NPV analysis of Pike Coal Mine (NZOG = 71%)

[waaihoek]

.
I am keen to get some feedback on methods used to estimate the DCF / NPV value of the Pike River Coal Mine (NOG 71%). Initial construction phase due to begin next year on the west coast. Final access agreements have just been signed with DOC.

Input parameters known with some certainty are the reserves of coal (16m tons proved and probable, plus another 2-4m likely), the projected annual mining rate (1.1m tons/yr), the near term value of the coking coal ($US 75 / ton or more). Mining costs per ton of coal not so well constrained but could be around $NZ 65 / ton including transport to the point of shipment from the Shakespear Bay. Capex expenditure is about $NZ 62m.

The excel spreadsheet can be downloaded from:

http://fixx.co.nz/downloads/Pike-DCF-Modeling-V3.xls

If anyone with a financial / accounting background could comment on the spreadsheet, I would be much obliged.

Likewise if you spot any errors or dubious methodology, please advise. (I've never done a DCF / NPV before).

To keep things simple, mode! assumes constant values and everything in todays dollars (ie inflation effect assumed to be neutral in terms of actual value in todays dollars). For simplicity have also assumed capex expended in first year.

Mode! obviously sensitive to variations in exchange rate and price of coking coal / ton, and the cost of mining and transportation etc. You can play with the input parameters to see effects of different combinations.

I have depreciated the capex over the life of the mine and subtracted the annual depreciation from the projected yearly profit prior to calculating the tax payable. This of course improves the annual post tax profit, particularly in the early years, so is good for the NPV. Is this the most appropriate way to handle the capex ? Capex is also subtracted from the PV at the end of the calculation to give the net PV (ie the NPV) which I understand is the thing to do.

Overall the Pike project looks like it should have a NPV = $NZ 169m

With 71% of the project, value to NZOG = $NZ 120m
(or 60 cents/share, fully diluted (200m shares))

I think my costing per ton for mining and transport etc may be a little on the high side, but better a conservative valuation than being too optimistic.

Any comments on the NPV spreadsheet methods etc most welcome.

Thanks,

W

[Unicorn]

Hi W

I think your spreadsheet is a pretty good effort at quantifying a value for the NOG share of PRCC. Thanks for your efforts.

I see your figures as leaning to the conservative side. At $38US per tonne, MTO cost of about $55NZ is required for break even (best case, no debt). I recall somwhere around $35 to $40US was quoted long ago as being break even price point. This indicates MTO might have been about $55NZ at that time, so perhaps $65NZ is a bit generous even now.

I also feel your sale price is a bit low, or more correctly that the $US exchange/coal price combination could be more favourable. Estimating coal prices and exchange rates over 20 years has to be virtually impossible of course. My own view is that prices are now near their peak and likely to drop back with falling demand for steel. And part of the current spike in prices is due to depreciation of the US$.

I am not sure about the impact of WACC. What the spreadsheet appears to be saying to me is that the overall value is 60.1cps in excess of a 12% return. Changing the WACC to nil increases the final value to about 200cps - is this what the fundamental value of the investment is based on no debt and before any dividends are paid?

[waaihoek]

Hi Unicorn,

Thanks for the feedback and comments ....

With the parameters I aimed to err on the conservative side and selected a relatively high MTO/ton cost and relatively low sale price, I wanted to get a handel more or less on the baseline value of the Pike mine for NOG. You can have fun playing with the input parameters to the spreadsheet and see the effect on the resulting NPV value of the mine.

As I understand it the WACC (weighted average cost of capital) is a mixture of things, can be diferent things to different people, but basical factors in the opportunity and risk cost of what you might do elsewhere with your capex .... could just put the capex into gov bonds and get the "risk free" rate of return, whatever the gov bonds are paying ... maybe 4 - 5 - 6 % or whatever, or could try starting a coal mine .... more risks involved so you would expect the required rate of return for the project should be higher etc. Presumably very risky projects should use a high WACC to calculate their NPV.

Cheers,

W

[blackcap]

Waaihoek, thanks for providing the DCF valuation on NOG.

Again very interesting reading. Have not analysed it properly, however looks reasonable. WACC of 12% may be a bit on the low side (the equity requirement on a volatile coy like Nog may be quite high) but apart from that things look reasonable.

Implying that NOG has a valuation now of $1.50 odd is encouraging for a recent Nog holder.

Thanks again for the efforts and for making it avaialable for us.

[ananda77]

waaihoek

Any comments on the NPV spreadsheet methods etc most welcome

To get a realistic idea of the value/share of the Pike River Coal Mine to NOG, one could take an estimation of how much the mine could sell to an interested party today.

Starting with today's coke-coal prices and developing different scenarios based on various coke-coal prices, the resulting scatter-plot would give investors a fairly good idea of the value of the mine/share.

[Unicorn]

I am still having trouble with the concept of WACC, as it impacts on determining the raw value of the asset.

This is particularly because the amount of capital involved does not appear to be specified. Surely if there was a huge amount of capital involved then NPV should be smaller than it would be if the whole operation ran with minimal capital requirement. Yet the formula does not appear to take this into acount.

[waaihoek]

Unicorn,

The amount of capital involved is $NZ62m, and this capex is subtracted from the NPV once the latter is calculated.

The WACC percentage can be set in cell D6 at the top of the spreadsheet and is embeded into the NPV calculation via the parameters supplied to the excel NPV function. Click on cell Q44 to see these parameters. The parameters are the WACC and the range of cells representing the yearly NPAT cashflows over the life of the mine.

As I understand it the WACC is not applied to the actual capex for the project, but rather controlls how rapidly future earnings are discounted, ie the higher the WACC the lower the value of future earnings, particularly the earnings further away in time, ie the profit expected in year 15 has a much lower "present value" or PV as compare to the near term profit expected in say year 3.

Hope this helps.

Link to WACC stuff:

http://www.valuebasedmanagement.net/methods_wacc.html

W

[Happy]

W

your numbers are a little on the high side. 10 year coal prices have been $us 55/tn current high prices are a blip expect a fall back to normal over 5-6 years.

Also you have completely forgotton that need to pay the Crown a royalty...check out Crownminerals web site...also the project is two years away in cashflows so need to adjust for that as well...and also you may want to think about whether assuming that the price of coal and the costs will move in tandem in real terms...pretty unusual make all these changes and your numbers drop to closer to $70m ...

Happy...someone with a financial background...

[trendy]

Happy you should post your detailed analysis to show where you got the $70M from.

[skinny]

W - I did a similar exercise recently for a lead mine and was lucky enough to have it critiqued by a Mining Engineer who makes a living from estimating life-of-mine values. The WACC you are using looks pretty sensible to me and that is one of the most crucial inputs in these exercises. Just a few thoughts:

- The Capex in year 1 creates a tax loss which can be used to offset some of the tax paid later on (i.e. your DCF's in the initial few years may be too low)

- As Happy suggests it might be a good idea to look at trends in coal versus production costs and how reversion of coal and the NZD-USD to their average values affects the valuation. Perhaps they largely off set each other? You also need to adjust for any royalties and timing of prodn as Happy points out too.

- Generally speaking both in these calculations and in reality it is more optimal for companies to wind down production in the out years (i.e. for a fixed coal reserve you would have higher mining figures in the initial say 1-15 years and a tailing off of production in the out years). This will boost NPV.

- I would also double check the depreciation rules for mining operations in NZ tax law. You've depreciated the CAPEX only on what looks like a diminishing value basis. I'm guessing there might also be provision for reductions in the reserve value of the mine?

Cheers anyways, looks interesting, I should really buy NOG one of these days!

[Happy]

Skinny - take Ws model, put in say $55 or 60 /tn from 2010 in,
Take off an additional 5% for the Crown royalty.

Capex can't be expensed and depreciated, this is illegal. Has to be depreciated if >1 yr benefit...

The wacc is a little low but I can live with it. I'm a big holder and there is no way I think Pike is worth over $100m.


The first coal is 2 years away maybe 18 mths so need to disount by two further years, eg W year 1 is actually year 3. Also the capex will occur in year 2 (ie b4 mining occurs)...do all this and you get close to $70m,

[waaihoek]

Hi Happy, Skinny and others,

Thanks for your feedback and for pointing out the royalty tax etc. New Pike spreadsheet at:

http://fixx.co.nz/downloads/Pike-DCF-Modeling-V4B.xls

I have reworked the spreadsheet to include the royalty tax and also to deduct the capex, and previous permit costs, against the first cash flows as per my reading of the Crown Minerals Act (1991) and the Minerals Programme for Coal (1996). Also noted are the comments on the Treasury website regarding mining development costs:

“The company tax rate is 33%. ……... Depreciation rates for new assets are based on the economic life of the asset plus a 20% loading. There is immediate deductibility against income of forestry and mineral mining development costs, petroleum exploration expenditure and of most agricultural development costs.”

http://www.treasury.govt.nz/nzefo/2004/publicfinance.asp

http://crownminerals.med.govt.nz/coal/docs/min-prog-for-coal.pdf


Have also reduced the average forward price of coal to $US 70 / ton. I think the historical (last 10 years) average price of $US 55 / ton may be too low going forward.

Particularly as the developing role of China, India and other emerging economies in terms of world commodity prices is something of a new open book ... Seems to me that with the consistently high growth rates that China has posted year after year, and with India also posting significant growth, that we may have moved up a gear in terms of a broad range of commodity prices, including coking coal. But I agree that coking coal prices postulated to be heading for $US 80 – 90 / ton may be a short term trend -- but see coments by the Macarthur Coal chief executive at the bottom of the spreadsheet for a more upbeat view ....

With the royalty tax added and the long run coal price set at $US 70 / ton, the NPV is of course now substantially lower compared to the previous moode!. NOG's share of the NPV is now $NZ 92.4m

I wonder how relevant the PriceWaterhouseCoopers WACC figure is for NOG. See info at the bottom of the spreadsheet. If I use the PWC figure for NZOG WACC = 10% for Pike, then the NPV recovers much of the lost value due to the 5 % royalty and the lower coal price.

No doubt 10% is too low, but a reduction of 1% from 12% to 11% in the WACC pushes the NPV due to NZOG above $NZ 100m.

Considering effect on NPV of possible trends in exchange rate vs mining costs vs coal price .... to a degree these parameters may balance out to produce something of a neutral effect .... eg if coal prices fluctuate with a stronger vs weaker US dollar, likely to see a compensating movement in the NZ/US exchange rate. Have therefore based the mode! on constant parameters. But keen mode!ers can manually input changing prices and exchange rates into the spreadsheet to see the results for different scenarios.

Cheers,
Waaihoek

[Happy]

10% wacc is way too low, I would still run with 12% minimum and prefer 15%, there is a load of uncertainty remaining. The PWC numbers are not worth the paper they are written on for the purposes of this. No one would invest for a 10% wacc in an entity this risky.

Also there is an additional $10m in working capital upfront required.

Still think $70/tn is too high assumpmtion to use forever, prices for commodities never stay at record highs forever.

Do all this and you get around $60 m - roughly I think this is fair $s.

[waaihoek]

Hi Happy,

Agree that the PWC WACC figure is too low.

Think I will stay with an average $US 70 / ton coking coal price .... here is another report re possible contract prices for next year.

-----------------------------------------------------------------------------

http://www.aireview.com/index.php?act=view&catid=8&id=810

Contract hard coking coal to US$100/t next year?

After attending the Coaltrans Conference in Barcelona this week, GSJBWere analysts have provided feedback on the outlook for the coal sector.

The bullish mood among delegates leading into the contract negotiation period has reinforced the broker’s positive outlook for both coking and thermal coal prices.

A vote at the conference saw more than 40% of the delegates voting for a hard coking coal price contract of more than US$100/t next year, with a lack of availability supporting this forecast.

China’s move from a net exporter to a net importer of coking coal also provides support …………….

----------------------------------------------------------------------------------

With the sale price set at $US70/ton, and adding in the $10m working capital to the Capex (keep things simple), leads to a reduction in the NPV to $NZ 87m (NOG’s share).

Hope we will get more insights into the Pike project economics in the near term …… the Annual Report indicated that more info on Pike was due in the near term. Maybe some new info will be released at the AGM.

In the mean time gestimating future coal prices, mining costs and the exchange rate is a judgement call …. Punters can play with the spreadsheet and try different scenarios, and derive there own valuations.

I will revisit the spreadsheet calculations after the AGM is over and done with.

Thanks again Happy for your feedback.

W

[bbob]

Thanks Waaihoek et al for the time and effort you've put into this model, not to mention all the other info packed posts you've made. Something in the 2002 annual report caught my eye.
Page 8 column 2 para 2
"A new financial study, which incorporated a more detailed mine plan than the original 2000 feasibility study, was completed in March 2002. Based on reserves of 15.5 million tonnes of coking coal and using an after tax discount of 8%, the potential value of the project ranges from $70 million to $110 million depending on the other variables such as coal prices, exchange rates etc."
Whether that was the NZO calculated NPV at the time (prior to the last 2 years coking coal price increment) I'd like to hear people's thoughts about, but I'd suggest NZO may value PRCC more highly 2 years on ie > $70-110 million.
Has anyone access to those 2 previous feasability studies as their estimates of mining costs per ton etc would be useful guides for W's model?

[waaihoek]

BBob,

Thanks for the post .......

And good spotting re the $NZ 70 - 110 valuation posted in the NOG 2002 Annual Report ..... I had missed that. And yes that estimate was done before the recent rise in coking coal prices.

I wonder if the "after tax discount rate" is the equivalent of the WACC (which is also sometimes referred to as the "discount rate"). If it is, and NOG have used 8% in their estimate, I guess financiers and broker/analysts might think that is way too optimistic. But presumably NOG have their reasonsa for a low WACC or discount rate, maybe a favourable financial package from the steel mills / coal buyers as part of a long run sales contract ?

Putting that to one side I think I may also have been a bit too pesimistic with the mining, transport and operating costs set at $NZ 65/ton in the spreadsheet. Time will tell.

I am looking forward to the AGM since I hope we can get some more info on Pike project economics (and the latest Annual Report does promise updates on the project in the near term).

w

[bbob]

Waaihoek,
Hopefully the AGM rather than time will tell! I wondered about the operating etc costs as well. The 2000 feasibility study was positive at a time when the OECD coking coal price average import cost was $42.31 http://www.eia.doe.gov/emeu/international/cokeimp.html
but the NZ dollar was worth a whole lot less,
http://www.x-rates.com/d/NZD/USD/hist2000.html
balancing the coal price up
$42.31* rough average US/NZ 2.2 = circa NZ$95/ tonne
I don't know what sort of margin is necessary to be profitable but with the development costs etc to be considered it suggests the expected operating costs may have been a bit less than is currently mentioned in your model.
That does bring to mind that the NZ dollar is relatively high vs the US, a situation which may not last if our interest rates decline over the next couple of years or if the US economy gets its act together. It is not unreasonable to think this may work in NOG / PRCC 's favour, possibly quite significantly.
Cheers
bbob