Description

Grande Cache, which went public in April 2004, was formed in 2000 to reactivate coal mining in the Smoky River coalfield located in Alberta, Canada. Between 1970 and 2000, the coalfield produced over 50 million tons of metallurgical coal which was exported to steel companies on four continents. The previous owner went into receivership in March 2000 as a result of (a) depressed metallurgical coal markets, (b) a flawed strategy to convert the company to an income trust by attempting to rapidly expand production by adding significant leverage to its balance sheet, and (c) a change in permitting requirements which delayed the timing of such planned expansion.

Grande Cache acquired all of the engineering, environmental and geological data from prior operations as well as key infrastructure including all mechanical and electrical equipment in the process plant, the process plant itself, coal handling equipment and rail load out facilities. The purchase price for these assets was approximately $8-$10 million—a fraction of the actual worth of these assets (note that the company estimates it would cost in excess of $100 million to replace these assets).

The coal from the Smoky River coalfield is considered to be high quality, low ash metallurgical coal. Additionally, the coalfields are supported by excellent infrastructure as they are adjacent to a highway and Canadian National’s rail line. The company’s plan as stated in their offering prospectus was to produce 1.8 million tons of met coal per year over a 12 year period commencing by the end of calendar year 2004. However, its coal reserves are estimated to be in excess of 145 million tons, all located in adjacent mine sites. Accordingly, the company believes that it can produce significantly more than 1.8m tons of coal per year and will be able to extend its operations in Smoky River for several decades. The capacity of the company’s processing plant is 3.5 million tons of met coal and it is likely that the company will reach that capacity in two to three years.

The company’s original plan was to begin mining and production operations by the end of 2004. During fiscal 2006 ( begins in April 2005) the company expected to produce 1.1 million tons and 1.8 million tons during fiscal 2007. However, this plan is quite conservative and has been already adjusted higher by the company since their public offering in April 2004. The company will probably begin production early this fall and will likely to produce closer to 2 million tons for fiscal 2006, almost double their initial estimates. They are able to do that because they have decided to reactivate their B-2 mine, a decision made subsequent to the public offering. B-2 has been a productive mine for years and will require only minimal permitting to reopen. It is important to note that the majority of these mines are surface as opposed to underground mines, which mitigates the possibility of production delays, execution issues and mining cost increases. Additionally, the company’s “underground” mine is actually located in small hills above ground level, which is far easier terrain to mine than traditional underground mines. Lastly, it is important to note that all of the mines that the company expects to use over the forseeable future are mines that have recently been operational and were shut down in connection w/ the smokey river bankruptcy. Since these are not new mines, permitting to reopen these mines is not expected to be too difficult.

Management of Grande Cache is strong, with extensive experience in metallurgical coal mining. The top three executives were all high ranking executives at Fording Coal, the largest metallurgic coal producer in north America and one of the largest in the world. Many of the other members of management worked for the prior owner of Smoky River; thus, they have extensive experience with and knowledge of the Company’s coalfields.

The global metallurgical coal market has been very strong and shows no signs of abating. The current contractual price of met coal is $65 / ton for this year and is expected to rise to $75 next year. [Note that pricing in march of each year for the 12 month period beginning in April. Recently, there has been talk that contract prices may be as high as $85 per ton or more. Spot prices have recently been as high as $150. Worldwide supply of met coal has not been able to keep pace with increases in demand for steel. China has gone from a net exporter of met coal to a net importer. While there are coal mines in Northern China that may be able to supply some additional tonnage, China lacks the rail and transportation infrastructure to explore such potential resources. Additionally, there has very little investment in new capacity in the past 20 years. It should be no surprise that the company has already entered into multi-year arrangements to sell at least 1.1 million tons to Korean and Japanese steel producers, who have all been longtime purchasers of Smoky River coal. These customers and many others would be eager to absorb any additional tonnage produced by the company.

The Company, which is debt free, is trading at $3.6 (Canadian dollars), making it a very cheap stock based on its earnings capability . Based on the company’s production and cost estimates at the time of their IPO, the company’s operating results and valuation would be approximately as follows:

March Year end FY 2006 FY 2007

Tons Sold (millions) 1.15 1.80
Price Per Ton (us $) 65 65
Exchange Rate 1.37 1.37
Selling Price/Ton ($C) 89 89
Total Operating Costs/Ton ($C) 57 52
Revenue 102 160
EBITDA 37.1 66.7
D & A 6.2 7.4
Operating Income 30.9 59.3
Net Income 20.1 38.6
EPS 0.55 1.06

Company Stock Price ($ C) 3.65 3.65
Shares Outstanding 36.5 36.5
Market Cap ($ c) 133.1 133.1
Debt 0 0
Enterprise Value ($ C) 133.1 133.1

P/E 6.6x 3.5x
Enterprise Value/EBITDA 3.6x 2.0x


However, if the company is able to produce closer to 2m tons in FY 2006, which they have indicated (and i believe)is highly likely, then the company would generate EPS of approximately $1.19 per share. Further, if the price of met coal were to rise to $75, as predicted, then the Company’s EPS would be closer to $1.68 per share. It should be noted that the spot price for met coal has been between $125-$150 per ton (as high as $200)and current thinking among the "experts" believe that met coal could be as high $80-$85 for next year. As one can see, this is a very cheap stock. Even if met coal prices were to drop to $50, the company would still earn approximately $0.46 per share, giving it a PE of 8x.

Catalyst

1. Commencement of production/mining operations and execution of production plan, which will be significantly ahead of schedule.
2. Research coverage which is imminent.
3. Continued strength in met coal markets, which is expected due to ongoing supply/demand imbalance.