INVESTMENT COMMENTARY — Coal producer Hillsborough shows earnings potential

The coal sector may not be imbued with the romance associated with gold or diamond mining, yet “black gold” does generate profits for many a producing company.

Douglas Hurst, mining analyst for Sprott Securities, sees good upside in Hillsborough Resources (TSE), the only Canadian public company which generates the majority of its revenue from coal mining.

The issue is currently trading at $2.20, up from $1.75 at the time of Hurst’s recommendation in mid-July. The analyst predicts the stock could rise to $5 now that expansion plans are in place for its core asset, a 63% interest in the Quinsam underground coal mine 31 km southwest of Campbell River, B.C.

An expansion of the Quinsam facilities to 1.2 million tonnes per year from the current 518,000 tonnes, coupled with recent increases in the benchmark price of thermal coal, has Hurst predicting a big jump in cash flow and earnings over the next two years.

Preliminary estimates by Sprott place cash flow for fiscal 1996 at 90 cents per share, rising to 95 cents per share in fiscal 1997, as the planned expansion comes into effect.

One of Quinsam’s principal advantages is its proximity to a deep-water port. After washing at the mine-site, clean coal is trucked to a barge loading facility near Campbell River for transport to a deep-water loading facility at nearby Texada Island.

The expansion is expected to reduce cash operating costs to $30 per tonne by 1997, down from $37 per tonne in 1994.

On the pricing side, the benchmark price (based on 6,700 Kcal/kg thermal coal) increased to US$40.30 per tonne in 1995, from US$36 per tonne in 1994.

Quinsam expects to receive an average of US$34 per tonne for its 1995 production, increasing to more than US$40 per tonne in 1996.

Financing for the $16.6 million expansion is in place, funded in part through the sale of a 37% interest in the coal project to Marubeni for $11.1 million. Trilon Bancorp is providing a $5-million term loan, while a further $9 million in interest-free government loans will be used to upgrade the mine road and the barge loading facility.

Quinsam also holds a 100% interest (subject to a 5% net smelter royalty) in the T’Sable River coal property which hosts a reserve estimated at 11 million tonnes. The coal is higher quality than the Quinsam mine product and is closer to tidewater.

In addition to its coal assets, Hillsborough holds an 18% share position in Canabrava Diamond (TSE). It also generates sporadic revenue from Canadian Mine Development, its contract mining division.