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44.20.7050.6648
Nick Chalmers
44.20.7050.6636
nicholas.chalmers@canaccordadams.com
Reborn as Australian coal producer
BUY Acquires coking coal mine in Queensland
Caledon has acquired a 100% interest in the Cook coal mine in Queensland from
CDN : AIM : £0.07 (£0.36*)
Xstrata for the equivalent of around US$36 million. It also has an option to purchase
TARGET PRICE: £0.12 (£0.59*) the nearby Minyango coal exploration license area.
*Post 1-for-5 consolidation Production from Q1 2007
A US$15 million investment program is planned to allow production to recommence in
early 2007 and to build to a plateau of 1.8 million tonnes of coal per annum by mid-
2008. We estimate total operating costs at about US$54 per tonne, delivered FOB
Inside
Gladstone.
Executive summary ........................ 3
Background ..................................... 9
Steady-state operating cash flow of around US$29 million per annum
Our long-term average coal price for the 80% coking coal and 20% thermal coal mix
Project descriptions ..................... 15
likely to be produced at Cook is around US$70/tonne, giving a margin estimate of
Cook Coal Mine..............................15
US$16 per tonne, or an average operating cash flow estimate of around US$29 million
Minyango Coal Project...................28
Chinese Gold Assets......................31 per annum.
Recommendation
We initiate coverage of Caledon Resources with a BUY recommendation and a target
price of £0.12 per share, or £0.59 per share on a post share-consolidation basis.
Risks
We note that our valuation is highly sensitive to assumptions of the future coal prices.
We also note that the valuation includes the option over the Minyango at cost. This
project has the potential to deliver significant value, should exploration confirm the
company’s expectations of coal quantity and quality.
Canaccord Adams is the global capital markets group of Canaccord Capital Inc. (CCI : TSX|AIM)
The recommendations and opinions expressed in this Investment Research accurately reflect the Investment Analyst’s personal,
independent and objective views about any and all the Designated Investments and Relevant Issuers discussed herein. For important
information, please see the Important Disclosures section in the appendix of this document.
GBp
5
Enterprise Value £22M US$43M
4
Historical Financials 3
EXECUTIVE SUMMARY
Caledon has surfaced from a period of restructuring as an emerging middle tier coking
coal producer, having previously focused on gold exploration in China. Through a series
of transactions, the company has acquired the Cook Coal Mine, located in Queensland’s
prolific Bowen Basin, and an option over the adjacent Minyango exploration license. It
has recently completed equity and debt financings, which have funded the acquisition
and the refurbishment of the mine and associated wash plant.
Caledon formally agreed in August to purchase the Cook Mine from Xstrata for A$45.6
million (approx US$36 million) in cash. The transaction is expected to close later this
month, subject to shareholder approval at an extraordinary general meeting scheduled
for 13 December 2006. The company plans to bring the mine back into production
around the end of this year or early 2007, and to ramp up to steady-state production of
1.8 million tonnes of coal per annum from mid-2008. We estimate total steady-state
costs of production, including royalties, at US$54 per tonne of coal delivered FOB
Gladstone.
The mine is expected to produce around 80% coking coal and 20% thermal coal, for
which our long-term forecast prices are US$74 and US$53 per tonne FOB respectively.
(Our forecast long-term price for Cook coking coal of US$74 per tonne represents a 7%
discount to Canaccord Adams’ long-term forecast for Australian hard coking coal,
reflecting market consultant McCloskey’s view that, as a premium semi-hard product,
Cook coal is likely to fetch an FOB price somewhere between the benchmark hard and
semi-hard price.) With an average coal product sales price of US$70 per tonne, the
indicated steady-state forecast gross margin would therefore be US$16 per tonne, or
US$29 million per annum.
JORC compliant in-situ measured and indicated resources are 126 million tonnes, within
which recoverable run of mine reserves are 17 million tonnes, sufficient for the first 10
years of the operation. The likelihood of extensions to reserves beyond these levels was
pointed to by independent consultant SRK, which stated in its recent Competent Person’s
Report that it considers it highly likely that adequate accessible resources are available to
extend the reserve to and beyond 40 million tonnes of recoverable coal, which would
extend the mine life to over 20 years.
earmarked for the refurbishment of the mine and a further A$12-15 million for the coal
preparation plant. Estimates for working capital and other owner’s costs are A$12
million and A$8 million respectively.
Caledon has yet to finalise contract negotiations, but SRK has assumed fixed mining costs
of A$33.50 per tonne of RoM coal for the Magatar operation in its Competent Person’s
Report, this figure being based on projections provided by Caledon. We note that given
the fixed-cost structure of the mining contract, any cost benefit of this new system
compared to conventional continuous miner/shuttle car systems would accrue to the
contractor, the benefit obviously being that any overrun would be borne by the
contractor. However, we also note that Caledon may seek to finalise a mining contract
which is not fixed cost, therefore allowing it to benefit from any cost-savings achieved by
the proposed continuous mining-haulage system. Given the potential for cost savings and
the economies of scale offered by the project, we feel the latter option would be the
optimum outcome for Caledon.
The coal processing plant washes and sorts the coal, on the basis of density, to reduce
the ash content and to produce separate coking and thermal coal products. These are
then loaded onto wagons using the existing rail loop that connects the plant with the
state owned rail system, which transports the coal the 200 kilometres to export terminals
on the coast. Queensland’s rail and port infrastructure is currently running at around its
annual capacity of approximately 140-150 million tonnes of coal. As a consequence of
the mining industry’s plans to increase production to 210 million tonnes of coal by 2010,
port and rail capacity is being expanded with the aim of removing the current bottleneck
within two years. In the interim, Caledon will have the right to part of Xstrata’s quota for
rail and port capacity. Marketing of the coal will be undertaken by Xstrata under an
agreement which lasts for two years.
There is potential for additional reserves on the Cook license itself and further potential
exists on the adjacent Minyango Exploration License, over which Caledon has an option
to purchase 100% for total payments of A$40 million (US$30 million). Minyango hosts
down-dip extensions of the coal being mined at the adjacent Blackwater and Curragh
open pit mines, and strike extensions of the coal being mined at Cook. Company
presentations refer to a non-JORC compliant global in-situ resource inventory of 500
million tonnes of coal and SRK quotes Queensland government estimates that in-situ
resources within two seams to less than 300 metres of overburden total 205 million
tonnes. We note, it is likely that only one of the two coal seams will be mined. Caledon’s
management believes Minyango has the potential to be brought into production within a
relatively short period, at a rate of up to two million tonnes per annum for over 20 years.
Caledon’s initial work will focus on additional seismic and drilling programmes to better
define the structural characteristics of the seams, coal quality and extent of resources on
the property.
Caledon has assembled an experienced management team for the project. This includes
Peter Seear, as chief operating officer, and Mark Trevan, as managing director of its
Australian subsidiary. Mr. Seear has almost forty years experience in the coal industry,
including time in coal contracting and equipment manufacturing. Mr. Trevan joins
Caledon after 25 years with Rio Tinto, where for the last nine years he was general
manager – marketing for Rio Tinto Coal Australia.
Finances
At the end of November, Caledon raised a total of US$52 million (£26.5 million) in equity
through the issue of 331 million shares at a price of £0.08 per share. Together with the
25 million shares to be issued in connection with the acquisition of MTP (the company
that owns agency rights to the use of the proposed mining system in Australia) this will
increase the (pre-consolidation) number of shares in issue from 338 to 694 million.
Caledon will also receive US$12 million (A$15 million) in vendor financing from Xstrata
in the form of a convertible loan note. Together with cash held at the end of June 2006 of
US$16 million (£8 million), this takes Caledon’s total financial resources to US$79
million.
Of this amount, US$36 million (A$46.5 million) will be paid to Xstrata for the purchase of
the Cook Mine, and around a further US$7 million will be paid in stamp duty, transaction
costs and financing fees. Approximately US$9 million is to be used for the deposit and
first option payment in relation to the acquisition of the Minyango exploration license.
(The next A$9.6 million option payment due in March 2007 is payable in shares or cash,
at Caledon’s option. The company intends to fund the final payment of A$20.4 million,
which is due by the end of 2007, from cash flow.) Including a cash payment of US$0.4
million as part consideration for the purchase of MTP takes the total initial cash outflow
to US$51 million, which would leave cash of US$27 million at the end of 2006.
Together with after-tax operating cash flow from Cook during the first year (2007),
which we estimate to be US$14 million net of corporate G&A, the remaining cash
balance will be used to fund the mine and plant’s refurbishment (US$15 million) and
associated working capital and owners costs (US$15 million). By our calculations this
would leave cash of around US$11 million, which we note would be insufficient to fund
the planned feasibility programme and US$15 million (A$20.4 million) final option
payment at Minyango. However, we note the potential for operating profit in 2007 to
come in higher than our forecast, particularly if coking coal prices were to remain
around current levels of US$115 per tonne, compared with our 2007 forecast price for
Cook coking coal of US$93 per tonne. We also note that the company states in the re-
admission document that, if necessary, it may seek to raise additional debt or equity to
meet the deferred Minyango payments and capital expenditure commitments over the
next 15-months as they fall due.
DD&A US$M -1 -2 -2 -2 -2 -2
EBIT US$M 7 21 28 24 19 21
Interest US$M 0 0 0 0 0 0
Tax US$M -2 -6 -8 -7 -6 -6
Earnings US$M 5 15 20 17 13 15
Cash Flow
Operating cash flow US$M 0 8 19 20 17 13 15
Invested cash flow US$M -53 -45 -1 0 0 0 0
Cash flow from financing activities US$M 64 0 0 0 0 0 0
Net cash flow US$M 11 -37 18 19 17 12 14
Cumulative cash flow US$M 11 -27 -9 10 26 39 53
Valuation
Given its status as a development company, we consider that a sum-of-the-parts
approach is the most appropriate valuation methodology for Caledon at this stage. We
have also compared the valuation with other listed coal companies to provide context.
Using a discount rate of 8%, which we would typically use for a non-precious metal
producer located in Australia, we derive an NPV for the Cook Mine of A$148 million
(US$116 million) for the first 10-years of operation, or A$230 million (US$181 million)
for the potential 20-year life as supported by SRK’s expectation that additional resources
will be converted to reserves (see summary cash flow model for Cook Mine in Figure 26).
To arrive at our target price we have reduced the value of the first 10-years by 20% to
take account of the risks that we believe are associated with achieving the targeted
production levels and cost structure. We have reduced the value of the second 10 years
of the project by 30% in recognition of the additional risks we believe are involved with
completion and resource conversion.
We have also allowed for the value of Minyango at cost (US$8 million first option
payment), Caledon’s Chinese exploration interests (nominally valued at US$5 million)
and the company’s stake in Dynasty Gold (US$2 million). We have also allowed for our
estimate of residual cash at end of 2006 and the convertible debt provided by Xstrata.
The following table gives a breakdown of our suggested valuation for Caledon.
Figure 3: Valuation
8% Full value Risk Risked
discount rate A$M US$M Valuation
Cook (yrs1-10) 148 116 20% 93
Cook (yrs 11-20) 82 65 30% 45
Minyango 10 8 0% 8
Chinese gold assets 6 5 5
Dynasty stake 2 2 2
Enterprise Value 249 196 153
Net current assets 27 27
Long-term debt -12 -12
Net Asset Value 211 168
With respect to this valuation, we note that the forecast operating costs are relatively
fixed (mining and processing are both contracted) and that capital costs are relatively
limited. As a result, even more than usual with this type of analysis, the main driver of
the valuation relates to revenue, both in terms of production and coal price.
With respect to the rate of production, we consider that the ability to control ground
conditions at the operation is the most significant factor. We note that the planned
mining method incorporates a revised bolting pattern which should allow mining in a
given area to be completed more rapidly than previous methods.
With respect to the coal price, we note that coking coal from Cook is categorised as being
between hard and semi-hard in quality. Coal consultant McCloskey suggests that, as an
independently-marketed product, it would sell at a discount of around 7% to McCloskey’s
long-term forecast price for premium hard coking coal. In our base-case valuation, we
have applied a similar discount to Canaccord Adams’ long-term forecast price for hard
coking coal, which we note is somewhat lower than McCloskey’s. We note that if
McCloskey’s suggested long-term price of US$84 per tonne for Cook coking coal was
applied to our model, our risked valuation would increase from £0.12 per share to £0.16
per share.
The following sensitivity table plots our risked NAV estimate for a range of coking coal
prices and discount rates. We would point out that this sensitivity table assumes coking
coal prices are flat from 2008 onwards, whereas in our base-case valuation our long-
term flat price of US$74 per tonne comes in at year 2012.
Discount rate
8% 0.02 0.04 0.07 0.09 0.11 0.14 0.16
10% 0.02 0.04 0.06 0.08 0.10 0.12 0.14
12% 0.02 0.03 0.05 0.07 0.09 0.10 0.12
15% 0.01 0.03 0.04 0.06 0.07 0.09 0.10
Source: Canaccord Adams estimates
We note that our risked valuation in Figure 3 does not take account of the potential for
additions to reserves, particularly from the Minyango license area, but also from Cook,
beyond the 40 million tonnes assumed in our model. Nor does it take account of the
potential to increase throughput at the coal plant, which was originally designed to
process 3.5Mtpa of coal, some 75% greater than the anticipated production rate. We note
that additional capital would be required to bring the plant up to its original design
capacity and to expand existing mine site infrastructure to cope with the increased
production rate.
We have assembled a table of Australian listed coal companies and their consensus cash
flow and earnings (Figure 28). This indicates that, on average, these companies trade on
multiples of earnings ranging from 5.4-20.6 times (average 12.6) 2008 earnings and
within the range of 3.8-17.4 (average 8.8) times 2008 cash flow. Applying these averages
to Caledon’s forecast earnings and cash flow would suggest a value of £0.12-0.14 per
share.
Investment Risks
The main risks to our target price, and rating, are attached to revenue (being a function
of coking and thermal coal prices), the Australian/US dollar exchange rate and
production volumes. The large amount of existing infrastructure and plant already on
site, together with the planned use of contract miners and plant operators, results in
relatively low budgeted capital costs and an operating cost structure that is largely fixed.
The key risk to our valuation is that the company may not achieve its targeted production
rate at the cost it has indicated should be possible, and we note that the valuation is
particularly sensitive to coal prices.
Risks relating to coal transport and marketing are limited by the two-year port and rail
access deal and marketing contracts negotiated with Xstrata, although longer-term we
note that the company will have to make its own rail and port arrangements.
We also note the significant potential for additional exploration on the Minyango coal
license area to better define coal resources, to establish the coking coal/thermal coal split
of the seams, and also to get a better understanding of the structural geology of the area.
Conclusion
We consider that the refurbishment of the Cook Mine offers the prospect of generating
significant cash flow in the short-term and the option over the Minyango license offers
the potential for an increase in reserves and production rate in the future.
We initiate coverage on Caledon with a BUY recommendation and a £0.12 per share
target price (or £0.59 per share on a post-consolidation basis). We note that achieving
the operating targets at Cook would remove the risk factors that we have chosen to
apply, with the result that our calculated NAV would increase by around 30% to £0.15
per share.
BACKGROUND
Overview
Caledon Resources plc was admitted to London’s AIM market in 2003, initially focusing
on four gold projects in Southern China. More recently, the company has taken equity
interests in a number of companies through private placements. This included minority
stakes in Afcan Mining Corp (owner of the Tanjianshan gold project in western China)
and Dynasty Gold.
The company’s search for an appropriate acquisition culminated in late 2005 with an
approach from a third-party proposing Caledon purchase the Minyango coal property, an
undeveloped brown-field coking coal asset in Queensland’s prolific Bowen Basin. Whilst
in preliminary discussions over Minyango, Caledon became aware of a competitive
tender for the adjacent Cook Mine by the latter’s owner, a subsidiary of Xstrata plc
(XTA:LSE). Management subsequently decided to proceed with both the Minyango and
Cook transactions, on the basis that Cook added existing production and supporting
infrastructure, plus an estimated resource base of over 100 Mt of high-quality coking
coal, to Minyango’s exploration potential.
In June 2006 Caledon signed a heads of agreement with Xstrata to acquire Cook for a
total consideration of A$45.6 million in cash, and the company’s shares were suspended
from trading (by virtue of its size the transaction was deemed a reverse takeover under
AIM’s rules). The principal acquisitions and disposals are scheduled to be completed
following an extraordinary general meeting on 13 December 2006, at which
shareholders will vote to approve the transactions and the recently completed £26.5
million equity financing. Assuming approval, the newly issued shares will be admitted for
trading on AIM the following day (14 December 2006).
In connection with the Cook and Minyango acquisitions, Caledon also agreed to purchase
a company called MTP, owner of certain intellectual property rights and revenue
royalties arising from mining technology that Caledon intends to use at Cook. A$5 million
of the A$8.5 million purchase price will be settled through the issue of new Caledon
shares at the placing price of £0.08 per share. A further A$3 million in shares will be
paid, at the then prevailing market price of the shares, on completion of the Minyango
acquisition, and the A$0.5 million balance of the total consideration will be settled in
cash. MTP’s principal directors, Peter Seear and Mark Syropoulo, introduced Caledon to
the Minyango and Cook acquisition opportunities, and will be appointed to Caledon’s
board of directors.
Share Structure
Caledon’s shares are listed on AIM under the ticker ‘CDN’. The shares were suspended
from trading on 19 June 2006 following the announcement of the proposed acquisition of
Cook, the transaction constituting a reverse takeover under AIM’s rules. Caledon had
338 million shares in issue prior to suspension, which at that time were trading at
£0.0588 per share.
During the suspension period, the company placed 331 million new shares at £0.08 per
share, raising gross proceeds of £26.5 million. The placing, plus a planned one-for-five
share consolidation to follow, is subject to shareholder approval at an extraordinary
general meeting scheduled for 13 December 2006. If approved, the new shares will be
admitted for trading on AIM the following day (14 December 2006).
A further A$5 million in shares will be issued as part payment under the A$8.5 million
MTP acquisition agreement. The company will therefore have approximately 139 million
post-consolidation shares in issue, giving it a market capitalisation of £56 million based
on the placing price. On a fully-diluted ‘in-the-money’ basis, Caledon will have 140
million shares outstanding.
Finances
Caledon had US$16 million (£8 million) of cash at its last balance sheet date of 30 June
2006. The US$36 million (A$45.6 million) Cook acquisition and initial deposit and option
payment under the Minyango acquisition agreement (US$9 million) will be funded using
the US$47 million (£23.7 million) net placing proceeds. The balance of the placing
proceeds, plus a further US$12 million (A$15 million) which is to be raised through the
issue of a convertible loan note to Xstrata, will be used to fund initial capital expenditure
requirements at Cook (US$15 million) and initial working capital and owners costs
(US$15 million). Caledon is still negotiating with Xstrata over the terms of the loan note,
but it is expected to have an annual coupon of 9% and to be convertible into Caledon
shares at a price equal to a 10% premium to the £0.08 per share placing price. The
principal amount is repayable after a year if the note has not by that date been converted
by Xstrata.
The second, A$9.6 million option payment due in March 2007 is payable in shares or
cash at Caledon’s option. The company intends to fund the final payment of A$20.4
million, which is due by the end of 2007, from cash flow. However, we note that Caledon
states in its AIM re-admission document that, if necessary, it may seek to raise additional
debt or equity to meet the deferred Minyango payments and capital expenditure
commitments over the next 15 months as they fall due.
BOARD/MANAGEMENT
Robert Alford - Executive Chairman
Mr. Alford joined Caledon as non-executive chairman in February 2005. He took up the
position of executive chairman in September 2006 in order to manage the company’s
transition from Chinese-focused gold explorer to Australian coal producer. Mr. Alford
previously spent over 20 years with Nelson Hurst Group plc, where he was latterly joint
managing director. He is a member of Lloyds.
role which led eventually to the establishment of Menzies Gold. He is a member of the
Australian Institute of Mining and Metallurgical Society and a Member of the Mining
Industry Consultants Association.
PROJECT DESCRIPTIONS
COOK COAL MINE, QUEENSLAND
The Cook Coal Mine is located 30 kilometres south of the town of Blackwater in the
south-central part of Queensland’s Bowen Basin, one of the world’s great coal provinces.
The coal preparation plant (CPP) is located 14 kilometres north of the mine, at the site of
the abandoned Leichhardt colliery. The Cook property is bounded to the east by the BHP-
Mitsubishi owned Blackwater mine, one of Australia’s largest open-pit export-quality
coal mines.
There are currently 30 coal-mining operations in the Bowen Basin, collectively producing
approximately 115 Mt per annum of coking coal. Open pit and underground production
from the basin represents more than 50% of the world’s sea-borne coking coal. The vast
majority of underground coking-coal mines in the Bowen Basin are longwall mining
operations.
Cook acquisition
Prior to its acquisition by Caledon, Cook was part of Xstrata’s Queensland Coal
operations, which encompass two well-established mining complexes, Oakey Creek and
Newlands-Collinsville-Abbot Point. In June 2006, Caledon and Xstrata signed a heads of
agreement for the sale of Cook to Caledon, and an asset-purchase agreement was drawn
up in August. A relatively small asset in the context of Xstrata’s overall coal portfolio,
Cook has suffered from underinvestment in recent years, and was placed on care and
maintenance prior to the sale negations with Caledon. Caledon is of the opinion that
Xstrata wished to divest the asset as it required a disproportionate amount of
management time, being the only small underground mine in the company’s Bowen
Basin portfolio.
The full A$45.6 million cash purchase price will be settled later this month, subject to
shareholder approval of the transaction and capital raising at an EGM scheduled for 13
December 2006. An initial A$5 million down-payment was paid in July from Caledon’s
existing cash reserves, and the A$40.6 million balance will be funded using the placing
proceeds.
The acquisition includes all mining rights to the Cook Mine resource, reserve, mine
infrastructure and mining equipment; sub-leases over haulage roads; and access to the
CPP, rail loop and load-out facilities. It also provides for a long-term rental agreement
allowing Caledon use of the CPP, and outlines the terms of marketing and off-take
arrangements for the sale of coking coal from Cook as well as rail and port access
guarantees for the first two years of operations.
Xstrata chose not to sell directly CRM, the company holding the Cook mining lease, as it
wishes to retain the undeveloped northern part of the property. CRM has instead granted
subleases to Caledon. All the other CRM assets described above were included in the
sale. Caledon considers that the northern portion of the Cook resource has little
commercial value without access to the remainder of the Cook property and the adjacent
Minyango property.
MTP acquisition
In connection with its Bowen Basin acquisitions, Caledon is also purchasing the entire
issued capital of Mining Technology Partnerships Pty Ltd (MTP), a company that owns
revenue royalties arising from the mining technology that Caledon intends to use at
Cook. The acquisition will be settled through a A$500,000 cash payment, the issue of
A$5 million in new Caledon shares at the £0.08 per share placing price, plus an
additional A$3 million in shares, to be issued at the then prevailing market price, on
completion of all staged payments under the Minyango acquisition (see page 29).
MTP and its principal directors, Peter Seear and Mark Syropoulo, introduced the
potential acquisition of Minyango to Caledon, which in turn led to the company’s interest
in Cook. Caledon proposed the acquisition of MTP in lieu of paying a direct introduction
fee to Messrs Seear and Syropoulo. However, MTP is also the exclusive representative in
Australasia of Magatar, the proprietor of certain intellectual property rights relating to
the continuous mining-haulage technology that Caledon plans to use at Cook. MTP is
entitled to receive revenue royalties equal to 5% of the per-tonne amount to be charged
by Magatar arising from the use of the mining technology by Magatar at any mining
contracts entered into in Australia (with the exception of Cook and Minyango), New
Zealand and Indonesia.
Production history
Cook was established by Broken Hill Proprietary (BHP) in 1975 to replace production
from the failing Leichhardt Colliery to the north, which was eventually closed in 1982.
BHP’s operations focused on the Castor Seam, which when washed produces export-
quality coking and thermal coals.
In 1983 the mine was sold to McIlwraith McEachern, whom subsequently sold it to Arco
in 1989. Arco held Cook for four years, before selling to Oakbridge in 1993. Oakbridge
sold 50% to Resource Management & Mining (RM&M) and 50% to Glencore International
AG in 1994. RM&M sold their half share to Centennial Coal in 1997, and Xstrata took
over Glencore’s interest in 2002. Xstrata subsequently purchased Centennial’s 50% share
in April 2004, increasing its ownership to 95%. Tokyo Boeki Limited (TBL) purchased the
outstanding 5% from Glencore as part of its coal-purchasing strategy. Xstrata replaced
Centennial as the mine operator at this time.
Both longwall and continuous mining techniques have been employed at Cook in the
course of its operating history. Prior to placing the mine under care and maintenance,
Xstrata was operating a board and pillar underground mine in the Castor Seam, utilizing
conventional continuous mining equipment. Initial workings were also driven into the
Argo Seam below. Production has fluctuated widely over recent years, due mainly to
difficult geological and geotechnical conditions. Continuous miners have proved better
equipped to deal with these issues, as the performance of longwall mining units is
inhibited by the occurrence of extensive faulting in the area. Saleable coal production at
Cook has averaged around 400,000 tpa over the past five years, but declined to around
200,000 tpa in the year to June 2005 (Figure 10).
The coking coal product from Cook is currently railed 318 kilometer via the Blackwater
rail system to the port of Gladstone for export.
600
500
400
kT
300
200
100
0
2001 2002 2003 2004 2005
Source: CRM
The Castor Seam has been the primary source of historic production from Cook, and is
encountered at a depth of approximately 170 metres from surface. The seam averages
2.8 metres in thickness and its product mix is approximately 55% coking quality and
45% thermal quality. The Argo Seam (which is actually a coalesce of two seams, Pollux
and Orion) is encountered at a depth of around 183 metres, and is the primary target
seam for mining by Caledon. Argo ranges in thickness from 2-6 metres, averaging
between 4.5-5 metres. There is limited data on the quality of Argo Seam coal, but initial
indications are that the coking/thermal split is higher in favour of coking coal compared
with the Castor Seam. Caledon indicates that the split could be around 80-85% coking
and 20-15% thermal, with the Pollux Seam material indicating higher coking-coal
qualities than the Orion Seam material.
Workings on the Castor Seam at Cook have been bounded by two major fault systems –
the Kennedy fault to the north and the Tannyfoil fault to the east. Many smaller faults
have also been identified through the progression of mine development, and the
structural geology of the seam is now well understood.
Over 3,000 boreholes have been drilled over the entire Cook and Leichhardt Collieries, of
which 1,400 holes cover Caledon’s Cook project area. The Castor Seam was intersected
by 1,350 holes, and the Argo Seam by 400 holes.
The most recent resource estimation for Cook was compiled by McElroy Brian Geological
Services (MBGS) in June 2005. Since calculation of that resource estimate, less than
200,000 tonnes of coal has been mined from the Castor Seam, while none of the Argo
Seam has been depleted. As part of its due diligence review of Cook Coal, SRK reviewed
MBGS’ resource estimation and concluded that it satisfies the requirements of the JORC
Code for mineral resource reporting. SRK points out that the area to the northeast of the
Kennedy and Tannyfoil faults is not entirely included in the MBGS resource report, and
believes it is an area which may yield a significant amount of additional resources.
SRK also prepared an independent estimate of reserves at Cook based on the MBGS
resource numbers and a 10-year mine plan prepared by SMG Consultants. The estimated
reserves are inclusive of the estimated coal resources, and are based on recovery factors
ranging between 32-50%, depending on the mining method and panel layout. SRK notes
that these extraction factors could possibly be optimised as more information becomes
available during the mining process, and states that adequate accessible resources are
available to justify 40Mt of ‘recoverable’ coal. No out-of-seam dilution has been applied
to the RoM numbers as Caledon plans to leave behind around 0.5 metres of hanging-wall
coal to support roof control. In-seam dilution is minimal. The reserves are reported as
‘saleable’ based on an overall yield of 89% from January 2008 onwards.
Coal quality
Coal quality data for the Argo Seam is scarce, and, based on currently available
information, SRK concluded that only broad assumptions can be drawn. The data
captured to date comes from two Xstrata boreholes, strip samples and a bulk sample
(Figure 14). We note that a significant amount of coal from Xstrata’s trial Argo Seam
workings has been washed in the past, yielding approximately 80% coking-quality
product and 20% thermal-quality product.
According to MBGS, the down-hole geophysical trace of the Argo Seam shows a
consistent profile across the project area. MBGS concludes this indicates that the Argo
Seam has a tendency to be reasonably consistent in terms of coal quality attributes, and
that ash content and density could be expected to be regular across the project area.
Despite the lack of coal-quality data for Argo, SRK assumes in its competent persons’
report that the product mix will be 82% coking coal and 18% thermal coal. This
assumption is based on a coal-quality report by A&B Mylec published in September
2006. The moisture and ash parametres adopted by SRK (coking product 9.5% moisture
and 8% ash, thermal product 9% moisture and 15% ash) are assumptions based on
parametres shown in a frame agreement that Cook Colliery negotiated with the adjacent
Blackwater Colliery.
Caledon is currently testing a total of 32 data sources (drill core and bulk samples) for
coal-quality purposes.
Mining
Caledon plans to increase Cook’s run-of-mine (RoM) production from its most recent
levels of 300,000 tpa to around 1.5 Mtpa by mid 2008, and to approximately 2 Mtpa over
the longer-term. The existing mine-transport infrastructure and CPP has a design
capacity of 3.5 Mtpa. The company envisages employing mining contractors, contract
mine managers and wash-plant managers to achieve its production targets. The total
initial investment required to upgrade the mine is estimated by Caledon at A$5.6 million
(US$4.2 million).
Caledon plans to resume underground unit mining operations at the Castor Seam by the
end of 2006 or early in 2007. However, in the longer-term mining will be focused on the
Argo Seam, which lies 10-20 metres below Castor. As mining will take place beneath the
existing Castor Seam workings, the likelihood of encountering unknown geological
structures which could adversely impact the proposed mining operations is deemed to be
minimal. However, SMG’s preliminary mine design report identifies the potential for an
adverse interaction between the Castor Seam and the proposed Argo Seam workings,
particularly at goaf edges between Castor-workings panels, and concludes that further
studies are needed to establish the probability, nature and extent of potential rib failure.
The base-case mining plan developed by SMG works off the estimated reserve of 17 Mt,
which would provide for a 10-year life of mine at the forecast RoM production rate of
approximately 430 kt for the financial year ending June 2007, 1,400 kt in financial year
2008 and 2,000 ktpa thereafter. However, we note that SRK considers that adequate
The initial phase of production is scheduled to run from the end of this year to 2009, and
will be undertaken by Australian mining contractor Titan. Mining will focus on the
Castor Seam, making use of existing access points and mine infrastructure. Production
will come from two rented continuous miners, supported by a fleet of shuttle cars, and
will follow a conventional board-and-pillar method similar to that employed prior to the
recent cessation of operations.
The second phase of production is expected to commence during the second half of
calendar year 2007, and will be undertaken by South African-based mining contractor
Magatar. The proposed Magatar operation involves a partial-extraction mining method,
utilising a custom-built continuous-mining unit coupled with a Prairie continuous
conveyor system. This set-up is expected to provide the necessary flexibility required to
exploit the resource effectively. Magatar’s is a patented system, the agency rights to
which are held by MTP in Australia. Caledon believes the system can achieve
significantly higher productivity rates than the conventional continuous miner-shuttle car
system employed at Cook to date.
Figure 15: Continuous miner (top) and continuous haulage unit (bottom)
We note that Cook will be only the second coal mine, and the first in Australia, to utilise
the proposed continuous haulage system. The first such system to be applied at a coal
mine is due to be in operation by year-end 2006 in South Africa. The technology was
developed in the potash mines of Canada, where eight of the systems are currently in
operation. The first such system has been in operation for more than a decade.
Caledon has yet to finalise contract mining negotiations for the second phase of
production, but SRK has assumed fixed mining costs of A$33.50 per tonne of RoM coal
for the Magatar operation in its Competent Person’s Report, and we note that this figure
is based on projections provided by Caledon. As outlined earlier, Caledon may seek to
finalise a mining contract which does not have such a fixed-cost structure in order to
benefit from any costs savings which may arise from the proposed mining system. We
also note that Caledon would have the ability to ramp back up its conventional board-
and-pillar operation to make up for some or all of any shortfall from the Magatar
operation.
2,500
2,000
1,500
kT
1,000
500
0
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Processing
Caledon has entered into a long-term rental agreement with Xstrata for use of the latter’s
coal handling and preparation plant (CPP) at Cook. The CPP has a nameplate capacity of
500 tph, which equates to an annual capacity of 3.5 Mt. The plant has been in operation
since 1975 and employs standard coal-washing technology (jigs, dense media separation
and cyclones).
The condition of the CPP has deteriorated due to a lack of investment since its
construction, and requires a significant amount of repair work to return it to an
acceptable operating condition. In order to handle the increased volumes of RoM coal
feed envisaged by Caledon, a flotation circuit may also need to be installed to prevent the
fines circuit from overloading. This is particularly important given the higher proportion
of fines in Argo Seam coal, which is expected to have coking properties across the full
size range. SRK estimates that 17% of coal feed will be lost to fines pre-modification of
the CPP, and 6% post.
Caledon anticipates that a total investment of A$12-15 million (US$9-11 million) will be
required to upgrade the preparation plant, including the addition of a flotation circuit.
The planned upgrades essentially involve equipment add-ons, and so no significant
downtime is expected. We note that SRK recommends that a full review of the process
route is undertaken using representative size-by-size ‘washability’ data of the new Argo
Seam RoM feed.
Infrastructure
SRK concluded that the existing mine infrastructure is generally in an acceptable
condition, and is capable of sustaining continued operations at the current nominal
capacity and of permitting expansion as envisaged under Caledon’s longer-term
development plans. In terms of regional infrastructure, the Bowen Basin is host to four
heavy-haul railway systems and five ship-loading terminals. However, due to over-
capacity, rail and port access is severely constrained at present.
Under the Cook purchase agreement, Xstrata agreed to provide the necessary rail and
port access for Caledon’s production for the first two years of scheduled operations at
Cook, at a time when access to rail and port facilities is expected to be particularly
challenging. To the extent that Xstrata is unable to provide such access, Xstrata will
acquire Cook coal directly at market prices on an open-book basis. Caledon must source
its own rail and port access beyond the second year of operations (2009 onwards).
Caledon expects rail and port allocation constraints to ease beyond 2008, as the
Queensland Government has committed to make significant investment in infrastructure
over the intervening period. Gladstone Port is currently being expanded by 30 Mt, to an
annualised rate of 75 Mt, with work scheduled for completion by 2009. The rail-carrying
capacity is also being expanded over the same period to match the port expansion.
Despite these planned expansions, SRK recommends that scheduling of the upgrade of
the Cook CPP be linked to confirmation of future availability of additional rail and port
capacity. We note that Caledon believes that several producers in the region are over-
committed in terms of requested capacity use under Queensland’s ‘take-or-pay’ rail and
port capacity-allocation system, and the company is confident of receiving offers to take
up excess capacity as those producers seek to avoid penalty charges.
Marketing
Xstrata is making its general marketing expertise available to Caledon on a take-or-pay
basis for the first two years of Cook’s operation. Under the terms of the agreement,
Caledon pays a marketing fee equal to the higher of 3% of gross revenue or US$2.75/t of
coal sold. Caledon and Xstrata have agreed a production schedule (Nominated Annual
Tonnage) of 900,000 tonnes of coal in 2007, escalating to 1.5 million tonnes in 2008.
Caledon is limited to this production level until 2009 due to the rail and port constraints
referred to above.
Caledon mandated coal market consultant McCloskey evaluated the likely market price
achievable for Cook coal, based on McCloskey’s forecast FOB prices for bench-mark
Queensland hard and semi-hard coking coal. McCloskey concluded that, being a
premium semi-hard product, Cook coking coal could achieve a price similar to or better
than the mid-point of its forecast future prices for hard and semi-hard coals (Figure 18).
Project parameters/valuation
We have used the CPR to guide the inputs to our cash flow model but have made a
number of adjustments, particularly with regard to coal prices and the US$/A$ exchange
rate, to reflect Canaccord Adams’ internal forecasts. We have based our production
profile and operating cost structure (Figure 19) directly on the numbers presented in the
CPR, which we note SRK based on estimates provided by Caledon. On this basis, we
calculate total cash costs (inclusive of Queensland’s 7% state coal royalty) at
approximately A$72 per tonne of saleable coal produced (US$54 per tonne)
working capital and other owners costs. We note that Caledon’s estimated capex figure
includes 15% contingency.
To arrive at our base-case valuation we have used Canaccord Adams’ Australian forecast
FOB prices for Australian hard coking coal (Goonyella) and thermal coal, as presented in
Figure 20 below. As outlined on page 24, we note that Cook coal is a semi-hard product,
which McCloskey believes could achieve a long-term price equal to around a 7% discount
to its forecast long-term price for premium hard coal. We have therefore applied a
similar discount to our own long-term hard coking coal price forecast of US$79 per
tonne, which we note is somewhat lower than McCloskey’s long-term price forecast for
hard coking coal of US$90 per tonne.
The following chart compares the forecast coking coal prices, as suggested by McCloskey
against those of Canaccord Adams.
Figure 21: Comparison of McCloskey and Canaccord Adams coking coal price forecasts
120.00
110.00
100.00
McCloskey hard coking
McCloskey suggested Cook
90.00 McCloskey semi-hard
Canaccord Adams hard coking forecast
Adjusted Canaccord Adams forecast
80.00
70.00
60.00
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: McCloskey
We also provide a chart showing our forecast of the breakdown of operating costs and
operating margin per tonne of coal sold, over the first 10-years of the operation’s life.
Figure 22: Breakdown of average operating cost and operating margin per tonne
Forec as t operat i n g c os t s an d operat in g m argi n ( US $/t )
90 22
80
21
70
60 20
20
17
10
0 16
2006 2007 20082009 2010 2011 2012 20132014 2015 2016
A summary of our base-case cash flow model of Cook using our discounted internal
coking coal price forecasts is presented in Figure 26 in the appendix. The following
sensitivity tables (Figures 23 and 24) plot the 10-year and 20-year NPV of Cook
(assuming 100% equity funding and discount rates of 8% and 10%), against a range of
flat (from 2008) coking and thermal coal prices.
Thermal Price
30 -158 -1 113 225 337 449
40 -123 25 137 249 361 473
50 -87 50 162 274 386 498
60 -52 74 187 298 410 522
70 -17 99 211 323 435 545
Local company QCoal Pty Ltd, which is affiliated to the vendor, has reserved rights to
develop near-surface, potentially open-pitable portions of the deposit, but only within a
limited defined area at one end of the property. QCoal also has the right to a 1.75%
royalty on any future coal production from Minyango.
Acquisition Agreement
Title to the Minyango property is held by Blackwater Coal, a wholly-owned subsidiary of
BVI company Hazelhurst Holdings. Hazelhurst is in turn owned 100% by BVI company
Watami Trading, the ultimate vending party.
On 29 September 2006, Caledon signed an option agreement to acquire the entire issued
capital of Hazelhurst for a total consideration of A$40 million, payable over a 15-month
period. Caledon can exercise the option at any time during the option period, which ends
on the tenth business day following the fulfillment of certain conditions, including
shareholder approval of the transaction at the upcoming EGM.
As part of the total consideration due, a non-refundable option fee of US$1.5 million
(A$2 million) was paid to Watami in lieu of acquiring the option. The first staged
payment of A$10 million is due to be paid to Watami no later than 10-days after
admission of the placing shares. After this payment, Caledon has until six months and 45
days from the date of the acquisition agreement to undertake initial resource delineation
and coal-quality studies on Minyango.
Should Caledon decide to proceed with the project beyond this point, a further A$9.6
million is payable to Watami in cash, shares or a combination of the two (at Caledon’s
election). Upon payment, Caledon would then be free to proceed with more advanced
exploration studies on the project. Should it elect not to proceed with the project after
these initial studies, Watami has the right to buy back all the shares in Hazelhurst in
consideration for the full refund of all monies paid by Caledon to that date.
Within nine months of the second staged payment, Caledon must make the final payment
installment of A$20.4 million. This payment may be delayed by up to three months in the
event that Caledon has not completed its planned feasibility work. However, if the
company chooses not to proceed at this point and therefore declines to pay the A$20.4
million due, Watami has the right to buy-back 51% of Hazelhurst for a consideration
expected to amount to A$15 million less the aggregate amount of any third-party
borrowings of Hazelhurst and its subsidiaries at that time.
Of the four target coal seams, Caledon considers Aries, Castor and Pollux as offering
potential for delineation of resources and reserves. These seams are of sufficient
thickness to allow extraction via underground mining methods and, from the limited coal
quality data available, Caledon believes all three can produce a high-quality thermal coal
and an export-quality coking coal product.
Exploration work to date suggests that the three coal seams of interest vary in seam and
interburden thicknesses as follows:
The thicker areas of the Aries Seam are interpreted as coalescing of the seam with the
Castor Seam, and the thicker intersections in the Castor and Pollux seams are thought to
reflect coalescing of these two seams to form the Gemini Seam. The overall interburden
thickness between Aries and Pollux ranges from 20 metres in the north to 50 metres in
the southern end of the property. The interburden sediments generally consist of
competent material suitable for underground extraction.
Nevertheless, based on work completed to date and knowledge of coal quality from
resources on adjacent properties, Caledon believes Minyango coal could provide a mid-
volatile hard coking product and a thermal by-product after beneficiation. The company
expects a total yield of 70-85% providing mining dilution does not exceed 10% by weight.
Development plans
Caledon plans to undertake feasibility work on Minyango over the next 9-12 months at a
total cost of approximately US$2.5 million. The first stage of the work programme will
include preliminary-stage drilling (20 holes planned) and seismic studies to determine
coal-seam continuity, coking-coal quality, and to provide an initial idea of the potential
structural characteristics of the seams (faults and other potential disturbances). The
second phase of the feasibility programme will include in-fill drilling to delineate a set
volume of potentially underground mineable, drill-indicated material from within the 500
million tonne conceptual resource.
In 2004, Caledon signed an agreement with MMLC to earn a 70% equity interest in the
7.2 square kilometer Mojiang mining concession and surrounding exploration
tenements, as well as a 90% interest in exploration ground to be acquired in defined
counties in southern Yunnan Province, in return for funding US$1 million of exploration
expenditure over a three-year period and completing a feasibility study. Caledon
commenced drilling at Mojiang in February 2006, with a view to completing a resource
estimate by the end of the year.
In addition to Mojiang, Caledon holds majority interests in the Hengxian, Gaolong and
Badu exploration projects in Guangxi Province. These assets are held through subsidiary
companies Blackwatch Resources and Blackwatch Mining.
Dynasty owns three advanced gold exploration projects in northern China – Hatu, Wild
Horse and Red Valley. It has inferred resources of just under one million ounces of gold.
Other noteworthy shareholders in Dynasty include AngloGold Ashanti Ltd (AU:NYSE) and
Avocet Mining plc (AVM:AIM).
APPENDIX
FYE Dec LoM Total 2007e 2008e 2009e 2010e 2011e 2012e 2013e 2014e 2015e 2016e 2017e
CC production kT 1,777 732 646 348 51 0 0 0 0 0 0 0
Magatar production kT 36,136 316 1,058 1,549 1,954 1,954 1,954 1,954 1,954 1,954 1,954 1,954
Total ROM production kT 37,913 1,049 1,703 1,897 2,005 1,954 1,954 1,954 1,954 1,954 1,954 1,954
Wash plant recovery % 92% 81% 86% 92% 92% 92% 92% 92% 92% 92% 92% 92%
Coking coal yield 82% kT 28,467 699 1,208 1,433 1,515 1,476 1,476 1,476 1,476 1,476 1,476 1,476
Thermal coal yield 18% kT 6,249 154 265 315 332 324 324 324 324 324 324 324
Coking coal price (FOB) US$/t 92.93 85.30 80.75 75.94 72.12 74.15 74.15 74.44 74.44 73.82 73.82
Thermal coal price (FOB) US$/t 52.06 52.50 52.50 52.50 52.50 52.50 52.50 52.50 52.50 52.50 52.50
Coking revenue US$M 2,142 65 103 116 115 106 109 109 110 110 109 109
Thermal revenue US$M 328 8 14 17 17 17 17 17 17 17 17 17
Exchange rate US$/A$ 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75
Gross revenue A$M 3,294 97 156 176 177 165 169 169 169 169 168 168
Cash operating costs A$M -2,169 -68 -101 -109 -114 -111 -111 -111 -111 -111 -111 -111
Marketing fee A$M -127 -3 -5 -6 -7 -7 -7 -7 -7 -7 -7 -7
Queensland royalty 7% A$M -231 -7 -11 -12 -12 -12 -12 -12 -12 -12 -12 -12
Total cash costs A$M -2,526 -78 -118 -128 -133 -129 -129 -129 -129 -129 -129 -129
DD&A A$M -54 -1 -2 -3 -3 -3 -3 -3 -3 -3 -3 -3
Total operating costs A$M -2,580 -80 -120 -131 -136 -132 -132 -132 -132 -132 -132 -132
Pre-tax cash flow A$M 767 19 38 48 43 36 39 39 40 40 39 39
Taxation 30% A$M -214 0 -5 -14 -13 -11 -12 -12 -12 -12 -11 -11
Net operating cash flow A$M 553 19 33 34 31 25 28 28 28 28 27 27
Capex A$M -54 -39 -2 0 0 0 0 0 0 0 0 0
Project free cash flow A$M 499 -20 32 34 30 25 27 27 27 27 27 27
10-year NPV at 8% DR 8% DR A$M 148
US$M 116
20-year NPV at 8% DR 8% DR A$M 230
US$M 181
Source: Canaccord Adams estimates
FYE Dec 2007e 2008e 2009e 2010e 2011e 2012e 2013e 2014e 2015e 2016e 2017e
Profit and Loss
Revenue US$M 73 117 132 132 123 126 126 127 127 126 126
Costs US$M -59 -88 -96 -100 -97 -97 -97 -97 -97 -97 -97
Corp G&A US$M -6 -6 -6 -6 -6 -6 -6 -6 -6 -6 -6
EBITDA US$M 8 23 30 27 21 23 23 24 24 23 23
DD&A US$M -1 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2
EBIT US$M 7 21 28 24 19 21 21 22 22 21 21
Interest US$M 0 0 0 0 0 0 0 0 0 0 0
Tax US$M -2 -6 -8 -7 -6 -6 -6 -7 -7 -6 -6
Earnings US$M 5 15 20 17 13 15 15 15 15 15 15
Cash Flow
Operating cash flow US$M 8 19 20 17 13 15 15 15 15 14 14
Invested cash flow US$M -45 -1 0 0 0 0 0 0 0 0 0
Cash flow from financing activities US$M 0 0 0 0 0 0 0 0 0 0 0
Net cash flow US$M -37 18 19 17 12 14 14 15 15 14 14
Cumulative cash flow US$M -27 -9 10 26 39 53 67 82 97 111 125
Source: Canaccord Adams estimates
Figure 28: Comparable Australian coal producers (mixed coking and thermal)
Shares Mkt
Consensus
Price Out Cap EV Consensus EPS PE CFPS P/CF
Company Ticker Currency (local) (M) (US$M) (US$M) 2007e 2008e 2007e 2008e 2007e 2008e 2007e 2008e
Centennial Coal CEY AUD 2.75 302 653 1,183 0.15 0.27 18.2 10.1 0.53 0.67 5.2 4.1
Coal & Allied CNA AUD 78.00 87 5,311 5,465 3.17 3.80 24.6 20.6 4.15 4.49 18.8 17.4
Excel Coal* EXL AUD 9.50 215 1,606 1,786 0.54 0.81 17.6 11.7 1.04 1.42 9.1 6.7
Felix Resources FLX AUD 4.16 188 615 626 0.19 0.23 22.2 18.4 0.22 0.35 18.9 11.9
Gloucester Coal GCL AUD 4.03 79 249 262 0.45 0.41 8.9 9.7 0.64 0.53 6.3 7.6
Macarthur Coal MCC AUD 4.91 187 724 610 0.37 0.44 13.3 11.1 0.48 0.65 10.2 7.6
New Hope NHC AUD 1.30 808 823 493 0.07 0.09 18.2 13.9 0.11 0.12 12.0 11.1
Resource Pacific RSP AUD 1.34 194 204 237 0.05 0.25 27.9 5.4 0.09 0.35 14.9 3.8
Average 0.62 0.79 18.9 12.6 0.91 1.07 11.9 8.8
*Share price represents Peabody take-out price
Source: Company reports, Bloomberg
An analyst has visited the issuer’s main operations in Queensland, Australia and partial payment was received from the issuer for the related travel costs.
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Mark Maybank, CA, CBV, Dennis C. Wassung, Jr., CFA, MBA, Boston 1.617.788.1510
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