What is this photo of below? Is it a large over cooked sausage? Has someone drilled into a bitumen road? No it's a core sample from Riversdale Mining`s coal deposit at Tete in Mozambique and its thick and high grade coal from one of the world`s great new coal provinces.
At Southern Cross you know we like meeting companies across a range of industries that many big brokers wouldn't even have in their doors. We realise you have to look far and wide to make money. We also realise you need to be early in emerging stories to make the real money.
Last week we hosted a lunch for emerging African coal player Riversdale Mining (RIV).
Riversdale currently has a market cap of $1.8bn and has attracted some very interesting shareholders ranging from Macarthur Coal billionaire Ken Talbot to Indian steel giant Tata Steel amongst others. While domestic institutions are rarely seen on these emerging resource company registers, offshore players continue to make a fortune out of the sector by seeing the value and taking the risk early in companies like Aquila and Fortescue as just two examples. All the early stage money is made by foreign investors, a fact which continues to disappoint me.
Riversdale is another stock the savvy offshore investors have already made good money out of and are likely to make a lot more. The management team is strong with Chairman and CEO Michael O'Keeffe the former MD of Glencore Australia. The Glencore connection ensures RIV coal industry knowledge is first rate.
Riversdale has 2 main assets, one in South Africa and one in Mozambique. Africa has always been considered high risk in the investment portfolio`s of Australian institutions and as a result many stocks with largely African assets don't tend to get a large number of Australian Funds on their registers ; Paladin being one example.
Whilst RIV is already making good money from their South African asset in Zululand (currently producing ~0.8mtpa of high quality anthracite coal) the main game is their large and highly prospective tenements in the 'Moatize' basin in Mozambique which we believe will deliver huge value to RIV longer term.
A few weeks ago in our note on coal we suggested that there was a massive supply squeeze coming in both coking and thermal coal in the next few years. We also questioned where the growth in hard coking coal production was going to come from to meet the huge growth in global steel production forecasts. We said it was hard to see where the "Fortescue of coking coal" was. BHP backed up our view of the tightness of the seaborne coking coal market in their Carbon Steel Materials briefing this week.
While we believe we have found "the FMG of coking coal" in Australia in Aquila (AQA) that we have written about already (and it had doubled since), we also believe we have found the African version in Riversdale Mining. RIV's coal assets in Mozambique are of a world class, tier one scale and grade and RIV could be a very, very large company 4-5 years down the track. Sound familiar?
Where are these assets?
Riversdale has 290,080ha of tenements located in the Tete province. This includes the Moatize basin, which is one of the largest undeveloped coal basins in the world.
With mining companies we always like to see who the neighbours are. For example, FMG has BHP and RIO. RIV also certainly has the right neighbours. Vale (CVRD) is right next door and Mittal has also been trying to buy tenements in the area in recent years. RIV purchased their original leases in late 2006 then the adjoining leases from Aquila in August 2007 who were not keen on selling to Vale . They simultaneously had the Indians breathing down their neck trying to buy the assets as well. RIV currently has the largest tenement holding in the Moatize basin, and therefore the area is locked up and divided in ownership between themselves and Vale. The best part about it all is that the Mozambique Government have said they will issue no new licences so the value of existing licences in the area will clearly go up.
Why Mozambique?
The location of Mozambique is interesting from a number of perspectives. In terms of proximity, the coal can be easily moved to India, Europe and also Brazil, areas which remain highly short coking coal yet are pushing large steel production expansion plans.
Brazil and India are forecast to account for almost 50% of world coking coal demand growth between 2008 -2011. Whilst both these countries have plentiful iron ore, they are lacking in the coking coal needed to fuel their large steel production growth.
When you think about the freight rate differential the Australian iron ore producers are starting to extract, you can see how RIV longer term can push the same argument. Freight costs from Mozambique into India, Europe and Brazil are far lower than from the Bowen Basin. With freight rates poised to go higher in the next few years, this could be another plus for Riversdale. RIV estimate it costs Indian consumers of coal US$6 a tonne less to get the coal from Mozambique to India rather than from Australia to India.
Tata Steel, the world`s 6th largest steel maker last year bought a direct 35% stake in the Benga and Tete licences controlled by Riversdale. I think a direct investment from Tata was a huge vote of confidence for RIV and for Mozambique in general. Remember pre buying the Anglo Dutch steel giant Corus, Tata Steel was around 75% self sufficient in their raw material needs. That dropped to 15% post Corus and clearly Tata knows which way input cost prices for coking coal and iron ore are heading and it certainly doesn't appear to be downwards. Just like Mittal, Posco and the other steel giants, Tata appear keen to de risk their raw materials costs by partially controlling upstream production. This Tata investment is just like the Russian Steelmaker MMK who bought a stake in FMG and is now up $1bn on his investment. I believe end customers buying stakes either directly or via shares is a huge vote of confidence in a project.
The Asset
In Mozambique the current resource estimate for RIV is 1.9 billion tonnes. This is only after drilling out less than 2,000 ha of their 290,000 ha of land in their area (less than 2%). As you can see in the chart below they still have huge areas to explore and are right next door to the big gorilla Vale (shown in Green) but have a much larger area.
The company seems to feel the resource base could easily be 4-5 billion tonnes over the next few years. When you see Ken Talbot doing coal deals at between $3.50 -4.00 a tonne of resource for Macarthur, which is already in large scale production, if you put a US$1.00 per tonne 'in the ground' valuation on RIV`s resources on a 4-5bn range you are talking about a backstop valuation of $20 a share or more that corporates' would be happy to pay for now. That is before you even think about what this company could spit out from an earnings perspective.
Coal outcropping from the surface (no high strip ratios here)
Exploration Upside; even drilling for a toilet
If you do not believe the exploration upside in the region look at the photo above. The area circled in red was where RIV drilled a hole to put the new toilet in at their exploration camp. At 20m they had such high grade coking coal hits they decided there might have been better places to put a toilet!
Riversdale`s production growth profile is ramping up towards 6mpta of hard coking coal production in 2013-14 along with 2mpta of export thermal coal and 4mpta of domestic coal . The plans in the initial stage are to use the existing rail line to Beira that CVRD also plans to use for their first stage of growth (capacity 18mpta) of which RIV only want 6mpta of rail capacity. As they ramp up production Riversdale plan to barge the coal down the wide and flowing Zambezi River and load it straight onto the Panamax ships in the Zambezi estuary.
The Bowen Basin in QLD currently has an average cost base of around US$70/tonne FOB and is likely to go upwards due to higher diesel and increasingly higher strip ratios (some up to 15 to 1). Overburden is becoming increasingly expensive to strip. Then you also have the QLD Government behaving like a bunch of 3rd world dictators via increasing royalties with no consultation with the coal industry. Are we in QLD or the Congo?
RIV estimates their Moatize coal assets will have an initial strip ratio of 1 to 1 and a life of mine strip ratio of 4 to 1. The mining can take place at surface, with some coal seams already exposed, and all operations being open pittable. The FOB price takes into account very conservative cost estimates for the washing, rail and port handling. Total costs are expected be around $55 a tonne for RIV and that assumes $25 of port and rail costs and $30 of mining costs.
As part of their longer term growth plans RIV are already looking at barging down the Zambezi to the coast and then using trans shipping (loading barges onto larger vessels off the coast) which is more cost effective than rail and also avoids any potential longer term rail or port bottleneck issues. For example if you used trans shipping to cape size vessels it would reduce transport handling costs to around $8 from $20 per tonne and bring down total costs to $33 a tonne rather than $55.
It is easy to see that even if you used more conservative cost numbers, that Riversdale has a very high margin business in Mozambique. 6mtpa of hard coking coal, 4mtpa of domestic coal and 2mpta of thermal leads to EBITDA well north of $1bn once the project is fully ramped up.
What still needs to be done to get RIV up to a 6mpta hard coking coal producer?
First of all, the rail line upgrade and refurbishment needs to be completed. Currently two large Indian rail companies RITES and IRCON are doing that (they own 51% of the Joint Venture and have a 25 year concession to operate) and that should be completed by late 2009. Also the port facilities at Beira need to be upgraded. That will be around $500m and that is needed to upgrade the existing facilities to handle panamax vessels, upgrade coal loading facilities and rail lines into the port and the like.
In terms of power, RIV plans to source power from the Cahora Bassa Hydro system with a line currently running close to the tenements. RIV is also looking at developing a 500MW plant with a partner ELGAS (the Mozambique gas company) to supply electricity to the project. The cost to develop the plant is approximately $900m and the plant would be supplied thermal coal from RIV's operations. RIV would take 50-70 MW for their own operations and run everything off electricity, thus offsetting the rising cost of diesel, and ensuring a reliable power supply. RIV`s operations are clearly highly profitable even if they have to use diesel but they would prefer most of the operations to be powered by electricity.
Why are domestic institutions and brokers non believers?
In an identical situation to FMG and most other emerging growth plays in the resource space the locals are not there in RIV in scale. They worry about Mozambique, they worry about port and rail infrastructure and they worry about coal quality. The same brokers who write that RIV is overvalued at a $2bn market cap will have it as a buy at $20bn market cap - that is just how analysts work. (I even remember seeing a broking analyst write up that when BHP spun off the steel assets they should have divested the upstream raw materials business and kept steel - that would have only cost them US$200bn!)
RIV has quite high ash content (10.5% ash in coking coal and 20% ash in thermal export coal) but much like magnetite in the iron ore industry, end customers are now having to face the fact that the quality they previously relied on (high grade lump in iron ore and low ash coking coal) is getting rarer and thus they are happy to take alternative products.
Companies are increasingly more comfortable accepting they have to go to more exotic locales to source their raw materials. Mittal is currently building iron ore mines in places like Liberia and Senegal in Africa where you probably have to stop mining to let the annual coup go on! Mozambique is a Commonwealth Country. They are clearly looking for foreign investment and they want to generate export income and Aussies have a good name here given BHP have been in the area before.
RIV at $10.80 looks very interesting. You can see that if they get the resource base up to 3-4bn tonnes over the next 18 months or so, that using a highly conservative EV/T of resource of $1 gets you to $20-25 per share as a starting point.
EV/Tonne of resource -RIV is cheap
Largest Global coking coal producers -RIV would be in the Top 10.
RIV Price at posting:
0.0¢ Sentiment: LT Buy Disclosure: Held
