SouthGobi’s direction murky after Hong Kong deal

VANCOUVER — It’s been a nightmare two years for Mongolia-focused producer SouthGobi Resources (TSX: SGQ; US-OTC: SGQRF), as it weathers socio-political challenges and low coking and thermal coal prices.

SouthGobi is operating below capacity at its Ovoot Tolgoi open-pit coal mine, placed half of its workforce on furlough in June and has seen a drop in share price over the past 18 months. Adding to the uncertainty is a recent share transaction between Turquoise Hill Resources (TSX: TRQ; NYSE: TRQ) and Hong Kong-based National United Resource Holdings.

SouthGobi’s output decreased over the first two quarters of 2014, with second-quarter production pegged at 550,000 tonnes of raw coal, which compares to 640,000 tonnes during the first quarter.

As a result SouthGobi registered a US$23.2-million net loss, or 12¢ per share over the past three months, which is a year-on-year improvement from the US$33 million, or an 18¢-per-share loss registered during the second quarter of 2014. Over the first six months of the year the company has experienced a US$44-million net loss, or 23¢ per share. Its full-year loss in 2013 totalled US$237 million, or $1.30 per share, with annual revenues pegged at US$58.6 million.

Direct cash costs of products sold dropped 10%, or US85¢ to US$8.23 per tonne, while average realized selling price per tonne of aggregate coal products declined from US$10.90 over the first six months of 2013 to US$9.08 over the same period in 2014.

“Coal prices in China declined further in the second quarter compared to the first quarter of 2014 in response to excess seaborne supply, and the global metallurgical coal market remains oversupplied,” president and CEO Ross Tromans noted during an Aug. 11 conference call. “Coal producers around the world continue to focus on efficiency and cost reduction, while announcing production curtailments, closures and reductions in workforce, as well as delayed start-up or withdrawal from expansion projects. It has been a similar situation in Mongolia.”

SouthGobi has sought more sources of capital in order to maintain what it labels “appropriate liquidity levels,” and was bailed out in late May when controlling shareholder Turquoise Hill — which is majority owned by Rio Tinto (NYSE: RIO; LSE: RIO) — extended the company a US$10-million revolving credit facility to meet short-term spending requirements. The company also completed the sale of its Tsagaan Tolgoi mining licence during the second quarter, which provided net proceeds of US$1.3 million.

Around two months later, however, Turquoise Hill reduced its exposure in SouthGobi when it sold half its equity position — totalling 56 million shares, or 30% of the company — to National United Resources for US$24 million. Turquoise Hill CEO Kay Priestly said on Aug. 12 that there are no current plans for the remaining equity holdings, and added that the credit facility appeared to “maximize value and provide a good path forward for SouthGobi from a liquidity standpoint.”

National United Resources is principally engaged in coking coal trading, natural resource-related logistics business, outdoor advertising and other media-related services. It only entered the coking coal trading and natural resource-related logistics business a year ago, and is building up networks and cost relationships in the industry.

“Natural United Resources management believes that acquiring a stake in SouthGobi will allow them to further secure supplies of coking coal with our company, give them an opportunity to form a strategic alliance and continue to diversify and strengthen their natural resource business,” Tromans said. “We have talked to [them] because they are customer of ours, and we are aware of that — but it’s too early to discuss the change of direction of the organization.”

Tromans added that SouthGobi’s mid-term objective remains securing additional and immediate sources of financing. The company previously stated in March that it would have trouble meeting its debt obligations this year and could face a default of a US$250-million convertible debenture issued by China Investment, which owns more than 16% of the company.

SouthGobi is also dealing with a lawsuit from the Mongolian government, as the nation’s anti-corruption body investigates the company for tax evasion. Back in 2012 Chinese state-owned Aluminum Corp. of China offered to buy SouthGobi for US$926 million. The Mongolian government blocked the deal with its Strategic Entities Foreign Investment Law legislation.

SouthGobi has traded within a 52-week window of 47¢ to $1.44, and dropped 60%, or 74¢ over the past year, en route to a 56¢ close at press time. The company reported a US$6-million cash balance in early August, and has 187 million shares outstanding for a $105-million market capitalization.