Coal sector M&A activity has picked up this year, with no end in sight. Rio Tinto (RIO) made a proactive acquisition when it bought an emerging coking coal player in Mozambique and it recently tendered for the 25% of shares of Australia's Coal & Allied Industries that it doesn't already own. Anglo American (AAUKF.PK) and BHP (BHP) are both reportedly looking at Walter Energy (WLT), (stock up 21% on Sept. 7th). Alpha Natural Resources (ANR) acquired Massey Energy, Arch Coal (ACI) acquired Intl. Coal. Vale and Tata Steel have great emerging coal market exposure in Mozambique. Glencore (GLCNF.PK) is stalking a south African coal producer named Optimium Coal. Peabody Energy (BTU) and Mittal (MT) are buying Macarthur coal. Peabody also won a coveted spot on Mongolia's Tavan Tologi development team. Please see my thoughts on Tavan Tolgoi here and here.
One company that has been noticeably absent from this game is Teck Resources (TCK). To be fair, Teck is already the second largest producer of premium hard coking coal in the world. But, Teck will not remain # 2 if the M&A dance continues without them. Alpha Natural Resources is catching up to Teck, and a combined Anglo American and Walter Energy would be a competitive threat. Teck has all of its coal assets in one Canadian basket, so the company would greatly benefit from some diversification.
The emerging coking coal exporting countries of Mozambique and Mongolia will increasingly be key drivers of supply. As was stated in the opening paragraph, some companies have already set down roots in these two frontier countries. However, Teck remains 100% exposed to Canada. Don't get me wrong, their Canadian coal operations are very good, but having all of one's eggs in one basket is risky. Seeing as there are already two dominant emerging coking coal players in Mozambique, Rio Tinto and Vale (VALE), Teck would have a hard time establishing a foothold in that country. However, in Mongolia one of the two dominant coal producers is a prime takeout candidate for a company like Teck. That company is named SouthGobi Resources (SGQRF.PK).
In part due to my copious comments and analysis on SA, I have recently been retained by SouthGobi Resources as a consultant. In my frequent talks with CEO Alex Molynuex, I continue to believe that the Company is a prime takeout target. Alex said on his 1st quarter earnings conference call, and again in an interview that I conducted with him, that 57% shareholder Ivanhoe Mines (IVN) is speaking with interested parties.
SouthGobi Resources, the Canadian-listed Mongolian coal producer, announced this week that it is producing coal at an annual rate of 5.3mm metric tonnes and that production continues to ramp up. In CY 2012, SGQ will mine and sell approximately 7mm tonnes of coal, most of it coking coal. This level of production makes SGQ one of the two dominant coal producers in Mongolia. Here is my instablog on SGQ's press release.
While much has been written about Mongolia's massive Tavan Tolgoi coking coal deposit, market participants appear largely unaware that SGQ's production profile will dwarf that of the 3 recently announced winning mining groups. For example, Tavan Tolgoi is expected to be producing 15mm metric tonnes of coal, about 2/3 of it coking coal, by 2016. Of that amount, Peabody Energy will control 3.6mm tonnes with its respective 24% stake in the project.
By 2016, SouthGobi will be producing 12mm-13mm tonnes of coking coal, including 3mm tonnes of premium hard coking coal. As such, SGQ will remain one of the top two producers in Mongolia for many years to come. As a dominant producer in a frontier country that many global miners, steel companies and commodity traders like Glencore (GLCNF.PK) want to get access to, SGQ is a prime takeout candidate. To put SouthGobi's production in perspective, within 5 years it will be exporting roughly half of what Teck currently produces. Combined, Teck and SGQ would be producing greater than 40mm tonnes of coking coal, keeping Teck comfortably in second place behind the BHP-Mitsubishi Alliance.
I believe that within 6-12 months, SGQ will be taken out. The reason for my conviction is twofold. First, like Mongolia, Mozambique is an emerging coking coal exporting country with two dominant coking coal companies. There, Rio Tinto just acquired one of the two dominant players, Riversdale Mining, for a hefty 8.5x 2014 EV/EBITDA multiple. The other major player in Mozambique is global mining giant Vale. Second, the company is known to be for sale. Interested parties are already talking to 57% majority owner Ivanhoe Mines. Teck should take a close look at SouthGobi. If they don't acquire it, a competitor will, leaving few options for Teck to gain access to Mongolia.
Just as many miners are interested in getting into Mozambique, many are also interested in getting a foothold in Mongolia. In fact, Mongolia's coal exports are already running at greater than 20mm tonnes per year, while Mozambique is only beginning to export coal in 2h 2011. Mozambique is thousands of kms from China, while SouthGobi is just 45km from the Chinese border. Coal from SouthGobi's mines arrive at Chinese steel mills faster and more reliably than coal from, say, Canada, Australia or Africa.
SGQ is in the early stages of substantial organic earnings and production volume growth. Within 3 years, the company will be exporting at a run-rate of 10mm tonnes of coking coal and generating a run-rate of up to $600mm in EBITDA. Compared to the 8.5x multiple of 2014 EBITDA that Rio Tinto just paid for Riversdale Mining, SGQ is trading at less than half of that. Sooner or later, perhaps when the world realizes how slow the ramp up will be at Mongolia's Tavan Tolgoi coking coal deposit, potential suitors will recognize not only how cheap SGQ is, but also its importance as a major strategic asset serving China's every growing needs.
SGQ is the perfect hedge for the global seaborne coking coal markets. If (when) Australia's coking coal mines get inundated by massive flooding, as they have twice in the past 4 years, SouthGobi's proximity to China becomes even more valuable. Strikes, transportation bottlenecks and severe winter weather in Canada and other coking coal exporting countries represent further headwinds for global supply that is mitigated by SGQ's production on China's doorstep.
Finally, SGQ's enterprise value of about $1.6 billion makes it easily digestible. Given the proven ability of the global miners to issue debt with fixed coupons of 4%-5% these days, SGQ is a very cheap option on the continued tightness of the coking coal markets. I think that any of the following companies could be interested in acquiring SGQ; BHP, VALE, Anglo American, Xstrata (XSRAF.PK), Glencore, Noble Group (NOBGF.PK), ArcelorMittal, New World Resources (NWCSF.PK), Banpu (BNPJF.PK), Exxaro (EXXAF.PK), Walter Energy, Fortescue Metals, BTU or Arch Coal (ACI).