Proactive investors

Caledon Resources

Caledon - Cook starts to cut the mustard

Why have investors been selling UK-listed coal miners – even the big boys like Xstrata, Rio and BHP Billiton - as if they were going out of fashion?  

Lack of understanding of the global market for the black stuff is probably the key reason. Gloom and doom has hit the commodity markets in the last three months, culminating in almost catastrophic price falls in some metals over the last 2-3 weeks. Steelmakers are cutting output. Car manufacturers are suffering from slumping sales. Nickel mines are closing and PGM miners are losing money hand over fist as metal prices have been driven down and down and down to ridiculous levels…even gold, that safe haven in times of trouble, is some 30% down from the $1000+ level hit earlier this year.

But coal’s different, surely? Falling steel output does not immediately bring about a slump in the demand for coking coal, and a concomitant drop in price, because most coal producers sell the majority of their product under contract, to a fixed price decided annually by negotiation with their customers. Unlike nickel or platinum or copper, there is virtually no spot market in coal, and thus no opportunity for “investors” – the polite name for the speculative hedge funds who drive today’s metal markets – to manipulate the price for their own profit. The coal producers enjoy fixed prices until at least next March, and will continue to supply contracted tonnages of coal.

The supply/demand dynamics of the market show that all types of coal – particularly seaborne coking coal from the Australian coalfields, where infrastructure deficiencies are limiting increased production – is in short supply worldwide. Many analysts and coal producers are predicting even now that there will be no significant downturn in coal prices – particularly for coking coal - for the 2009-2010 coal year, and some are even suggesting that coking coal prices could rise beyond the current year benchmark of US$300 per tonne.

So the sell-off has been illogical and panic-stricken – real baby & bathwater stuff - as a coal mining company with secured contracts is a far safer investment right now than just about any other resource stock….

Yet, from its highs earlier this year, when it reached £1.56 per share, Caledon Resources has been on a steady decline for many weeks, finally hitting just 15p last week, a drop of fully 90%.  They aren’t alone: Polo Resources has seen its share price drop from 22p to under 2p and is valued below its bank balance, and GCM Resources has suffered a savage fall to 22p from a bid-generated high of over £3. Cambrian Mining is another dramatic faller, while BHP Billiton, the largest single producer of coking coal, has seen its share price crumble from £22 to just £8, Xstrata, from highs of £45, has been looking £7 in the eye, and Rio Tinto slumped from over £70 to just £20 last week.

Of the juniors, Caledon is perhaps the most inexplicable crash. They are a producing miner, and whilst the build up to full production of around 100,000 tonnes per month has been slower than the company and its shareholders would have liked, there are good reasons for the lag, and production is increasing month on month.

Owner and operator of the Cook Colliery in Queensland’s Bowen Basin, Caledon has had a patchy year. It’s fair to say that the price would not have reached its highs without an aggressive buying campaign by Polo Resources, which culminated in Polo owning more than 52 million Caledon shares.

But since then the news from Cook has been one of steady – if unexciting – progress. The company listed successfully on the ASX in June, raising A$22 million, enough cash to make the final payment on their Minyango exploration property adjacent to Cook and carry out mine improvements and renovation work at the Cook washplant.

Having already downgraded their over-ambitious production forecasts for the calendar year 2008 due to technical problems with their innovative new Magatar continuous mining/conveying system in the early part of the year, June’s quarterly report took these down further to 600k-700k tonnes of saleable coal. Whilst the teething troubles with the ABM25 continuous miner had finally been ironed out, the laborious crossing of a known fault had hit output figures for May. However, whilst on the surface these figures were disappointing, it was notable that June had been a record production month, delivering 55,000 tonnes of coal and taking Cook into profit for the first time.

Since June, production has steadily increased. July continued the rising trend, with 62,000 tonnes being mined. The June quarter had shown run-of-mine production of 127,000 tonnes of coal, whilst by the end of September, in spite of a re-crossing of the underground fault, mine output was up to 167,000 tonnes. Output of saleable coking and thermal coal showed almost a 50% increase quarter on quarter. The company have prudently lowered their year-end figures again, to 500k – 550k tonnes of saleable coal for the calendar year. This implies a continuing climb in output that should – at the current rate of production growth – prove achievable, particularly as the remaining panels scheduled for mining by the Magatar unit are fault-free.

In the meantime, redevelopment at the pit bottom is progressing. The new drift into the bottom of the Argo seam was essentially finished by June, with belt and services installation completed by August. The company’s refurbished Joy continuous miner has been configured to match the cutting profile of the ABM25 in order to develop roadways in coal in preparation for the redeployment of the Magatar, and coal production from this activity commenced last month. But development is taking longer than anticipated due to tight labour supply conditions, and Caledon now think it will be November before they have enough staff underground to complete this operation.

But how is Cook doing right now? Has the picture ever been gloomy enough to warrant a 90% drop in the share price and a market cap of just £32 million?

To be honest, even though the half-year accounts have been released, it’s not a simple job to deduce the present from the past. For one thing, it is necessary to work in three currencies – the US$ for coal prices, the A$ for Caledon’s own accounts, and GPB for share price and market cap figures. And secondly, sales for the first five months of the year were delivered at the 2007 contract price which was sub-US$100 per tonne, so the June accounts only reflect a few weeks of revenue at the now prevailing rate of around US$280 per tonne.

The revised mining targets suggest the output of a further 300k – 350k tonnes of saleable coal by the year end, in keeping with the current production growth profile. With the current 85:15 coking:thermal coal split, and taking the lower target of 500k tonnes for the year this could generate – at US$280 per tonne – around US$70 million in coking coal revenues alone for the second half of the year. Converted to A$ at today’s rate, this gives full year revenues of A$135 million, without allowing for thermal coal sales in the second half. Costs for the first half were approximately A$175 per tonne sold, plus A$10 million in overheads, debt service etc.  Whilst it is not realistic to apply the high H1 mining costs per tonne to the increased output of the second half, it’s the only ballpark we have! Assuming 500k tonnes saleable output for the year, then, and assuming no unforseen difficulties, net profit before tax might be in the region of A$40 million, or about £16 million. Should the company reach its 550k tonne target, net profit could be approximately A$75 or about £30 million. So – provided their new mining targets are achieved - although the half year accounts reflect a significant loss, Cook should deliver a far more satisfactory year end result.

Investors are clearly beginning to wake up to the fact that at 15p per share, Caledon could well be sitting on a p/e ratio of just ONE! A glimmer of returning confidence in the commodity markets has made a big impact on Caledon’s share price, which is currently rising steadily towards 30p – a 90+% increase in less than three market days. Although such a rise cannot compensate shareholders for the mauling that commodity stocks have taken in recent weeks, it is a first step towards restoring Caledon’s market valuation to a less ludicrous level.