Summary: Rio Tinto sold its 40 per cent interest in the Bengalla mine in NSW to New Hope Corporation. There were another five bidders, who are likely to be interested in another 40 per cent stake in the mine, owned by Wesfarmers. The return on capital at Wesfarmers’ resources division is roughly a tenth of the return at Bunnings and the chief executive is not married to coal.
Key take-out: Investment banks value Wesfarmers’ coal assets at up to $1.3 billion but the value could rise substantially higher – if the company is prepared to sell and can find a buyer.
Key beneficiaries: General investors. Category: Coal.
Profits from mining coal are very skinny today but profits from selling coal projects can be quite attractive as Rio Tinto discovered last week and as Wesfarmers seems likely to discover soon as it mulls the future of its controversial coal assets.
For Wesfarmers, a company better known as a retailer via its Coles, Kmart, Target and Bunnings brands, coal production is marginally profitable, but the sale of its mining interests could unleash a substantial amount of capital, perhaps as much as $3 billion.
If that happens the question investors would ask is what Wesfarmers might do with the money – expand some of its other business units or return a portion to shareholders, something it has done in the past with windfall gains.
Whatever happens the changing nature of the coal industry is stimulating interest in Wesfarmers, not that this story is investment advice, for that it is essential for you to ask your licensed investment adviser.
To understand what’s happening in coal it is important to first see the difference between producing coal and selling the mines, a contrast partly explained by a worldwide ownership shuffle which is seeing coal assets return to specialist operators while companies with other interests abandon a business which is becoming too hot to handle.
Rio Tinto’s sale of its 40 per cent interest in the Bengalla mine in NSW was one step in what is likely to be a dramatic scaling down, if not total exit, from thermal coal, the sort burnt in power stations to make electricity, and the target of toughening environmental laws and stricter bank lending rules.
The new owner of that 40 per cent in Bengalla is New Hope Corporation, a specialist coal miner which is prepared to shrug off warnings about the future of coal which have been raining down on the industry from very high places, including the Governor of the Bank of England, Mark Carney.
A few days after New Hope paid Rio Tinto $US606 million ($A865 million) for its 40 per cent of Bengalla, questions started to be asked about the value of other coal assets, especially those producing high quality coal that will benefit from the closure of low quality (and high cost) mines.
But the examination of the coal industry by most investors and stockbrokers was not deep because it has become a poorly researched sector that is regarded as a profit-free zone given the current low prices for the product itself and the controversies which follow its owners.
Overlooked at the time of the Bengalla sale were four important facts:
- There were another five bidders for Rio Tinto’s 40 per cent in the mine.
- Wesfarmers also owns 40 per cent of Bengalla.
- Bengalla produces thermal coal, which is far less valuable than metallurgical coal, the material used to make steel, and
- Wesfarmers has a second coal asset, the 100 per cent owned Curragh mine in Queensland which mainly produces metallurgical coal.
Under-bidders for Rio Tinto’s 40 per cent of Bengalla are likely to already be knocking on Wesfarmers’ door seeing if it is ready to sell, which is quite likely given that its chief executive, Richard Goyder, hinted last week that coal was not top of his must-have list.
When asked by a Eureka Report reader whether Wesfarmers would sell its coal mines he repeated a standard remark about all assets being for sale at the right price, but he also noted the controversy surrounding coal, the rise of alternative sources of energy, improving battery technology for storing electricity and the troublesome nature of coal. (Watch the full Eureka Interactive interview here.)
What Goyder did not say is that coal is Wesfarmers’ worst investment, contributing just $50 million last year to the group’s after-tax profit of $2.44 billion.
Even worse for a company that prides itself on applying strict metrics such as return on invested capital was that the resources division (which is all coal) returned 3.4 per cent on capital versus a group average of 9.8 per cent. To put it another way the coal division has a return on capital roughly a tenth of the return on capital achieved at the flagship Bunnings business which manages a stunning 33.5 per cent.
No business generating low returns like that ever survives long at Wesfarmers.
So, if the chief executive is not married to coal, many shareholders do not like it being part of the group portfolio and Bengalla had five under bidders there seems to be nothing stopping the quick sale of Wesfarmers’ 40 per cent in Bengalla for a price close to the $865m New Hope paid for Rio Tinto’s stake.
That leaves three interesting facts to consider.
- Bengalla is the smallest coal asset of Wesfarmers and is clearly worth somewhere in the vicinity of $865 million.
- The 100 per cent owned Curragh mine in Queensland is bigger, has more coal in its reserves than Bengalla, and has government approval to expand.
- Curragh mainly produces high value metallurgical coal.
Set against those facts are independent valuations of Wesfarmers’ coal assets, including $1.18bn by Macquarie and $1.3bn by Citi.
Curragh with its superior qualities should be worth at least $1.5 billion, and almost certainly a lot more because mines are often sold on the basis of a dollar valuation on reserves and resources in the ground.
The Bengalla sale, according to the investment bank UBS, was priced at $US7.27 per tonne of coal in reserve, the highest classification of mineral in the ground.
If that $US7.27/t was applied to Curragh’s last reported reserve of 281 million tonnes it would be worth $US2 billion, or $A2.9 billion.
The notional numbers rise further if a value is assigned to the 711 million tonnes classified as a resource.
Valuing the Wesfarmers coal operation is, of course, meaningless unless the company is prepared to sell, and it can find a buyer.
The directors of Wesfarmers will now be looking at that lowly 3.4 per cent return on its capital invested in coal and asking whether the money can be better used elsewhere in the group, while also getting Green activists off their back.
The next instalment of the coal-in-Wesfarmers debate will be heard at the company’s annual general meeting in Perth on November 12, an event which might bring fresh pressure for action given the environmental pressures and the chance to liberate capital stuck in a poor investment.