A$20/t for road freight & production cost no higher than A$55 (he expects it could be lower - his large operation has a $32 cost)

So thanks to our coal industry expert.

We know the focus is the potential for 100-300mt, but we always go looking for worst case/bottom scenario. What we have here, which is MOST unusual (& great) for a junior IPO, is a rock solid back up plan. It’s almost worth calling this a no brainer, even though they haven’t stuck any holes in the ground as yet! As long as that historical info on the current resource is right, it looks incredibly undervalued.

The NEC presentation has been released to ASX, but not on website yet. You need to read it, as well as some of the prospectus, which is on the website http://www.northernenergy.com.au/
You should be able to get the presentation from www.asx.com.au or your normal source of market announcements.

I’m getting confirming information that the industry/analysts have a consensus that the new potential low point in any future cycle is around US$80/t, up from previous US$50. Similar to oil low point projection moving up from US$20/bbl to US$30. However a good mate who is in the industry suggest US$70 would be a better low figure & I’m using an even more conservative US$65.

Now I'm still working on this VITAL point, as if it holds true, then we may very well be looking at our next “no brainer”

Reason being is that we know they have 6-7mt of HARD coking coal at the old Ashford works now. The fall back position if they don’t find heaps more in the 2 adjoining tenements, is to go with a small operation to produce 0.5mtpa. This would be small enough to transport by road, which adds $20/t, or so to production cost. Using conservative numbers, production shouldn’t cost any more than A$55/t (probably less), add an extra $20 for road transport for total A$75. Current price for hard coking coal is US$120-140/t. IF & still an unproven “IF”, we can confirm low point will be no less than US$65/t, then we have a winner.

Using US$0.80 for A$1 & that would deliver a cash margin of A$18.75/t or A$9.4m free cash flow. Now they only own 50% of Ashford so far, but will move to 75% paying 5m NEC shares. Although I expect Renison will eventually go for handing over the other 25% for a royalty. But for now we must use 75%.

So that’s now A$7.1m cash flow

On 58.6m shares that’s 12.1cps. Looks like PE’s/cash flow multiples are 6-8 for junior coals.

Using 7x & that would give us an SP of $0.85 And that’s just for Ashford, with the small back up plan. They have 2 other very good tenements on top.

So I see this as 2-3 bagger minimum, with not much risk, all on the back up small plant. Possibly 10++ on a big find.

$0.85 assumes worst case with coal price dropping from current US$120-140/t to US$75/t. If it holds at even the lower current of US$120 = A$150; then that’s $75/t cash margin or $28.1m & that’s an incredible 48cps!!! That is not an impossible prospect in 2-3 years from now. Ok, they will obviously have to issue more paper, but not too much as I expect much of the funding would come from a partner, likely Chinese (but they would take a stake in Ashford, so there would be some dilution), so they can secure what they desperately need; HARD coking coal. So halve the 48cps. NEC will still be some $’s.

We know the steel price is going to come back in 2006 from those huge rises just announced. That’s because a lot more steel production volume is due to come onto world markets in 2006. So steel prices likely to peak, then fall. BUT, guess what all that new steel production needs? Iron ore (so they will remain strong) AND Coking Coal, with HARD coking coal the best & most sought after.

If they do find 100mt+ (they’re looking for 100-300mt), they will go with a 2-4mtpa plant & that would be worth quite a bit more.

Key is HARD coking coal that is in very short supply. We know ALL current Australian output is firmly tied up long term. The Chinese have already knocked on NEC’s door. They are desperate for more long term supply of hard coking coal for their steel mills.

From here, they first need to get a rig. Then they will drill a few holes to bring what they have at Ashford to JORC status. Then they need to have the new tenements confirmed, then get a mining tenure for those blocks, then drill out into the new prospective areas.

No question, they are hunting the big one & will not be thinking of the back up plan for a while; until they know if they have a shot at the 100mt+ or not.

Look at page 12 of the preso for comparisons & you’ll see that NEC is CHEAP.

It is VERY early days, so no question RISK is high, but we have ex QCT resources people running NEC, so they have been there & done that before. I’ve met the MD over lunch & was impressed. He’s a no nonsense miner who has been there & done that with QCT.

RISKS:

Apart from the obvious normal ones for any start up, the big one is that bottom of the coal cycle price. Coking coal prices were around that US$50 and lower into 2004. GSJB Were have their long  term coking coal price at US$48.50. But one thing that will help it not return to those levels is that alternate technologies have failed (plus the big increase in steel production from 2006). There was a time when the method using coking coal was thought to have its days numbered. Not any more. It’s now the main game in town again & likely to be for many years to come. Plus the fact there is just none available from Australia, gives some confidence in the US$65 & certainly that should hold for the next 2-3 years at least. The earliest any of the analysts I have spoken to, suggest a downturn in coal prices is 3 years.

BUT, if it does return to those low numbers, NEC would be making losses.

So I would suggest that NEC is for those with a reasonable risk tolerance.

Mkt cap now at 35c is just $19m, look at page 12 on the preso & you’ll see this is tiny. I think LONG TERM, anything up to 40c (=mkt cap $21.4m) is good buying.
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