What's Fording Canadian Coal's Takeout Value?

A major coal deal was struck in the United States this week, as Cleveland Cliffs Inc. (CLF) agreed to buy Alpha Natural Resources Inc. (ANR) for almost $10-billion.

That got Desjardins Securities analysts John Hughes thinking: What would a takeout of Fording Canadian Coal Trust be worth?

By factoring in a number of financial and physical metrics based on the Cleveland-Alpha deal, he calculated a "theoretical" takeout value for Fording of C$98.96 a unit, a premium of about 20% on the current price.

In a note to clients, Mr. Hughes wrote:

We understand that this exercise is largely a game in numbers; however, the values are based on a 'real' deal currently in the marketplace.

He also pointed out that Fording produces only metallurgical coal, while Alpha Natural produces a combination of metallurgical coal and lower-priced thermal coal.

Mr. Hughes maintained his "buy" rating and price target of C$85 a unit on Fording. He calculated that the company should pay out C$12.50 a unit in distributions this year based on its coal contract price of $275 a tonne. He also points out that even higher prices are possible in the next coal contract year beginning in April of 2009.

He wrote:

We note several other 'players' in the seaborne metallurgical coal market continue to negotiate for the current contract year, including recent market rumours indicating a target level of $370/tonne for contracts with Japanese steel producers. Any announcement regarding a settlement of contract prices at or near this level would be an extremely positive indication of potential contract prices for Fording for the upcoming contract year.

Comments

[Mark fromReston]

I haven't read Hughes' analysis so I don't know how he got his number, but based on the ANR deal, I tried to run some numbers also to come up with a value for FDG.

First, because the Cleveland Cliffs offer for ANR was part cash/part stock, the value of the deal has fluctuated with the movement of Cleveland Cliffs' stock price. Originally, the deal was reported to be worth $10 billion, but they also used an $8.3 billion figure. To be conservative, let's use Yahoo Finance's current market cap figure for ANR of $6.86 billion, which also has the effect of backing out ANR's debt.

Based on the ANR deal and the info contained in their deal presentation, I used 2 metrics disclosed in the ANR deal and applied them to FDG. One is value to revenue and the other is value to reserves.
For value to revenue, ANR had $2.5 billion in estimated 2008 revenue of which 56% is from met coal or $1.4 billion in met coal rev. Using the $6.86b deal value, gets you a multiple of 4.9 times revenue. FDG is expected to have $3.7 billion in revenue (using the Yahoo Finance estimates, which may or may not reflect the new contract price for met coal). Using the 4.9 multiplier and dividing by approximately 150 million outstanding shares for FDG, gets you approximately $120 per share.

The valuation based on reserves is a little trickier. ANR has 61.8 mm total reserves, of which 73.4% or 45.36 million tons are met coal. The deal value to reserve ratio is thus $6.86 b divided by 45.36 mm or $151per ton of reserves
Fording's website states their reserves at 664 mm tons. I don't know if this is an apples-to-apples comparison with the "type" of reserves for ANR (i.e. proven or proven and probable), but it is the lowest figure stated on the FDG website. In addition, it's not clear if this figure represents FDG's 60% interest in the Elk Valley coal mine or if it is the total amount of reserves. For the sake of argument, I will assume FDG has 60% of those reserves or 398 mm tons. Multiply by the $151per tn from the ANR deal and you get a total value of $60 billion. Divide by 150mm shares and you get a figure of over $400 per share. That seems high to me and maybe the reason is that since FDG has larger reserves and a longer time to sell them, they have to be discounted over a longer time frame. Also, the ANR deal could have placed a greater weighting on the steam coal portion of ANR's business on the theory that the demand for steam coal will be more constant without the huge variations in price that we have seen in met coal over the past few years.
At any rate, a few years back when met coal prices rose to approximately $200 per ton, FDG share price rose to approximately $120 per share. It's hard to imagine with met coal prices close to $300 per ton and the possibility that they stay close to that range for possibly another year that FDG's stock price does not surpass $120.

[Emerald]

Fording has burned investors in the last three years so be careful with management here. They are not on everyone's buy list.

[Mark fromReston]

My apology, but I have made several mistakes in my message. First, I misstated the amount of reserves for ANR and thus all my numbers are off. It has been reported to me that the industry looks at total reserves, which includes 3 different categories. Also, I erred in trying to calculate FDG's price by forgetting to account for the prior stock split. On a pre-split basis, FDG would already be at 3 times its current price, so the comment about comparing the current met coal price to the stock price is inaccurate. Again, apologies for bad work.

[pachanguero]

nice work mark

[John Egan]

Emerald... Or anyone.... Re: "Fording has burned investors in the last three years so be careful with management here. They are not on everyone's buy list.".... Re we talking about something like the Halloween issues for HTE, or are you suggesting something else... I have been looking at Fording for their type of coal and dividend, but can't seem to find any issues as suggested.... (Gotta admit, their numbers on Yahoo don't look very promising.. )

Thx jegan ;-)