Wescoal: Poised to outperform

Despite global demand constraints.

This article was first published in the latest issue of the Moneyweb Investor. To read the magazine click here.

Despite the dire conditions in the coal mining sector we think Wescoal presents investors with an attractive risk. Its shares on a price:earnings multiple of six appear undemanding. Buoyed by the operationalisation of its flagship mine, Elandspruit, and the ramping up of production at its other two older collieries, Wescoal is poised to outperform. We maintain our previous buy opinion on its shares.

Wescoal recomm

Wescoal’s revenue in the year to end-March fell 5% to R1.59 billion (FY15: R1.67 billion), largely because of reduced sales from trading activities which management attributed to a more conservative credit policy and a tough business environment. Profitability at operating level, however, improved, thanks to a strong performance from the higher-margin activities. The mining division increased its contribution to operating profit to 79% (1H16: 73%), which helped the operating margin improve to 6.3% (FY15: 2.8%). This translated into 79% growth in headline earnings to 27.1c/share(FY15: 15.2c/share). 

Wescoal share price (rebased)

Wescoal graph

The macroeconomic picture for international coal prices is mixed. China’s demand for coal is expected to remain under pressure as its economic growth slows down and the government switches emphasis from investment-led growth towards demand-driven domestic consumption. Furthermore, the government is intent on reducing long-term coal imports to curb rising pollution levels, putting further pressure on the already ailing market. India, in contrast, is expected to ramp up consumption as it attempts to meet rising energy demands but we doubt if this will be enough to drive market prices to comfortable levels.

Given this not-so-rosy outlook on global coal prices we expect Wescoal to continue supplying the bulk of its output to Eskom and other local industrial consumers. Coal provides about 80% of SA’s primary energy needs, supplies inputs for the manufacturing of synthetic fuels and is also used directly as a fuel in various manufacturing processes. Given the limited availability of alternative energy sources and uncertainty over government’s nuclear energy plans, the current energy mix dominated by coal is likely to be with us for some time to come. Furthermore, once the Medupi and Kusile power stations are fully operational, it is projected that demand for coal will outstrip supply. That’s a challenge for SA but a tailwind for coal miners as it will be positive for coal prices.

Wescoal will benefit form increased production output. Run-of-mine production in FY16 was 1.9-million tonnes. Elandspruit, which was operational only for about eight months, produced 1.2-million tonnes. Annualised, that translates to about 1.8-million tonnes or production growth of 31%. The Khanyisa and Intibane collieries contributed about 0.6-million tonnes but with the ramping up of production going on at these mines, we expect higher production volumes in the short to medium term.

Management has set production targets of 4-million tonnes per year in the medium term and 8-million tonnes per year in the long run. When these targets are met the group will be generating the bulk of its income from the higher-margin mining activities. At present, lower-margin trading activities contribute more than half of group revenue. The higher contribution from the mining division and the volume-based costs dilution are likely to see overall margins expand despite depressed coal prices.

That said, we think Wescoal’s investment case will be more solid once management has addressed two issues. First is the black ownership level. While black ownership in Wescoal stands at 40% it still falls short of the 50% required by Eskom for all its suppliers. Until that is rectified the group will be operating on short-term contracts and that poses a significant risk to performance.

Second, the group has to ramp up its exports. Like many junior miners, Wescoal sells the bulk of its coal to Eskom. While this provides steady business, prices are often lower than what could be attained on the international market. 

Wescoal table 2

Bull Factors

  • Increased demand for coal by Eskom and other players to stabilise prices received
  • Elandspruit colliery is starting to produce coal and that will boost group earnings 

Bear factors

  • Increased competitor activity and logistics oversupply in the trading division likely to put pressure on already slim margins
  • Over-reliance on Eskom

Nature of business: Wescoal is involved in the exploration and mining of coal. Through its subsidiaries Chandler and MacPhail, it provides logistical support for distributing coal to the market. It operates its mining business through three collieries: Khanyisa, Intibane and Elandspruit.

Disclosures: The analyst has no financial exposure to the instrument discussed. The opinion represents his true view.

Wescoal table 1

COMMENTS   0

You must be signed in to comment.

SIGN IN SIGN UP

LATEST CURRENCIES  

USD / ZAR
GBP / ZAR
EUR / ZAR

The Budget Speech explained
Moneyweb’s 2020 national budget offering, including infographics and audio ratings, as well as past budget coverage....

The Investor Issue 48
Separating out the noise from useful information in the markets is not easy. The trick to staying the course is to keep an eye on ...

The Investor Issue 47
Some people intuitively understand that investing for future gain is a long-term process that cannot be rushed. The management of ...

The Investor Issue 46
While US innovation soars and its tech listings continue at a ferocious pace, SA has no real plan for how to embrace the 4th Indus...

The Investor Issue 45
As the investment world falls more and more in love with the simplicity that ETF investing offers, index providers are realising t...

The Investor Issue 44
Company financial statements are the last line of defence for investors wanting to protect their investments. But these cannot alw...

The Investor Issue 43
What makes one CEO great and another mediocre? The Moneyweb Investor ponders this and other leadership questions in the latest iss...

The Investor Issue 42
Stagnant economic growth and questionable economic policy is hampering the development of mid-sized - and investible - businesses ...

The Investor Issue 41
If you are one of those people who invests more energy into your credit card or medical aid rewards programme than you do your ret...

The Investor Issue 40
Volatility in global markets is higher than it has been in years, giving investors the jitters. Some 'experts' are suggesting a re...

The Investor Issue 39
From lessons from Buffet to building your own crypto-portfolio (a risky endeavour by anyone's standards), this issue of The Moneyw...

The Investor Issue 38
They say the art of investing is to ignore the short-term noise and focus on attaining long-term goals. That's true, but that does...

The Investor Issue 37
Getting the economy on the correct footing requires that everyone pulls their weight. Our writers this month have gone above and b...

The Investor Issue 36
The past year is littered with train wrecks like Steinhoff, SAA and Eskom. But there is real sense of ‘back to business’ in So...

The Investor Issue 35
Stock markets are soaring, but productivity is not. Innovation continues, but leads to fewer new jobs. And the great and the good ...

The Investor Issue 34
South Africans are fed up with corruption, or anything that has even a whiff thereof, as JSE rockstar Naspers is currently experie...

The Investor Issue 33
As the year races towards its close, investors will be forgiven for feeling a little breathless. The British WWII propaganda phras...

The Investor Issue 32
Anyone would think that getting an economy moving is rocket science. It's actually not. It requires single-minded commitment. Whil...

The Investor Issue 31
We examine the opportunities of forex trading, the best unit trusts, e-commerce at Richemont and more. ...

The Investor Issue 30
Despite what the astrologers say, there are no shortcuts when it comes to successful stock picking. Fundamental analysis counts. T...

NEWSLETTERS WEB APP SHOP PORTFOLIO TOOL TRENDING CPD HUB

Follow us:

Search Articles:Advanced Search
Click a Company: