Description

Colonial Coal International Corp. (CAD)

($ figures in Canadian $, unless otherwise specified)

Recommendation

Buy common stock.  This is a speculative special situation in that CAD is a motivated seller of its two exploration metallurgical coal properties in British Columbia, Canada in an environment where the market for commodities is booming.  CAD’s assets are strategically situated within the Peace River Coal Field, in close proximity to development assets owned by major producers such as Teck Resources, Glencore and Anglo American.  It is led by an experienced CEO with an ~11% stake in the Company and a history of successful coal exits.  While a sale is inevitable, I have zero insight into when a transaction might take place, and so this may very well be a dead money investment for who knows how long.  What we do know is that in early 2019, CAD retained financial advisors to market its two properties, either together, or individually.  The process stalled on account of the pandemic but my presumption is that it's back on track now given the significant global interest in met coal supply and the record high coal pricing levels around the world.  There aren’t that many high-quality met coal resources of this size anywhere in the world in stable jurisdictions such as Canada, and even fewer that are actively available for sale.

Valuation is obviously always tricky with non-producing resource names and the range of outcomes here is likely to be very wide, including the potential for a total wipeout.  Assuming a fully diluted share count of 188mm, the market is currently valuing the assets at ~$374mm.  Based on the measured, indicated, and inferred (mouthful, I know) mineable resources totaling ~695mt at the two properties, the current stock price implies a value of $0.54/t.  Assuming that the resource projections are not completely bogus (big if!), this valuation implies a material discount to prices paid for similar met coal resources.  High quality met coal deposits in stable jurisdictions tend to trade in the $2.00 – 3.50/t ballpark even in times where the spot prices are much lower than they are currently.  Add to all this the strength of the balance sheets of potential buyers who are now increasingly flush with excess cash and looking to grow their asset base and you have a very interesting lottery ticket type setup.

Company Overview

Based in Vancouver, CAD is a pure-play metallurgical coal development company that holds a 100% interest in two strategically located development-stage coal project assets in the preeminent Peace River Coal Field (PRC) of western Canada.  CAD’s assets are strategically situated within the PRC, proximal to development assets owned by major producers, Teck and Anglo, implying infrastructure synergies.  The two resource-stage coal properties, Huguenot and Flatbed (Gordon Creek), are not in commercial production and therefore don’t generate operating revenues.  Under the ownership, or even a partnership, of a larger, well-funded suitor, one or both projects could possibly reach initial production within 4 or 5 years.  Huguenot has a contained resource of 277.7mt of combined, measured, and indicated resources plus 119.2mt of inferred resources, making it one of the largest deposits in the region.  The Gordon Creek deposit on the Flatbed property has a contained resource of 298mt of inferred resources.  Coals from both Huguenot and Flatbed rank as premium metallurgical coking coals, very similar to products sold by Teck and Anglo.

PRC is one of the world’s foremost coal fields and is served by established high quality infrastructure (transportation, power, ports, etc.).  PRC produces high-quality met coal, which is low in sulfur, ash and phosphorus. Product is shipped by rail to the coast, and then sent by bulk-cargo ships, mostly to Asia, from the ice-free, natural deep-water port of Ridley Terminals in Prince Rupert. Prince Rupert is significantly closer to East Asian markets than major U.S. coal fields. On account of recent trade issues between China and Australia, Canada has emerged as a preferred supplier to coastal Chinese steel mills. 

The chart below lays out the PRC including CAD’s two properties:

Generally speaking, CAD’s “build it and they will come” strategy and game plan is to replicate the outcomes that the Company’s founder, David Austin, pursued at the two coal companies he previously founded, Northern Energy & Mining and Western Canadian Coal.  Western was sold to Walter Energy in 2010 for $3.3bn.  In 2011, Anglo acquired the remaining 25% of PRC (held by NEMI and Hillsborough Resources) for $166mm ($664mn for 100%).  Sure, those sales were during the commodity bubble years but nonetheless impressive outcomes.  

The Huguenot Project

The Huguenot project is situated in the southern portion of the PRC, adjacent to Anglo’s feasibility-stage Belcourt South open pit project. The asset is ~110km trucking distance (or ~85km by rail) from the Quintette and PRC rail loadouts to link with the existing rail line. The project currently consists of one contiguous block of 17 coal licenses covering 9,531 ha, which were acquired by Company insiders beginning in 2005.  Management projects that Huguenot will produce a clean premium HCC product with low ash, low sulfur and low phosphorus, similar to other HCC products exported from B.C.

The Huguenot HCC open-cut and underground resource estimates are summarized in the table below:

Huguenot projected production over its life is summarized in the table below:

Based on a Preliminary Economic Assessment study (always suspect, I know) that was done for Huguenot in 2020, the post tax NPV of the project is estimated to be $944mm, at a 10% discount rate, with IRR of 26.3% and a payback period of four years using a coal price of US$174/t.  Furthermore, CAD estimates a breakeven HCC price of US$125/t (10% discount rate) and a required price of US$137/t to earn a 15% IRR. For context, the current spot FOB prices are well in excess of US$400/t, the 2021 average FOB price is US$209/t and the average FOB price since 2014 is US$158/t.  The PEA assumes production of 72mt of HCC over a period of 27 years, or average production of 2.7mt per year.

Summary of the project economics are presented below:

The Flatbed (Gordon Creek) Project

The Gordon Creek project is located within CAD’s 100%-owned Flatbed Coal property, ~27km south-southeast of the town of Tumbler Ridge. The property is in the central portion of the PRC, adjacent to Anglo’s Trend mine as well as Teck’s Quintette project. As such, the project is located close to key infrastructure, such as the PRC and Quintette rail load-outs, existing and planned power lines, and B.C. Provincial Highway 52.  The Gordon Creek project is projected to produce a clean premium HCC product with low ash, low sulfur and low phosphorus, similar to other HCC products exported from B.C. The expected PCI product is similar to low-vol PCI product currently exported from northeast B.C. or Queensland, Australia. 

The Gordon Creek resource estimates are summarized in the table below:

Gordon Creek projected production over its life is summarized in the table below:

Based on the 2018 Preliminary Economic Assessment study for Gordon Creek, the post tax NPV of the project is estimated to be $579mm, at a 10% discount rate, with IRR of 24.4% and a payback period of four years using a HCC price of US$160.5/t and a PCI price of US$140.5/t.  Gordon Creek is expected to produce a total of 39.3mt of HCC and semi-hard coking coal over a 22-year period, followed by 18.1mt of PCI product from year 20 through 30.

Permitting, Environmental and Social Issues to Consider

For any coal project to advance in B.C., it must acquire a provincial Environmental Assessment Certificate and a federal Environmental Assessment Decision Statement. The provincial and federal impact assessment processes usually are completed in parallel to eliminate duplication of activities. Management expects a 2 – 3 year permitting process once initiated. The most recent permitted coal project in northeast B.C., Murray River, received its provincial EA certificate in October 2015 and federal EA Decision Statement in December 2017. The Sukunka (Glencore) and Wolverine-Hermann (Conuma Coal) projects are currently undergoing the environmental assessment process. 

A preliminary environmental study was conducted on the Huguenot project in 2013, which identified no known environmental issues that would prohibit project advancement. However, the study noted that declining caribou populations and the release of selenium were growing concerns in the region. Since that time, the selenium issue has expanded significantly, with Teck being subjected to multiple lawsuits and committing >$2.0bn to the construction of multiple water treatment facilities and other ancillary requirements. Moving Huguenot into production will likely involve the construction of an Active Water Treatment Facility or a Saturated Rock Fill plant, another piece of infrastructure that could benefit from being shared with proximal projects. From a social perspective, the project is located within the Treaty 8 First Nations Territory. Management has been in constant communication with First Nations leaders since 2012, and no major issues have been identified to date. Communications with local communities to date have been restricted to mayors and other community leaders only.

No material environmental work has been conducted on the Gordon Creek project. However, as with Huguenot, declining caribou populations and the release of selenium are major concerns in the region. Moving Gordon Creek into production will likely involve the construction of an Active Water Treatment Facility or a Saturated Rock Fill plant, another piece of infrastructure that could benefit from being shared with proximal projects.

Permitting risks, however, are real as the owners of Grassy Mountain are finding out. Grassy Mountain is a coal project in Alberta where a joint federal-provincial review panel just denied the permits needed by the proposed mine after ruling the environmental consequences would likely outweigh the economic benefits. The panel’s decision was largely based on concerns about selenium.  Riversdale Resources, the owner of the project, is now evaluating its next steps.  While CAD’s assets are not in the same region, any potential buyer will have to factor the permit risk into the decision whether to bid (and the bid price).   

Some Thoughts on Met Coal Fundamentals 

Recently, we’ve seen an extremely volatile period for the global commodity markets. Demand for met coal, an essential raw material in the production of steel, has soared as the global economy recovered from the pandemic.  While demand soared, supply chain issues constricted availability of all things including met coal.  Additionally, flooding and safety challenges, border closures, strikes and various other global factors curtailed trade.  On top of this, the trade issues between China and Australia only worsened the situation.  All of this collectively led to tightness in the met coal market and contributed to an historic surge in prices. 

Current and historical prices for met coal:

It’s not unusual for coal prices to experience extreme increases – floods, damage to infrastructure and other types of unforeseen events have historically caused surges but usually they last for a few months at a time.  Going forward, similar types of events will certainly lead to price spikes again, but there is an underlying long-term trend that could keep met coal prices elevated. On the supply side, investment in both coking coal mines and coke batteries has been declining and is expected to continue to decline, given sustainability concerns.  Banks and governments continue to announce that they are halting future investments in new coal mines.  

On the demand side, high quality seaborne coking coal will continue to be an essential input for production of the steel that’s needed for infrastructure development including that required to support electrification and decarbonization. Over the long-term, demand for seaborne coking coal should remain strong fueled by growth in blast furnace steel production in regions such as India and Southeast Asia which have limited scrap availability and little to no access to domestic coking coal supply.  The market share for seaborne coking coal imports in these countries is forecast to increase from about one third currently to more than half by 2050. And supply growth is clearly constrained as shown in the graph below. Without new greenfield and brownfield projects, there may be a significant supply gap between 2025 and 2030 which is not very far off.

In order to decarbonize, the steel industry is unlikely to converge on a single emission abatement technology. It’s more likely a range of technologies will need to be deployed as they become commercially viable. Of these technologies blast furnace plus carbon capture utilization and storage is the most cost competitive and commercially viable solution for large scale adoption.  This technology is unlikely to be displaced to scale by any other technology this half century. It is also the only abatement technology capable of decarbonizing the steelmaking industry and that drives continued demand for high quality seaborne coking coal.

Summary Financials

The Company has cash of $4.2mm as of October 2021.  Assuming a burn rate of $1.5mm per year, this cash should last for at least two years before management needs to raise additional financing for operations and further property related studies.  

The Company has no funded debt at the moment and only a small amount of office lease liability.  

The Company has 174.368mm shares outstanding and 13.37mm options outstanding at strike prices ranging from $0.31 – 2.29/sh.  Curiously, insiders were just awarded 4.67mm options last month.  

Valuation Thoughts

The PEAs for Huguenot and Gordon Creek spit out very large values for two properties.  But obviously, this has a garbage in, garbage out element to it and so I feel more comfortable with M&A comps.  

Since 2010 Western Canada has seen significant M&A activity in the metallurgical coal market.  Below are some relevant transactions:

The last two on the list are the most recent transactions.  

In June 2018, Bathurst Resources Limited agreed to invest $121.5mm in stages in Jameson’s Crown Mountain hard coking coal project in B.C. When fully funded, Bathurst will own 50% of Crown Mountain. The purchase price equates to about US$1.86/t of Crown Mountain’s coking coal resources.  

In February 2019, the Hancock Corporation, a private Australian-based coal company, launched a A$591mm bid for 80.2% of Riversdale Resources, another private Australian company. (Prior to the bid, Hancock owned the remaining 19.8% of Riversdale.) Riversdale’s key asset is the Grassy Mountain coking coal project in southern Alberta, Canada. Grassy Mountain has estimated resources of about 195mt of high-quality hard coking coal. By May 2019, Hancock achieved an 85% ownership interest in Riversdale Resources requiring Hancock to increase its offer to all Riversdale Resources shareholders to A$2.70, up from the original A$2.20 per share bid, equivalent to about US$2.68/t of Grassy Mountain’s coking coal resources.

CAD is currently valued at $374mm and has about 695mt of coking coal and premium PCI coal resources, equivalent to a valuation of only $0.54/t of resources.  I believe this compares favorably to the above comps particularly when you consider that met coal prices today are significantly higher than they were in 2018 and 2019.  

Catalyst

Sale of the entire Company or one of the assets