The last financial year was tough for Wescoal (WSL), with disruptions to production as a result of labour unrest and poor weather conditions. Nevertheless, the group produced 5.9 Mt of coal. This compares to a production of 6.8Mt in the prior year and targeted production of 8Mt for the 2020 financial year.
Given the supply disruptions, the generally poor sentiment surrounding South African small cap stocks and the huge concerns at Wescoal’s largest offtaker, Eskom, it is not surprising that the company’s share price has been decimated. The share is hovering at approximately R1.20 or a market cap of R520m. In my opinion, these depressed levels offer an extremely cheap entry point into a business that has demonstrated its ability to act as a consolidator of smaller coal assets within the known coal districts of the country.
Keith McLachlan made an excellent case for an investment in Wescoal by pointing out that the business is trading at a free cashflow (FCF) yield of over 30%. This in a period where production was severely affected by external once-off factors. Management in their 2019 annual report goes as far as to claim a FCF yield of 74%, but this does not allow for replacement and growth capex, which are required to be reinvested into the business. The business also trades at around 50% of its NAV of R2.53/share.
In early November it was announced that Black Royalty Minerals (BRM) are acquiring the Gupta tainted Koornfontein assets for R 300 million. Resource and reserves were not clear from the announcement and media reports, but the assets consist of an open pit and two underground mines and a total capacity of approximately 3.5Mtpa.
The R300m appears to be a bargain basement price, after the preferred bidder, Lurco, failed to raise the initially agreed purchase price of R500m. At the Lurco price, Koornfontein would change hands at R142 per ton of annual production, at the bargain BRM price, the deal is at R86 per ton of annual production. Wescoal is currently trading at R65 per ton of forecast 2020 production. The trading business is included as a free extra in this assessment.
Furthermore, in February 2020 ASX-listed TerraCom made an offer for Universal Coal that values the company at R1.7bn. They forecast their production for 2020 at 8.4Mtpa, valuing Universal’s South African mines at R200/ton of annual production or roughly three times the value attributed to Wescoal’s production.
In July and August management repurchased 17m shares or 4% of the outstanding shares of the company at an average price of R1.58 per share reflecting their own conviction that the company is undervalued at current prices. With the current share price 25% below this last repurchase price and the significant cash generation, we can expect management to continue share repurchases in the foreseeable future. Management is also eating their own cooking with director Muthanyi Ramaite buying shares at current prices since December 2019.
Unfortunately, a trading statement in November 2019, showed that production problems continue into the 2020 financial year, with H1 production only at 2.7Mt. Most of these problems appear to be temporary, and a production rate of 0.65Mt per month from Elandspruit, Khanyisa and Vanggatfontein should be possible in the medium term. This lower production will result in a loss per share for the first half, but EBITDA of R140m will be maintained. This means that even in this terrible production period, the company is operating an annualised cashflow yield of around 45%.
With the reality of climate change, coal is no longer a sexy investment. In fact, investors are justifiably concerned about coal’s long term viability. In the department of energy’s latest Integrated Resource Plan (IRP) published earlier in 2019, coal is expected to continue to make up almost 60% of the country’s energy mix in 2030. Much of the coal mining capacity to support this blend still needs to be constructed. Even, if international pressure and the increasing competitive nature of renewals force an accelerated reduction of the coal mix in South Africa’s grid, the most optimistic transition is expected to take several decades. In order to keep the lights on in the interim, coal will need to be burned in Mpumalanga’s power stations and Wescoal will be able to snatch up cheap, highly cash generating assets.