new broker report just out

The following report was compiled by Mirabaud Securities in the UK and looks like it was released just before the UK market closed last night. I have been fortunate to have followed all their reports from the early days of CZA's move into coal and this group have always been spot on with their valuations and analysis.Do a Google and you should see most of their previous reports.

I notice in the UK now (market closed) that there is bidding about 10 cents above the day's close, so whether this report has anything to do with it, I couldn't comment.

Well worth a read for holders or those interested in CZA

Cheers.



Coal of Africa - valuation raised to 305.8p - land swap adds Makhado development


Coal of Africa (CZA) and Rio Tinto have announced a major exchange of coal mineral rights in South Africa’s Limpopo Province, plus the establishment of an exploration JV over certain coal prospecting rights that the parties have pooled. The deal is subject to regulatory approval.

The swap will allow the development of an optimal mine plan for CZA’s 100%-owned Makhado (formerly Baobab) coking-coal project, as one of the farms acquired from Rio Tinto – Lukin – lies between the farms CZA had earmarked for its initial mine at Makhado. Lukin gives CZA a contiguous strike length for the initial mining area of >20km. This has allowed us to develop a DCF analysis of Makhado, based on an initial mine plan. Thus far we model only a 19-year life. However, in practice we believe Makhado’s life will be significantly longer, and we expect the land exchange to be followed by a revised resource statement for Makhado within the next month and a half.

Valuation increase

The addition of an initial cash-flow model for Makhado raises our base-case valuation to 305.8p per share. This is a base case because it assumes conservative long-term coal prices after three years of US$100/t for coking and US$55/t for thermal (attachment, p3, for sensitivity analysis). This compares with our previous valuation of 283.0p (18 June). The Mooiplaats thermal coal project in Mpumalanga Province is scheduled to start production before the end of this year.

We model Makhado and the Vele coking-coal project (formerly Thuli), also in Limpopo Province, as a single business unit as there is significant interplay between the two. Most importantly, we now assume that steel producer ArcelorMittal will take its coking-coal almost exclusively from Makhado (see attachment, p4).

An important factor, given that CZA will receive the vast majority of its revenue in US dollars (including domestic coking-coal sales to ArcelorMittal South Africa), is the rand rate. Since our previous valuation of 18 June, the rand has strengthened from R8.02/US$ to R7.80. This alone would have reduced our previous valuation from 283.0p to 274.5p. On our current valuation, a 10% weakening in the rand raises our valuation by 17%, and a 10% strengthening reduces it by 21%.

Coal prices

Our valuation is based on our standard methodology of forecasting near-term commodity prices (see individual mine tables in attachment) and assuming prices return to long-term incentive prices from 2012 (we stress these are assumptions for equity-valuation purposes, not forecasts). For this valuation we use market prices of US$55/t for thermal coal and US$100/t for coking coal (in 2008 money – we inflate prices at 2.5% US dollar inflation and costs at 7% for South Africa, and assume the rand depreciates at the inflation-rate differential).

Our near-term prices are based on recent annual contract price settlements. In the case of coking coal, the benchmark that ArcelorMittal has agreed to follow for CZA’s domestic sales is the FoB price achieved by Rio Tinto’s Kestrel mine in Queensland. Kestrel’s price for the current Japanese financial year to March 31, 2009, if it has been agreed, has not been disclosed. We use the US$305/t recently secured by BHP Billiton for its Queensland operations for the current contract year, but we note that Xstrata has yet to settle and is reported (by the Tex newsletter) to be aiming for a settlement closer to spot prices of US$350-370/t.

We believe that the growing scarcity of coking-coal resources – evinced by the speed at which steel producers are buying them – suggests that our assumption for coking coal, in particular, is very conservative. We have run a range of coal prices in our long-term assumptions (which come in from the contract year starting April 1, 2012) – see attachment.

In thermal coal, our near-term prices are based on a contract price of US$125/t. This compares with last Friday’s record weekly spot-price average for thermal coal from South Africa’s Richard’s Bay terminal of US$177/t.

Last Friday’s record spot price also puts into context the retracement in the middle of last week in coal equities triggered by a one-day 13% fall in the API 2 index (thermal coal for delivery in Europe one year ahead) to US$190/t. Post that fall, this translated into a one-year forward FoB price at Richards Bay (API 4 index) of US$166/t, from which level the one-year price has since recovered to US$182.5/t today (also a record high).

The sell-off in coal equities was clearly an overreaction – not only was the trigger a small and temporary correction in coal futures, but in CZA’s case international thermal-coal sales represents less than a quarter of our valuation. We argue this has created a significant buying opportunity in CZA, as our valuation represents an 89.9% premium to the current price.