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Buy Keaton – Intellidex

Eskom coal hunger presents growth opportunity for junior miner.

With Keaton commissioning a third colliery in the third quarter of this year, its long-term investment case becomes more compelling.

Its net asset value (NAV) of 421c/share is more than double its market price and its shares look cheap for the growth it promises. It is even more compelling if you compare it with its peers whose NAVs are largely in line with their market prices. With the new colliery expected to churn out 1.4Mt per annum (Mtpa) once in full production, the company is edging closer to beating its target of 5Mtpa. Another mine at developmental stage is expected to be online in two to three years.

With demand for coal almost assured from South African power utility Eskom, the fortunes of most junior and mid-tier coal miners in SA are largely dependent on how much coal they can dig out of the ground. Eskom offers prices usually on cost-plus long-term contracts. While the prices to Eskom are considerably lower than export prices, the costs of supplying the product to Eskom are lower and come with an added advantage of reliability.

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Keaton sells the bulk of its thermal coal from the current collieries – 70%-90% of total sales – to Eskom with its metallurgical coal and anthracite being sold to domestic industrial consumers and Brazil. While this high quality coal is exposed to depressed international coal prices, it is a much smaller portion of the group’s earnings. However, the arrangement does enable Keaton to benefit from any recovery in international prices.

Keaton posted satisfactory results for the interim period to end-September which were largely in line with market expectations. Total sales were up 7% to 1.45 metric tonnes (Mt) translating into R783m (1H15: R710m) in revenue, reflecting 10% growth. Headline earnings per share, however, fell 29% to 13.7c/share due to the increased number of shares issued and finance costs. No dividend was declared but we expect a maiden dividend at the end of the financial year as the company has accumulated a large cash pile.

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Keaton maintained steady production throughout last year, a trend that is likely to continue in the next 12 months. Its production update for the quarter to endDecember shows that rolling 12-month sales for thermal coal were up 5% while that destined for export and industrial consumers was 72% higher.

Based on these forward estimates and valuations we think Keaton’s market price is trailing its intrinsic value. Trading at a forward price: earnings ratio of 7.1, we expect this to re-rate as pipeline projects become operational. While its business is subject to a number of external factors, we think it offers good long-term value for investors with a high risk appetite. We issue a speculative buy recommendation.

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Bull factors

  • Increased demand for coal by Eskom and other players to stabilise prices
  • Commissioning of a new mine removes dependence on a single colliery for the majority of its production

Bear factors

  • Over-reliance on Eskom
  • Threat posed by possible enforcement of tougher BEE requirements for Eskom suppliers
  • Delays in regulatory process may lead to delays in the commissioning of some planned mines
  • Possibility of tighter regulation of domestic prices and export volumes if government’s proposal to declare coal as a strategic mineral is adopted

Nature of business: Keaton is a coal mining company that operates two collieries in Mpumalanga and Vryheld. It is acquiring and developing new coal-mining opportunities.

Disclosures: The analyst has no financial exposure to the instrument discussed. The opinion represents his true view. For Intellidex’s full disclaimer, methodologies and definitions please click here.

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