Description

Company Overview

Westshore is a single asset company who operates and owns the busiest coal storage and loading terminal in Canada located at Roberts Bank (south of Vancouver), British Columbia. It’s a simple business. The company operates the terminal on a throughput basis and is paid a handling charge by its customers under long term take or pay contracts when the coal is loaded on a ship - Westshore does not take title to the coal. Coal is delivered to the terminal in unit trains operated primarily by CP and BNSF and is then unloaded and either directly transferred onto a ship or stockpiled for future ship loading. The terminal has two deep water berths, four stackers, blending capability, over seven kilometres of conveyors and ~1.8 MT of storage capacity. Westshore provides service to its customers seven days a week, 24 hours a day. The asset is high margin (>50% EBITDA margins), has low sustaining capital requirements (<$20 mm post expansion) and serves customers under take or pay contracts. Once Westshore completes its upgrade project expected early 2019 (~$90 mm of incremental capital remaining 2018E of total ~$275 mm), the terminal is expected to have ~34-36 MMT of annual throughput capacity (up from ~33 MT). During 2017 Westshore shipped ~29 MT and is expected to ship ~30 MT in 2018.

Thesis Overview

I believe Westshore Terminals is a short. The company has a great asset with significant barriers to entry and a durable competitive advantage. However, its customer base is concentrated with Teck representing >60% of total volumes from their Elk Valley mines which produce ~26-28 MT per year on a flat profile. Teck is spending ~$300 mm of capital to expand capacity at their 46% owned Neptune Terminal, which is a low-cost option and direct competitor to Westshore (~33 km north of Roberts Bank). Neptune is increasing capacity by ~6 MT per year to ~18.5 MT expected to be complete around 2020. Westshore’s take or pay contract with Teck for ~19 MT per year ends in March 2021. Post contract expiry, it’s likely in my view that Teck’s expanded Neptune terminal will cannibalize volumes from Westshore or at the very least weaken Westshore's negotiating position heading into contract expiry (why else would they be expanding capacity ~6 MT connected to mines with flat mine production profile?).

Furthermore, Westshore’s remaining customers are largely thermal coal mines in Montana PRB, which are the swing producers in the sea born global thermal market (i.e. high cost). All of Westshore’s US thermal customers curtailed volumes during the recent downturn. If Teck were to reduce commitments through Westshore below 19 MT, Westshore’s negotiating position will be weakened with its PRB customers. Moreover, if during re-negotiation the thermal coal market and mine outlook is uncertain (it’s a cyclical commodity-based business, so this is not far fetched; Cloud Peak's contract is done in 2020, so Teck has time), Westshore’s negotiation position will be further compromised. Looking at another potential scenario, even if a cut in Teck contracted volumes were to be offset by an increase in thermal contracted volumes, the pro forma mix still calls for a higher cost of capital for Westshore. Moreover, Teck basically has a three year window to select opportune timing to renegotiate, which really does not work in Westshore's favour.

Potential undeveloped or mothballed mines in the hopper that could move tonnes through Westshore are unlikely to be financed. For example, Riversdale is proposing (and holding capacity at Westshore on ten-year contract) ~4.5 MT on brownfield Crowsnest Pass met coal mine site, in proximity to Teck’s Elk River mines. The company has two ‘long-term supporter’ shareholders (committing capital after pulling an IPO years ago), but the capital to build the mine is still not committed in my understanding. The project does have a chance, but it’s just that, a chance. While the revenue on held capacity from Riversdale should be valued, volumes & revenues contingent on over half a billion of capital still needed to be raised for a Canadian coal mining company is probably not prudent to include in a base case for volumes.

Looking at the stock, historically it has had a tendency to overreact to negative news. Whether it’s related to Teck, global met or thermal coal markets, potential US / Canada trade wars or potential US softwood lumber tariff retaliation from the BC government, there’s no shortage of noise around the name which can and is likely to in the future bring the terminals long-term viability into question.

Realizing this dynamic, I want to buy this name when there is blood on the streets and the outlook looks dim – trusting the coal cycle overshoots both ways & will eventually turn, Westshore’s take or pay contracts will largely hold up and Jimmy Pattison will likely be buying alongside me. Today, this is not the case at all. Teck is a consensus long name, sea-born thermal & met coal exports are earning very healthy margins for Westshore’s customers and analysts seem to be expecting >30 MT of exports from Westshore forever in their valuations (implying a potential cut to Teck’s 19 MT post 2021 is a out of consensus call). While the US / Canada trade tension & recent Teck volume reduction (along with them blaming Westshore for the issue) has been hurting the stock price to some extent, there’s still a lot of optimism implied in the price which is underpinned by shaky & historically volatile foundations.

A summary of some of the main business tenets is below, followed by a few perspectives on valuation.

The Moat

Westshore has little competition, a captive customer base and is in a market with high barriers to entry. It’s very unlikely another coal export facility will be built on the west coast of North America given numerous regulatory & environment hurdles, large upfront capital costs, few remaining deep-sea berth locations and limited links to existing infrastructure. A notable example of the regulatory / environmental hurdles, Millennium-Longview has been trying to get a brownfield coal export terminal (~44 MT planned capacity) approved in Washington since 2012 (first filed for permits) with little success and has recently turned to suing the state of Washington who is denying the company permits to ship coal to clients in Japan & South Korea. This is one example showing it’s incredibly unlikely a new competitor terminal will emerge.

Westshore also has advantages against the limited competitive base offering customers throughput, storage, and blending capabilities today. There are three export alternatives on the west coast of Canada, including Westshore (south of Vancouver), Neptune (northshore Vancouver) and Ridley Terminals (~1,000 km north of Vancouver in Prince Rupert). Relative to Neptune (46% Teck, 54% Canpotex), Westshore has blending capabilities, two deep water berths and ~1.8 MT of storage vs. Neptune which has no blending capabilities, one deep water birth for coal (of three total) and <1 MT of storage. Neptune has current coal capacity of ~12.5 MT (although effective capacity estimated lower) with ~$300 mm capital project for second rail car dumper, new conveyors, replace one ship loader and add additional track expected to increase capacity by ~6 MT. Neptune advertises they only ship met coal meaning Neptune doesn’t truly compete with Westshore for Montana PRB thermal coal imported to then ship to export markets in Asia. Looking at Ridley, this terminal is connected to CN making the Elk River region (CP connected) relatively captive to Westshore and Neptune.

Two-line hauls are far less competitive than one-line hauls, making Westshore the only viable export alternative for Montana PRB thermal coal mines via the BNSF. Westshore also has access from the CN connected northern BC and Alberta coal mines, making Westshore a viable potential alternative on potential restart. Rail & terminalling is a significant portion of total delivered costs for coal, meaning Westshore has a relatively captive customer base - if PRB thermal coal in Montana (or Elk River met coal in BC for that matter) want to find another path to meet customer demand in Asia outside of what they’re doing currently, they effectively can’t.

Where does the coal come from & how captive are these volumes to Westshore?

A majority of the volume moving from the terminal is from Teck Resources met coal mines in British Columbia. Teck is committed for 19 MT of capacity under a take or pay to March 2021. These tonnes are a direct shot on CP from mine to the terminal with the second viable option for Teck the Neptune terminal north of Burnaby. Teck has five mines in the Elk River region of southeastern British Columbia producing ~27 MT per year (since 2010 ~23.1-27.6 MT) of predominately high quality hard coking coal (~75%) with approximately one billion tonnes of reserves remaining. Estimated delivered costs of Teck’s Elk River mines is ~$100/MT (including >$11/MT paid to Westshore), placing Teck on the lower end of the global delivered cost curve for met coal (according to Wood Mackenzie). Teck is also the second largest sea-born steelmaking coal player in the world, implying their marketing capabilities are of the best in the world.

Neptune’s expansion capacity is a viable potential alternative to cannibalize a portion of the current Westshore throughput (why else would they be adding terminalling capacity on owned mines with a flat production profile?), but regardless Westshore will continue to ship a large portion of Teck’s coal post 2021. Teck also interchanges at Kamloops a certain Elk Valley volume to CN and also ships a small volume east to customers in the Great Lakes region of Canada & by direct rail to the United States (to BNSF), which I’d think are higher cost and likely to be reduced or perhaps eliminated post the Neptune expansion.

Cloud Peak, a public thermal coal producer, shipped ~4.2 MT via BNSF to Westshore in 2017 from their Spring Creek mine in Montana (2017 production 12.6 MT), with plans to increase to 5.5 MT 2018-2020 (BNSF & Westshore agreements in place). The Cloud Peak agreement includes a take-or-pay component but is likely more flexible than the Teck agreement. Cloud Peak also has volumes for JERA Trading from 2019 through the Q1 2023 which are expected to be moved through Westshore. Cloud Peak is relatively higher risk volumes longer term vs. Teck. In late 2015, with prices driven down by a glut of coal in the Asia Pacific market, Montana mines suspended exports entirely, with the company shipping just ~0.4 MT via Westshore in 2016. Delivered cost from Spring Creek is estimated at ~US$55/MT, with current Newcastle prices ~US$100/MT (from ~US$59 in 2015 and ~US$66 in 2016). Note Cloud Peak’s strategy, and communication to investors, is underpinned by their export strategy.

Signal Peak, a private thermal coal producer in Montana PRB, ships from the only bituminous coal mine in Montana (Bull Mountain) via BNSF to Westshore ~4 MT per year from a mine that has total production capacity of ~8 MT per year. Signal Peak is relatively higher risk volumes longer term vs. Teck. During the downturn the company announced ~20% of the workforce at the underground mine in central Montana had been laid off, with production cut from ~8 MT to 5.5 MT. Signal Peak’s coal is perceived as of unique & high quality in the PRB and its production profile was relatively more robust during the recent downturn than Cloud Peak’s, implying that it’s delivered costs are lower than Cloud Peak’s ~US$55/MT.

Lighthouse, a private thermal coal producer in Montana, ships ~1 MT via BNSF to Westshore from their Decker mine, which has total production of ~3 MT per year. Lighthouse is relatively higher risk volumes longer term vs. Teck, as the Decker mine volumes were reduced during the recent downturn. “Other” mines make up ~1.5 MT and includes Pet Coke from Oxbow Energy Solutions in Montana.

When looking at potential growth volumes, Riversdale is an important consideration for Westshore. The company is currently holding ~4 MT of capacity (10 year through-put commitment at fixed rates) at Westshore for their planned development of the Grassy Mountain Coal Project on a legacy mining area ~6 km north from Blairmore in the Crowsnest Pass, Alberta. There’s promotional hearsay that costs are expected to be lower than Teck’s Elk River mines (although rail agreements will dictate to a large degree whether this is true). Currently, the Project is being reviewed by the provincial and federal regulators and pending a favourable regulatory decision, is expected to start production in late-2020. The AER has not yet determined whether they intend to go to a public hearing. Should they decide to do so, a joint panel hearing would take place some time in 2018. Riversdale does appear legitimate (known for selling its original Mozambique-based operation to Rio Tinto) however it is uncertain to me to what degree their financing for the project are in order or whether their rail agreements are in place, which is very important to the viability and financability of the project. Prior estimates for capital were ~US$360 mm for 2.2 MT capacity, while current plans / commitments to Westshore are in the ~4.5 MT range.

Another mine worth considering, is the Grande Cache thermal coal mine shut down in 2015 with Grande Cache coal going bankrupt. Post restructuring and with new Chinese ownership (Sonicfield Global Ltd.) the mine is currently expected to resume operations in 2018. Westshore used to exclusively handle its coal volumes exported off the west coast. Westshore’s coal handling contract with Grande Cache had run to March 31 2022, also containing an exclusivity provision, with Westshore loading ~1.7 MT in 2013 from Grande Cache. Grande Cache is on CN, which has connection to Westshore, Neptune as well as Ridley (~18 MT capacity). Sonicifield is private, so it’s tough to gauge the potential of these restart volumes ultimately moving through Westshore, but it’s worth asking whether the prior contract is null & void through receivership or whether Westshore is still entitled to these potential export volumes on restart?

Where is the coal going?

During 2017/2016 Westshore’s export markets were as follows: Korea 37%/27%, Japan 22%/25%, China 12%/12%, S. America 6%/11%, Europe 8%/10%, India 5%/8%, Taiwan 7%/6% and Other 3%/1%. Of these volumes, 61%/74% was steel making coal (68% in 2015) and 39%/26% was thermal coal (32% in 2015).

Value Perspectives

Westshore is a very simple business, making the modeling process straight forward. Contracted cost inflation, VFPA lease terms, incetive fee structure, taxes etc. are all very transparant and simple to translate into excel.

Assuming ~30 MT 2018-2020 (~53% EBITDA margins), run rate volumes >25 MT 2022 (~47% EBITDA margins), ~$19 mm sustaining capital (with ~$90 mm remaining growth capex 2018E), ~3% escalation on existing contract pricing (even through contract expiries!), terminal 2022 EBITDA multiple of ~7x (implies <10% FCF yield) and ~12.5% discount rate, the net present value of the equity is estimated at <$15/share (>30% downside). To get to the current share price today on my model implies run-rate volumes >30 MT continue indefinetly, with 2022 terminal EBITDA multiple of ~8x and ~10% WACC – these assumptions are probable but still far too optimistic in my opinion (no meaningful margin of safety).

Also note the unfunded DB pension plan liability I netted against cash for the net debt calculation, but still included net interest expense for tax modeling (but excluded in FCF to firm used for the DCF, because it was included in net debt to arrive at an equity value).

I believe this stock will be a buy at some point in the future, but that said I just don’t believe there’s justification investors are being compensated for the risk they’re taking in the share price today.

Catalyst

Construction of Neptune. 

Analyst's capitulating on their current weak / misinformed biased views.

Renegotiation of contracts with Teck beyond 2021. 

Potential weakness in thermal coal markets in the next three years.

No news from Riversdale they've raised the half a billion or so to move forward.