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Interview with CEO Alex Molyneux of SouthGobi Resources. 3 comments
Checking in with Steve: We enlisted DTC’s friend and former senior hedge fund analyst Peter Epstein to conduct an interview with Alex Molyneux – CEO of Mongolian coal producer SouthGobi.
Interview with Alex Molyneux, SouthGobi’s CEO:
We enlisted the help of Peter Epstein, former senior hedge fund analyst and current market commentator, to interview Alex Molyneux, CEO of Mongolian coal producer SouthGobi (SGQRF.PK; SGQ.TO; 1878.HK). DTC has been a big fan of Alex and SouthGobi since Steve Doyle visited the Ovoot Tolgoi operations in May 2010 and called in his buy order from a ‘yurt’ on SouthGobi’s property.
His investment banking background, keen market knowledge and reputation for executing on strategic objectives has been a winning combination. Alex provides great insight into SouthGobi’s development, commenting on topics from political risk in Mongolia to a potential acquisition.
Disclosures: Peter Epstein owns shares of SouthGobi and may, in the future, be compensated by SouthGobi for consulting work, which may or may not include the writing of research reports.
DTC’s Steve Doyle has owned shares of SouthGobi since May, 2010.
Peter Epstein: First, can you describe SouthGobi Resources to those not familiar with the story?
Alex Molyneux: Canadian company SouthGobi Resources, (SGQRF.PK, SGQ.TO, 1878.HK), located just 45km from the Chinese border, is 1 of 2 dominant Mongolian coking coal exporters. We are in the early stages of explosive organic volume and earnings growth. Within 3 years, SGQ will be exporting a run-rate of 10 mm MT of coking coal. Our cash costs, averaging in the low US$20’s per MT, are among the lowest in the world. China’s 12th 5-yr plan clearly focuses on building out inland Chinese provinces where we have a distinct transportation advantage.
We have 535 mm MT of coal resources, which give us a +25-year mine life and we are actively exploring for more coal. SGQ is building a new paved haul road to the Chinese border that will be able to transport in excess of 20 mm MT/year. Unlike many global players, SGQ effectively has no capacity constraints. We just announced a third-party washing agreement with a company in China that will enable us to greatly enhance our margins next year. Despite minor setbacks from time to time, we have to date delivered the volume and margin growth that we advertised when we listed in Hong Kong in May, 2010.
Peter Epstein: Mongolia’s Tavan Tolgoi has been in the news a lot lately, did you apply to be a part of that project? What are your thoughts on the latest developments? Will this project be a competitive threat?
Alex Molyneux: We did not apply to be a part of Tavan Tolgoi as we’re focused on the assets in the Ovoot Khural Basin where our existing Ovoot Tolgoi Mine, proposed Soumber project and exploration targets are. These assets will generate high IRR’s for us because we’re already putting in infrastructure. This approach makes much more sense for us then being a minority consortium investor in Tavan Tolgoi. I believe that the Mongolian gov’t is doing a good job at managing this very complex process, but it will take a lot of time. I expect it will be at least 4 – 5 years before Tavan Tolgoi is producing 15mm MT of coking coal. [Credit Suisse was out with a note on August 24th saying that Peabody’s CEO
thinks it might take 5 – 7 years to reach 15 mm MT]
We do not consider Tavan Tolgoi a threat because:
I. China needs all of that coal, ours and more;
II. Tavan Tolgoi coals have different qualities than Ovoot Tolgoi or Soumber so they will be good to blend together rather than displace each other; and
III.The mines are 400km apart so the infrastructure routes and logistics are different and the coals won’t be competing for infrastructure, labor, materials, equipment, etc.
Peter Epstein: Given the high level of interest in Tavan Tolgoi (approx 15 – 20 parties applied to participate), do you think that some of these parties, who presumably are comfortable with Mongolian country risk, might take a closer look at acquiring SGQ?
Alex Molyneux: As I said on our Q1 earnings conference call in mid-May, 57% majority shareholder Ivanhoe Mines has received inquiries about a possible sale of the company. Interested parties should contact Ivanhoe directly. Given the quality, cost profile and location of our assets and a strong management team, I believe that investors will be rewarded for owning SGQ stock.
Peter Epstein: CIC (China Investment Corp) is your 2nd largest shareholder after Ivanhoe, have they opened doors for you in China?
Alex Molyneux: Yes, they are active in terms of getting information to better understand the Company and then looking for opportunities to add value. They have opened doors in the areas of logistics and marketing. We value the relationship and think that CIC will continue to add value going forward.
Peter Epstein: Can you update us on the status of the paved haul road from your mines to the China border crossing at Ceke? Will you be able to charge a toll to other bulk commodity producers in the area?
Alex Molyneux: We've been awarded a 15-yr build, operate and transfer contract to build a toll road in partnership with a Mongolian company named NTB LLC. This road will be capable of carrying in excess of 20 mm MT of coal per year. We will likely own 40% of this road, but we have agreed with our partner a number of specific rights which will protect our position and protect the ability of our partners to increase tolls. Construction will begin this year with completion in the 4th quarter of 2012. The haul road is likely to be a source of income for SouthGobi.
Peter Epstein: Can you give us further details on your recently announced plan to use a third-party wash plant to wash your moderate-high-ash coals and walk us through the economics?
Alex Molyneux: We have signed an agreement with a company called Ejin Jinda to off-take their washing capacity. They are constructing a wet-washing facility approximately 10 km from the border crossing (i.e., 50 km from our mine). The facility will have the capacity to process 3.5 mtpa of our raw coal and should be operating at the start of 2012 (it’s already substantially completed). All of the capacity will be for SGQ and it has all been licensed. So, financially here’s how it works (the following figures are not meant to be exact, but are representative):
We currently mine our lower quality coal with minimal on-site processing at ~US$20/t, coal that would ordinarily sell at the mine-gate for US$38.40/t, i.e. a US$18.40/t margin. if we process the coal at Ejin Jinda, the economics improve markedly.
First, we add the cost of trucking + export fees etc. to get it to the wash plant at around US$17.10/t. Thus, upon arrival at the wash plant the cost to us is US$37.10/t.
Then, it will be processed and we will pay a US$9.60/t all-inclusive fee. The washed coal will have an 85% yield, so the all-in cost will be US$37.10 + US$9.60 fee = US $46.70 / 0.85 yield = US$54.90/t).
However, the selling price for that coal at the washing plant is approximately US$96.00/t inclusive of VAT. Excluding VAT, it’s US$82.00/t and that coal would then be a US$27.40/t margin coal as opposed to a US$18.40/t margin coal.
We won’t need to contribute anything to the project because our fee to Ejin Jinda will include their capital recovery and profit. The extra cash flow we get from wet-washing our coals will create sustainable incremental earnings and will expand our NPV. There are some additional points that don’t get captured in the financial model, but that are important:
I. We feel that demand tension will grow more for the better quality products than for the marginal ones, so whilst the calculation above is performed on current pricing, I think that the gap between the better coal and worse coal will increase over time such that washing will actually add a lot more to us than we currently conceptualize.
II.Transport is included in the deal. Ejin Jinda will buy 300 trucks to bring our coal to China, which means that we will have dedicated capacity to export 1.1 – 1.3 mm MT per quarter across the border. This will be in addition to existing export capacity with customers and logistical contractors. Unlike many coal producers around the world, SGQ effectively has no export constraints as we ramp up to 10 mm MT of coking coal and beyond.
III.Coal will be stockpiled at the facility in China, so if from time to time the border or road to China is closed, then we will have a kind of surge pile in China to direct customers to. This will further enhance our reliability and level of service.
Peter Epstein: Now that SGQ is signing contracts directly with end users, upwards of 70% of your production by year-end, how satisfied have those customers been? Have there been any problems or have any customers canceled orders or contracts? What advantages does SGQ coal offer your end-users over alternative sources of coal that they have access to?
Alex Molyneux: We haven’t had any major orders cancelled. There have been one or two customers complain about the variability of our product. Right now our ash levels can vary because we’re mining and selling the coal raw. When we commission even just the dry washing plant at the end of this year, we will have facilities to manage this. However, we have also had other customers say that our coal is much better quality than they expected it to be. One reason for this is that our coal contains more by-products. For example, it has a higher yield of methane through the coking process. Coke plants generally capture the methane for co-generation and to manufacture methanol products. With this feature of our coal, it means that our coal has more value in use.
Working more with end-users that have advanced coal-to-chemicals facilities attached to their coke plants has become a key focus for SouthGobi. Taixi and Qinghua have become our two largest customers and their end-users do a lot of coal-to-chemicals business. Having closer relationships with our end users will help because we can refine our product to cater to the customer’s needs. This is a
win-win for the relationship as we can lock-in our volumes and possibly charge higher prices.
Peter Epstein: Speaking of coal-to-chemicals applications, you commented on your Q2 conference call a few weeks ago that you see an opportunity to add value as a supplier to these end-users. Can you describe the opportunity?
Alex Molyneux: Yes, I believe that there is a big opportunity for SGQ to earn incremental margins on coal that we deliver, as sole providers, to end-users with specific needs for some of the characteristics that our coal has. We are investigating this and expect to have more to say on the topic before year
end. While this is a work-in-process, suffice it to say that the range of possibilities is vast and the opportunity to brand our product as more than just a commodity coking coal is very exciting.
Peter Epstein: Given the focus of the 12th Chinese 5-yr plan, is your coal ending up in different places, such as south and west of your traditional end markets?
Alex Molyneux: Yes, this is happening. The development of the 19 provinces that make up the “inland west” has been prioritized even further in this 5-year plan. These are provinces where steel intensity per capita is one third that of the coastal regions of China. China’s double-digit growth that impacted
seaborne commodity markets so markedly did so because it was focused on the Chinese coastal regions. Now those regions are being left to their own devices, while the government moves the tool of policy-led fixed asset investment into the inland west to get them to ‘catch up’.
Our coal is increasingly being consumed in our own neighborhood and this is because we’re in a neighborhood where steel capacity and coke making is growing at double-digit rates every year and will do so for the rest of this decade. I have little doubt that the value of our coal will one day approach seaborne prices as regions like Gansu, the western part of Inner Mongolia and Ningxia develop properly.
The inland west has iron ore (especially in Qinghai and Tibet), copper, nickel, lead, zinc… it has plenty of thermal coal and is connected to Central Asia for gas and oil… what it’s lacking in spades is coking coal. Whereas 18 months or two years ago our coal was on a volume weighted average basis moving around
2,300km to an end-user, I estimate it’s now only moving on average around 1,400km. To put that in perspective, Australian coal travels about 8,000km to the same destination. The cost differential of transportation helps our margin, but perhaps equally important is the fact that on average our shipments arrive with greater precision than coals coming from Indonesia, Africa, Canada or Australia.
Peter Epstein: If you were to experience a cost blowout, where would it most likely come from? Will you have any trouble finding and keeping workers as you ramp up your production? Do you have any meaningful currency exchange risk?
Alex Molyneux: Diesel is a concern; it represents 25% -- 30% of our direct mining cash cost in any given quarter. If we see oil continue to move up, it’ll be the diesel that will be the main culprit in our cost structure change. I think that we have good access to workers. It doesn’t keep me awake at night. Also, we’re making some changes to our roster that will give us more efficiency out of our workforce. We don’t have meaningful FX risk as most of our input costs are commodity related (fuel, blasting and consumables). Labor is just under 15% of our cash cost and that’s really the only big Mongolian Tugrig exposed item… we make money on RMB strength because we set coal prices in RMB and are a US$ reporter.
Peter Epstein: Based on your 4 equipment fleets, how many MT of clean coal can you produce per year, 10 mm? Assuming no new mines except for Soumber, how many MT might you be able to reach in years 2015 and beyond? How much more equipment, labor, permits, wash plant capacity, etc would you need to reach that number?
Alex Molyneux: Yes, we have 4 fleets now and they can do 5.5 – 6.0 mm MT/year. However, our capacity will increase with the addition of a 5th fleet plus extra trucking capacity. With Soumber we can get to 10.5 mtpa of coal product fairly quickly. And, with some re-planning, I think we can get Ovoot Tolgoi + Soumber to 12 – 13mtpa but we haven’t completed those studies. In addition, we’re studying the feasibility of an underground mine at Ovoot Tolgoi, which could produce even more MT.
Peter Epstein: How is your relationship with the Mongolian gov't? Can you cite examples of positive or negative dealings with the government? What permits, approvals, etc. do you need from them over the next few years?
Alex Molyneux: Our relationship is good. Mongolia is pro-business. We just got the mining license for Soumber, which is evidence of the support the government gives to its miners. We need permits almost every day for this and that but now that we have the Soumber license, we have no material licenses hanging out there.
Peter Epstein: SGQ has had great success in its exploration program. Can you give us a big picture update on that program? What are your goals over the next few years?
Alex Molyneux: We have 535 mm MT of resources. All were found through green field exploration. I suspect that we can add another 150 – 200 mm MT. While some coal producers like to show that they have billions of MT of coal resources, our 535 mm MT gives us more than 25 years of mine life. We also have ~65 mm MT of very high quality attributable coking coal resources from our 19.8% stake in Aspire Mining, (AKM.AU)
Peter Epstein: Can you comment on Aspire Mining? There are at least a dozen emerging public and private Mongolian coal companies that you could invest in, why have you only invested in Aspire?
Alex Molyneux: We are well aware of the ‘dozen’ companies with Mongolian coal exposure. As you can imagine, we have looked at everything. Aspire was our first move because of asset quality. They have the best hard coking coal in Mongolia, maybe in the world. It’s very low volatile, very hard, has great caking and plasticity properties and will have a high wash yield. Aspire’s Ovoot is a long-term mega-
project. It probably requires US$700 mm of railway development to unlock it but this kind of project can sustain that. Maybe in 2020 we will see 20mtpa of premium hard coking coal from that project being railed to China. We see Aspire’s asset as on par with our own because the quality of the ore body (from a potential product margin perspective) overcomes the location issue. Most other companies we see in Mongolia don’t fit that profile. The ore body quality and location mix doesn’t work in most other cases.
Peter Epstein: Do you expect that many of these emerging coal producers will reach their production goals, even if delayed and over budget? Or, do you think that they will never get off the ground?
Alex Molyneux: Mongolian coal will be like emerging iron ore of Australia. As Fortescue Metals started up there was so much excitement all over Western Australia and so many little iron ore wannabes popped out into listed companies. The reality though, is that 5-6 years on, there’s no meaningful action out of areas like the mid-west region in Australia for iron ore. Coal, like iron ore is a low value bulk, so logistics is the key… it’s a “location, location, location” story. You can’t have equivalent or worse coal quality to SouthGobi and be hundreds of kilometers further west or north of China and credibly expect to be able to come into meaningful production soon.
Aspire is different because the coal quality will overcome their logistical challenges but even they won’t be a 5mtpa producer anytime soon. I suspect a bunch of projects get moving and a bunch just never happen. Aspire is different because the coal quality will overcome their logistical challenges but even they won’t be a 5mtpa producer anytime soon. I suspect a bunch of projects get moving and a bunch just never happen.
Peter Epstein: Alex, what keeps you up at night? What are the biggest risks that you face over the next few years?
Alex Molyneux: Our business is de-risking all the time. I would have said the Soumber mining license but that’s done now. It’s really just little things every day… keeping an eye on the team to make sure they’re happy and productive, keeping an eye on costs, etc. I’m spending lots of time personally on coal marketing. We will live or die by creating a genuinely liquid market for our products.
Peter Epstein: Assuming that SGQ can generate a run-rate of $500mm of EBITDA by 2014 on sales of 10 mm MT of coking coal, your stock is trading at about a 3x EV/EBITDA multiple. Recent M&A activity and companies considered to be likely takeout candidates, such as Riversdale Mining, Macarthur Coal,
Coal & Allied, Whitehaven Coal, and Aston Resources are trading at an average 7.1x multiple of 2013-14 consensus EBITDA. What do you think investors might be missing?
Alex Molyneux: We see a bunch of analyst notes and feedback from some investors saying that we trade at a discount because our coal is lower quality than say Mongolia Mining Corp… to me that’s bizarre… its coking coal not thermal, so it’s better than 70% of the coal out there… It’s similar coal to that of Yanzou’s Felix mines or Whitehaven’s and those companies are all going at much higher
multiples. Some people say it’s because we have more political risk as we’re Canadian-listed, not a Mongolian company… that’s bizarre too because you can see the Mongolian government has been very supportive. We have had no problem getting mining licenses, etc.
I think the truth is that our pricing model is a bit opaque because we’re not a seaborne FOB seller… but you can see from our pricing that we have loads of leverage and we’re doing exactly what we said at the time of the HK listing back in May 2010. We’re moving our prices up vis-à-vis benchmark prices… so to
those missing the boat, I say, “we’re delivering so please don’t miss the boat any longer”.
Dianna Ridgway: On behalf of Ted, Steve and the rest of the DTC team, I would like to thank Alex andPeter for a great interview and for adding to the ‘pool of coal knowledge’!
Dianna Ridgway/Senior Vice President
Doyle Trading Consultants, LLC
P.O. Box 4390
Grand Junction, CO 81502
Phone: 970 256 1192
Mobile: 408 858 0359
www.doyletradingconsultants.com
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Thanks for the link Peter, another great article.
Regards, Col4 Sep 2011, 09:57 PM Reply Like 1 -
Here's an article that just got posted to SA. Please take a look.
seekingalpha.com/artic...11 Sep 2011, 10:22 AM Reply Like 1 -
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