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 MARKET REPORTS |
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Stock pick
Stock of the week – Coal of Africa
May 19, 2008
Tim Morris, wise-owl.com analyst
Company: Coal of Africa
Code: CZA
Recommendation: Hold
Market Cap: $581m
It has been an action packed period since we profiled Coal of Africa (CZA) in early March. The company is well positioned to take advantage of booming global coal markets, and has been making solid progress at its South African coal projects. With followers of our recommendation now sitting on big gains, the focus for investors should shift to when is the right time to take profits.
For those unfamiliar with the story, South Africa is heavily dependant on coal, which provided 93% of its electricity requirements in 2005. This nation’s sole provider of electricity, ‘Eskom’, consumes 112million tonnes per annum (Mtpa). With most of its power stations running at near full capacity, it is in need of substantial new coal resources, and plans to build a new 12-15Mtpa coal fired power station every two years to satisfy growing domestic power demands. By developing its promising portfolio of South African coal projects, Coal of Africa aims to fill this domestic void and take advantage of strong coal export markets.
The company’s ability to meet coal hungry export markets was recently recognised by the world’s largest Steel company, ArcelorMittal, which is set to become a take a 16% stake in the company. The agreement with ArcelorMittal also encompasses an off-take agreement for a minimum 2.5m tonnes of coking coal per annum, with the option to increase off-take to 5m tonnes. The deal provides CZA a significant cash injection of over $130m to fund the development of its coal portfolio.
Recent developments within the CZA’s coal portfolio have seen the company move to full ownership of its most advanced project, ‘Mooiplaats’, where first production is now targeted for Q4 2008. Minable coal reserves currently stand at 76.1Mt based on exploration work covering 2/3rds of the company’s granted mining and prospecting rights. The initial plan is to produce thermal coal for domestic and export markets at a rate of 2.5-6Mtpa, after an 18-24 month ramp up period. At a production rate of 4.5Mtpa the project would support a mine life of 77 years. Expansions beyond this level are possible, but depend upon the results of exploration work to be conducted throughout the year.
Further exploration upside at Mooiplaats lies in the additional ground that the company is hopeful of securing the prospecting rights for. This area in question is currently under application, and if granted, would reduce the drilled area at Mooiplaats to only 1/3rd of the total landholding.
The company’s other key project, Holfontein, looks set to be sold to fellow ASX listed junior explorer, Lachlan Star (ASX code: LSA). The rationale for the sale has not yet been disclosed however we suspect that it will allow management to concentrate on developing the more advanced Mooiplaats project. The sale will also generate cash to fund other developments. The total price tag is $25m, made up of both shares in LSA and cash.
Coal of Africa’s largest resource base is hosted by its 100% owned Baobab project, located in the Limpopo province of South Africa. The project’s coal resources now total 713Mt, of which 156Mt has been identified as suitable for opencast mining. A conceptual feasibility study, drilling, and a mining application are all set to be undertaken from early 2008.
Combined with one of the company’s other projects located in the Limpopo province, known as ‘Thuli’, which itself hosts an inferred resource of 352Mt, Coal of Africa aims to ultimately produce 10Mtpa of coking coal. It is envisaged that 3Mtpa will be exported from Thuli, and 7Mtpa from Baobab. Providing clues as to the course of the eventual production ramp up from these two projects, the company has made moves to acquire rail freight rights for production of 1.5Mt in 2009, 4-5Mt in 2010-11 and 10Mt in 2012. Negotiations over freight rights are currently underway, and the company has indicated that confirmation will be provided in the June quarter.
Overall we view these developments as very positive. With a strategic shareholder as strong as ArcelorMittal, CZA should be well funded to realise its production ambitions. Since our initial ‘spec buy’ recommendation, the stock has experienced a very strong run, but given that the coal sector is still running hot and the company’s fundamentals continue to flourish, we are happy to continue riding any additional upside. However at the same time we are not inclined to allow juicy profits to become losses. Therefore in light of the strong share price run, while monitoring the company’s progress, we will watch the share price closely, so that we can signal to our members when they should be taking profits.
Tim Morris is an analyst at wise-owl.com, one of Australia's leading independent stockmarket research houses. Click here for your complimentary report.
Please note that CompareShares.com.au simply publishes analyst reports on this page. The publication of these reports does not in any way constitute a recommendation on the part of CompareShares.com.au. You should seek professional advice before making any investment decisions.
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