Contrarian investor Anglo Pacific picks up coal royalty

Anglo Pacific Group (TSX: APY; LSE: APF) is forking over US$60 million in cash and US$5 million in shares for a royalty on Whitehaven Coal’s (US-OTC: WHITF; ASX: WHC) Narrabri thermal coal mine in Australia at a time when the price of thermal coal is near a five-year low.

The deal — its second major acquisition since June 2014 — entitles Anglo Pacific to royalty payments equal to 1% of gross revenue on all coal produced from the operating Narrabri North mine in New South Wales, as well as all future coal mined from Whitehaven’s Narrabri South project.

“By definition we are looking for value — we’re contrarian investors,” Anglo Pacific Group president and CEO Julian Treger explains in a telephone call from London. “Coal was hit a while ago and coal prices have been low for quite some time. It looks like coal is not at the bottom, but it’s nearer to the bottom than the top, so I think there’s risk to the upside rather than the downside.”

Treger reasons that a dramatic move away from coal can’t happen in the short term and argues that “even Tesla is coal-powered because it’s powered off a coal-powered grid.” The mining executive also expects coal consumption will continue to grow.

“The outlook for coal is not as dire as people are portraying, and we are also confident that many of Whitehaven’s peers have got themselves into take-or-pay contracts, so have carried on producing even though they’re not making money,” he says. “That has been to avoid penalties, but because they are cash-strapped, they haven’t been investing in necessary capex, so within twelve months or so, we expect the strip ratios for a lot of Whitehaven’s peers to rise significantly, and that will accelerate coal mines going out of business.”

Treger adds that Anglo Pacific’s investment in the Narrabri mine “is a good bet to be making — given its position on the cost curve and given that it’s a new mine and therefore efficient.”

Mining at Narrabri North began in June 2010, with the first longwall coal being cut two years later.

In fiscal 2014, or the twelve months ended June 30, 2014, the mine produced 5.7 million tonnes of coal. Whitehaven expects the mine will produce 6.5 million tonnes in fiscal 2015 and 2016, and 7 million tonnes in fiscal 2017. (It has permits to produce up to 8 million tonnes of coal.)

Narrabri produces low ash (12%), low sulphur (0.5%), low phosphor, high-energy export thermal coal and a mid-volatile pulverized coal injection (PCI) coal. That means that Whitehaven’s sales to China won’t be impacted by guidelines Beijing released last Sept. 15 that restrict coal imports from Jan. 1, 2015, that exceed a maximum of 16% ash and 1% sulphur. Anglo Pacific also points out that just 7% of Whitehaven’s total sales in fiscal 2014 were to China.

Narrabri coal is sold into premium Asian markets, including Japan and Korea, and Whitehaven’s joint-venture partners — EDF Trading (7.5%); J-Power (7.5%); Yudean Group (7.5%) and a consortium of subsidiaries of Daewoo International Corp. and Korea Resources Corp. (7.5%) — have life-of-mine offtake contracts that take up most of the mine’s output. The contracts are for agreed annual tonnage sold at the Newcastle benchmark thermal coal price.

Treger describes Narrabri as a low-cost operation that is targeting operating costs of A$59 to A$62 per tonne (US$45.95 to US$48.29 per tonne) free-on-board (FOB). And he says those costs should come down even further when the mine reaches full production (8 million tonnes per year). “At the moment, we’re producing for around US$50 per tonne FOB, but over time it should produce at US$43 per tonne when it’s in full production,” he says. “But that’s going to take a couple of years, and obviously it will also be subject to various issues, like currency, in the interim.”

Anglo Pacific cites 2015 forecasts from the CRU Group, which it says place Narrabri at the mid- to low-end of the second quartile of the global seaborne thermal coal business costs … and at the low end of the first quartile of the global seaborne PCI coal business costs.

Treger also points out the higher calorific value of the PCI coal Narrabri produces is sold at a different price level than thermal coal. In the longer term, Whitehaven is targeting a coal mix of up to 20% PCI and 80% export thermal coal.

When Treger joined Anglo Pacific in October 2013, he inherited a portfolio built largely around coking coal (a royalty on Rio Tinto’s (NYSE: RIO; LSE: RIO) Kestrel coal mine in Queensland), some iron ore and uranium, and bits of copper, gold and silver. His goal was to renew the royalty company’s focus on acquiring royalties on bulk-mined materials such as coal and iron ore used in the steelmaking industry and on base metals like copper, rather than on the more competitive precious metals.

Last June Anglo Pacific picked up a 2% net smelter return royalty (NSR) for US$22 million on all mineral products sold from the Maracas vanadium project in Eastern Brazil. Maracas is owned and operated by Largo Resources (TSXV: LGO; US-OTC: LGORF).

Anglo Pacific holds a core portfolio of royalties over five mines that are in production and five royalties over projects that are in development or early stage development. But as a rule it targets production or near-production stage base metals and bulk materials assets, and Treger says there is a good window of opportunity to jump on royalty opportunities during the downturn in commodities and the mining sector.

“That window continues to be there and I don’t think it’s going to close in the short term,” he says. “It will be difficult times for the mining sector for at least another two years, so that’s the window for us to take advantage of acquisition opportunities.”

“It’s premature to take iron ore royalties because there’s still a lot of supply to come onto the market, but we’ll look at other commodities depending on where we think an appropriate entry point will be. With Narrabri and Kestrel we have two of the lowest-cost and highest-quality coal projects in the world, [but] I don’t think we want to be a specialty coal royalty business, and therefore we will be looking at diversity into other commodities. We continue to like base metals, we continue to like specialized products, precious stones, etc.”

But Treger’s investments always have the same things in common.

“Each situation has to fulfill our rigid return criteria and be a producer at the lower end of the cost curve in a good jurisdiction and have upside optionality. So it’s very, very case specific as to what we do.”

Anglo Pacific has a pipeline of 20 or 30 “situations” that it is “regularly monitoring,” and Treger’s favourite jurisdictions are Australia and North America.

As for the Narrabri royalty deal, “it’s not for everybody,” he concedes. 

“But in retrospect this will be seen hopefully as good timing to get exposure to coal, and we will continue to do other things in the months and years ahead because there is scope for a well-diversified royalty business in terms of commodities and geographies that doesn’t focus on gold and silver.”